58 Litigating CA Wage & Hour Class and PAGA Actions (23rd Edition) Seyfarth Shaw LLP | www.seyfarth.com contractual agreement would be a 10 or 15 percent charge added to the cost of a banquet. Such charges are considered as amounts owed by the patron to the establishment and are not gratuities voluntarily left for the employees. Therefore, when an employer distributes all or part of a service charge to its employees, the distribution may be at the discretion of the employer and the service charge, which would be in the nature of a bonus, would be included in the regular rate of pay when calculating overtime payments. However, the O’Grady decision changed this analysis by holding there is no per se rule that service charges categorically are not gratuities for purposes of Labor Code Section 351. The service charge at issue in O’Grady was an automatic 21 percent “service charge” levied on every food and beverage banquet bill. “According to plaintiff, part of the monies collected as service charges are kept by defendant, with the rest distributed by defendant to ‘managers and other non-service employees.’” Plaintiff alleged that the service charge constituted a gratuity, but defendant “failed to distribute the total proceeds of [these] gratuities to non-managerial banquet service employees” as required by California law, and thus defendant's practice ‘violates’ section 351.” The O’Grady trial court granted the defendants’ demurrer, citing Searle and Garcia, holding that service charges are the employer’s property, which they are free to retain or distribute. On appeal, the appellate court reversed, discussing Searle and Garcia, finding that neither decision should be read to establish a categorical rule that service charges are not gratuities. The O’Grady appellate court noted that the definition of “service charge” as opposed to tip or gratuity was not clearly defined, and seemed to be simply an affixed label: “Both Searle and Garcia, and this dispute, demonstrate that it all may come down to what label is used and who gets to do the labelling. In Searle, it was the employer who made the “service charge” into a gratuity. In Garcia, it was the city council that relabeled the hotels' “service charges” as gratuities and, like sections 350 and 351, mandated that they go only to employees performing the service, not management.” The O’Grady appellate court also felt that the employer’s retention of the service charge distinguished Searle and Garcia: “Neither Searle nor Garcia involved what we have here—an employee who alleges that what the ballroom customer meant for employees to have is being kept by the employer. Notwithstanding some of language found in the Searle and Garcia opinions, in neither case did the court take money from the employees. We do not believe the Searle court, or the Garcia court, or the Legislature, would accept or approve the proposition that an employer should have the unfettered freedom of definition if it might result in depriving employees of sums that otherwise might qualify as gratuities.” Since the O’Grady decision, numerous class action lawsuits have been filed against companies contending that service charges are in fact unlawfully withheld tips under Labor Code Section 351.287 In a recent decision, a court held that “After the decision in O'Grady, under California law, a mandatory service charge can indeed be considered a gratuity entitled to protection if a reasonable customer would believe the charge was a gratuity intended for the benefit of banquet servers. Where factual issues exist as to whether an objectively reasonable customer could understand the service charge assessed to be a gratuity, summary judgment is not an appropriate outcome.”288 Courts have recently held that “In assessing whether a service charge is considered a gratuity by a reasonable customer in the industry, the Court may consider several factors. In particular, the Court may look at various pieces of evidence of the surrounding context, including: (1) any written contracts between the parties; (2) the 287 See Gonzalez v. San Francisco Hilton, Inc. 2023 U.S. Dist. LEXIS 138072 (N.D. Cal. August 23, 2023) (employer summary judgment denied on certified class regarding withholding of portion of service charges based on allegation that service charges were tips under 351. Holding “In order for Defendant to prevail on its motion for summary judgment, there must be no reasonable confusion regarding the understanding of the term "service charge" as designated in the contracts with event providers.”) 288 Id. at *10.
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