Service charges under fire: Navigating a new wave of hospitality litigation

Service charges were never intended to become one of the hospitality industry's most litigated issues. For decades, hotels, restaurants, caterers and event operators have relied on mandatory service charges--particularly in banquet and group settings--to standardize pricing, offset labor costs and reduce the uncertainty inherent in discretionary tipping. What began as an operational convenience has evolved into a significant source of legal risk.

Today, service charges are at the center of a growing wave of litigation driven by regulators, plaintiffs' attorneys, and increasingly, consumer expectations regarding pricing transparency. The central question is deceptively simple: What is the customer paying for, and who ultimately receives the money? The answer is often less straightforward than operators believe.

Service charge or gratuity?

The distinction between a service charge and a gratuity carries significant legal consequences.

California Labor Code section 351 prohibits employers from collecting or retaining any gratuity that a patron leaves for or gives to an employee. By contrast, a mandatory service charge is not automatically considered a gratuity simply because it appears on a customer's bill.

The analysis instead turns largely on consumer perception. Courts increasingly examine whether a reasonable customer would understand the charge to be compensation intended for service employees. Labels matter, but they are not dispositive. Placement on the bill, surrounding language, marketing materials, customer communications and the overall context may all influence how the charge is characterized.

California's Court of Appeal underscored this principle in O'Grady v. Merchant Exchange Productions, Inc. (2019), holding that a mandatory banquet service charge is not categorically excluded from Labor Code section 351. Rather, whether such a charge constitutes a gratuity depends upon what a reasonable patron would believe under the circumstances.

Federal law has likewise evolved. The 2018 amendments to the Fair Labor Standards Act prohibit employers, including managers and supervisors, from keeping employees' tips, regardless of whether the employer claims a tip credit. Those federal protections do not, however, displace California's more expansive statutory framework and evolving case law governing gratuities and service charges.

Where the risk really lies

Many employers understandably focus on whether their contracts accurately describe service charges. Though in practice, litigation often turns on something broader: consistency.

Service charges appear in banquet agreements, catering proposals, menus, websites, invoices, banquet event orders, confirmation emails and point-of-sale receipts. Plaintiffs' counsel rarely examine these documents in isolation. Instead, they compare them against one another, looking for inconsistencies that suggest customers may have understood a mandatory charge to function as a gratuity.

A carefully drafted contract may offer little protection if a menu, invoice or salesperson characterizes the same charge differently.

A shift toward greater precision

One noticeable trend among hospitality operators is the movement away from broadly labeled "service charges" toward more carefully defined fee structures.

Many businesses now distinguish between administrative fees retained by the establishment and gratuities distributed to eligible service employees. Just as important, they consistently explain the purpose of each charge throughout the customer relationship, from the initial proposal through the final invoice.

The distinction is more than semantic. The more consistently a business identifies what each mandatory charge is intended to cover--and who ultimately receives it--the stronger its position becomes if those practices are later challenged.

Transparency has become a litigation issue

Recent litigation demonstrates that disclosure is no longer viewed as a mere contractual formality.

Customers increasingly expect mandatory charges to be disclosed clearly before making purchasing decisions, and regulators have adopted the same expectation. Although the precise disclosure obligations vary depending upon the applicable statute, the direction is unmistakable: mandatory charges should be described clearly, consistently and before the customer commits to the transaction.

Businesses should also ensure that every customer-facing document describes mandatory charges using uniform terminology. Consistency across contracts, menus, invoices, websites and marketing materials often proves just as important as the language contained in any single agreement.

California continues to shape the landscape

California remains at the forefront of service-charge litigation.

In addition to Labor Code section 351, California's pricing transparency requirements have expanded significantly. Senate Bill 478, commonly known as the Honest Pricing Law, generally prohibits advertising prices that exclude mandatory fees. Senate Bill 1524 created an exemption for restaurants, bars and certain food-service businesses, provided mandatory charges are clearly and conspicuously disclosed to consumers as required by the statute.

For hospitality businesses operating across multiple jurisdictions, California frequently establishes the most demanding compliance standard. Practices that may draw little scrutiny elsewhere can become the subject of class-action litigation here, particularly where customer disclosures vary from one document or platform to another.

The hidden risk: Operational drift

Perhaps the most common source of liability is not intentional misconduct but operational inconsistency.

A single banquet transaction may involve a sales proposal, a negotiated contract, banquet event orders, revised menus, email correspondence, invoices and point-of-sale receipts. Over time, forms are updated, templates diverge and employees develop their own shorthand for explaining mandatory charges.

Those small variations can become significant in litigation.

Equally important is employee training. Sales personnel, event coordinators and managers routinely answer customer questions about mandatory charges. An offhand explanation--such as describing a service charge as "basically the tip"--may later become evidence that undermines carefully drafted contractual language.

Accordingly, effective compliance requires more than well-written documents. It requires standardized forms, consistent terminology and training that ensures employees accurately explain mandatory charges throughout the customer experience.

The bottom line

The legal scrutiny surrounding service charges shows little sign of slowing. As pricing transparency receives greater regulatory attention and plaintiffs continue testing novel theories under wage-and-hour and consumer protection laws, hospitality businesses should expect continued litigation in this area.

Service charges are no longer simply an accounting mechanism. They occupy the intersection of employment law, consumer protection and contract drafting. Businesses that approach them with thoughtful structuring, consistent disclosures and disciplined operational practices will be considerably better positioned to withstand judicial scrutiny than those relying on legacy forms and inconsistent practices.