In a recent California Court of Appeals decision, employers are reminded of the necessity that unlimited paid time off policies be carefully drafted to avoid being required to payout unused vacation time at the end of employment. The court in this case took issue with a seemingly “implied cap” based on how an employer’s informal policy was communicated and administered. Truly unlimited paid time off without accrual does not vest under California Labor Code Section 227.3, and therefore does not require payout when employment ends. This case provides useful insight for employers that have already implemented, or are considering adopting, an unlimited vacation policy.

A Poorly Drafted Unlimited Vacation Policy May Trigger Payout

While there is no legal requirement in California that an employer provide employees with paid or unpaid vacation time, if an employer does have an established policy to provide paid vacation, they are subject to certain restrictions in how the employer executes its obligation to provide it. Under California law, earned vacation time is considered wages, and vacation time is earned, or vests, as labor is performed.

California Labor Code Section 227.3

California Labor Code §227.3 states that “whenever a contract of employment or employer policy provides for paid vacations, and an employee is terminated without having taken off his vested vacation time, all vested vacation shall be paid to him as wages. . .” Therefore, under a traditional policy where the vacation accrues, employers must pay employees for all accrued but unused vacation at the time of termination.

The McPherson Case

In McPherson v. EF Intercultural Found., Inc., the Court held that the company’s purported “unlimited” paid time off policy triggered an obligation to pay wages at the end of employment for vacation not taken by their employees. The court found that in the absence of a well drafted policy and past practice of administration, the employer had an “implied cap” of vacation days based on the number of days that were customarily taken by employees. Therefore, the employer’s policy was not truly unlimited, and the employer owed the plaintiffs in this case for certain accrued unpaid vacation benefits.

The Court Provides Unbinding Guidance to Employers

While the court suggested that true unlimited vacation policies may not trigger Section 227.3, it did not directly address the issue; however, it did set forth the following criteria that may not trigger an obligation to pay wages for unused vacation time when employment ends:

  1. The policy should be in writing;
  2. The policy should clearly provide that employees’ ability to take paid time off is not a form of additional wages for services performed, but perhaps part of the employer’s promise to provide a flexible work schedule – including employees’ ability to decide when and how much to take off;
  3. The policy should spells out the rights and obligations of both employee and employer and the consequences of failing to schedule time off;
  4. The employer’s policy in practice, should allow sufficient opportunity for employees to take time off, or work fewer hours in lieu of taking time off; and
  5. The policy should be 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.

The Court’s guidance provides useful insight in how to review and evaluate current unlimited vacation policies though, employers should keep in mind that the guidance is not binding and Courts of Appeal in other districts or the California Supreme Court may not agree.

California employers are encouraged to revisit their unlimited paid time off policies with counsel to ensure that the policies are tightly drafted.

Additional Resources:

California Labor Code 227.3

McPherson v. EF Intercultural Foundations, Inc.

California Department of Industrial Relations

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Lizet Ramirez – Lizet is a Client Compliance Manager for Sequoia One, where she works with our clients to optimize and streamline benefits compliance. In her free time, Lizet enjoys live music, travel, hiking and spa days.