California court finds employer liable under unlimited vacation policy

Recently, in McPherson v. EF Intercultural Foundation, Inc., the California Court of Appeals addressed the legality of unlimited or uncapped vacation policies under California law. Three exempt employees sued the company for payment of unused vacation time at termination, despite being subject to an unlimited paid time off policy, because they argued the policy was neither unlimited in policy nor practice. The court agreed. Fortunately for California employers, the decision sets forth guidelines for employers to properly implement such policies and avoid liability.

While California's labor laws are among the nation's most employee-friendly, employers in the state do have some flexibility when it comes to paid vacation, or paid time off, policies. First and foremost, employers are not required to provide paid vacation. Second, if an employer provides paid vacation, it may restrict new employees from accruing vacation time during a probationary period at the beginning of employment (which can last up to 12 months), and may limit the amount of vacation time which can accrue.¹ Once paid vacation time is offered, however, California law treats vacation pay as deferred wages, which vests as work is performed.

Employers must comply with Labor Code section 227.3, which requires:

1. Any limit on an employee's entitlement to paid time off must be expressed in a clear, written policy.
2. At termination, an employer must pay out any vested vacation time an employee has not used.²

California law prohibits "use it or lose it" vacation policies.

In McPherson, the majority of the company's salaried employees were subject to a standard vacation policy under which employees would accrue a fixed amount of vacation time per month, complete with carry-over and pay-out provisions for unused time. This policy did not apply to the plaintiffs in this case, however. Instead, plaintiffs' paid vacation policy was informal—expressed verbally or in an email—and allowed plaintiffs to take time off with pay while not accruing vacation days. Plaintiffs were required only to notify supervisors before taking time off, and taking time off during peak season was strongly discouraged. The company claimed this policy was, in fact, an "unlimited" paid vacation policy. The court disagreed. The policy was not unlimited, but rather was undefined, and therefore ran afoul of Section 227.3.

Two key considerations led to the court's finding that the company's paid vacation policy was not actually unlimited: policy and practice. First, the lack of a clear, written policy outlining the parameters of plaintiffs' available paid vacation time caused confusion. Plaintiffs were not informed of their rights or the company's obligations with respect to the use of paid vacation. They were not told, for example, that they did not accrue vacation because, unlike other employees, they could take as much vacation as they wanted; nor were they warned that they would essentially leave money on the table by not taking time off. Although plaintiffs understood they could take time off, schedules permitting, they did not understand the policy to be "unlimited."

Second, the company's policy was not unlimited in practice, because the company actually gave plaintiffs some fixed amount of vacation time—in the range of two to six weeks as was typically available to other exempt employees—not an unlimited amount (i.e., more than would be available to employees under the accrual policy). Plaintiffs collectively worked for almost 40 years, taking an average of two weeks of vacation each year, in part because their schedules precluded them from taking advantage of an unlimited vacation policy. The court held that an employer cannot avoid Section 227.3 by leaving the amount of vacation time undefined in its policy while impliedly limiting the amount of time actually available for approval.

Fortunately, the court's holding was based in large part "on the particular, unusual facts of this case." In other words, it does not preclude the use of unlimited paid time off policies, which can be both beneficial and appealing to employees and employers alike. The court explained that such a policy can avoid triggering liability under Section 227.3 if the policy:

1. Provides, in writing, that an employee's ability to take paid time off is not a form of additional compensation for work performed, but perhaps part of the employer's promise to provide a flexible work schedule.
2. Clearly defines the rights and obligations of both employee and employer and the consequences of failing to schedule time off.
3. In practice allows sufficient opportunity for employees to take time off.
4. Is administered fairly so that it neither becomes a de facto "use it or lose it policy" nor results in inequities, such as where one employee works many hours, taking minimal time off, and another works fewer hours and takes more time off.

Strictly adhering to these guidelines is crucial to any employer administering "unlimited" paid vacation policies, as the liability risk can be substantial. The court in McPherson awarded the plaintiffs compensation for 20 days of vacation per year, essentially the maximum amount of vacation time possible for any of the company's exempt employees and likely far more than the plaintiffs would have received under an accrual policy. Further, employers found in violation of Section 227.3 are also liable for the compounding penalties imposed for violations of Labor Code Sections 201 and 203 (for unpaid wages at termination and waiting time penalties). Should a class of similarly situated employees succeed on such a claim, the damages could be astronomical.