California Court of Appeal Issues First Opinion Addressing ‘Unlimited’ Paid Vacation Policies

April 02, 2020

The court held in an April 1 ruling that an employer’s purported nonaccrual, “unlimited” paid vacation policy violated California Law, but left many questions unsettled. Employers with “unlimited” vacation policies should promptly review their policies to ensure compliance, and should also assess how their policies interact with other types of leave, such as those granted by Congress recently in response to the coronavirus (COVID-19) crisis.

“Unlimited,” “flexible time away,” “out of office,” “no vacation,” and other “nonaccrual” paid vacation policies have become increasingly popular among employers and employees alike. Under an “unlimited” vacation policy, employees are free to take time off with pay, but do not gradually accrue vacation time as they would if the employer maintained a traditional vacation policy. Without case law addressing whether nonaccrual, unlimited paid vacation policies are lawful in California, these types of policies have long raised a number of potential legal issues for employers.

In McPherson v. EF Intercultural Foundation Inc., a California Court of Appeal has now addressed this issue for the first time, holding that an employer’s purported nonaccrual, “unlimited” paid vacation policy violated California Law. However, the opinion leaves many questions unsettled because the Court of Appeal limited its holding based on “the particular facts of this case.”

California Labor Code Section 227.3

Presently, there are no federal or California laws requiring employers to provide employees with vacation time. Vacation benefits are treated as a matter of contract between employers and employees. However, if an employer does decide to implement a vacation policy, the manner in which the employer discharges its obligation is governed by California Labor Code Section 227.3.

Section 227.3 prohibits any “use it or lose it” policy or agreement that would require an employee to forfeit earned vacation wages and requires that all vested vacation be paid to employees at their final rate of pay upon termination. Prior to McPherson, no court had specifically interpreted Section 227.3 in the context of unlimited vacation. However, the McPherson court relied on a number of prior decisions interpreting Section 227.3 to make its decision.

Most importantly, the court focused on Suastez v. Plastic Dress-Up Co., 31 Cal. 3d 774, 779 (1982), in which the California Supreme Court addressed the requirements of Section 227.3 and held that paid vacation is a form of deferred compensation. Suastez also held that a proportionate right to paid vacation vests as the employee renders services to the employer. Notably, the Labor Commissioner has also interpreted Suastez to provide for the daily vesting of vacation time.

The line of cases previously interpreting Section 227.3 demonstrate that courts will scrutinize employers’ vacation policies to determine whether they are subterfuges designed to undermine the purpose of Section 227.3; which is what the Court of Appeal did here.

The McPherson Decision

In line with the above, the lower court in McPherson found that “vacation time vests under a policy where vacation time is provided, even if the precise amount is not expressly defined by the employer in statements to their employees.” Here the employer’s “unlimited” vacation policy provided the plaintiff employees with paid vacation, but did not expressly limit or define the amount of time they were entitled to take. Rather, the employees submitted requests to their supervisors, who approved the requests on an ad hoc basis. The employer maintained that under its policy employees could take paid vacation without accruing vested vacation time.

The lower court rejected the term “unlimited vacation” with respect to this employer’s policy and instead used the term “undefined vacation,” reasoning that “offering vacation time in an undefined amount simply presents a problem of proof” as to how much vacation time employees could actually take and how much paid vacation accrues under a vacation policy. After determining that it was understood that employees could take approximately 20 days of paid vacation annually, but would not be able to take several months of paid vacation, the court held that the employees were entitled to up to 20 days of vested vacation time per year of employment.

The Court of Appeal largely affirmed the lower court’s decision “based on the particular facts of this case,” but the applicability of the holding is limited because the court did “not decide whether vacation wages are earned under an unlimited policy—whether ‘uncapped time off equate[s] to vested vacation’’—as that is not the policy here.” The policy at issue was not in writing and the employer apparently never told plaintiffs that it had an “unlimited” vacation policy or that their paid time off was not part of their compensation.

The Court of Appeal indicated that “truly unlimited time off policies” might not violate Section 227.3 provided such policies are presented in a writing that satisfies all of the following requirements:

  1. Clearly provides that employees’ ability to take paid time off is not a form of additional wages for services performed
  2. Spells out 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, or work fewer hours in lieu of taking 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

While the Court of Appeal’s analysis and apparent approval of such a policy is dicta, it is important that Companies clearly consider how to fairly administer such policies in order to meet the elements of the test.

DLSE’s Enforcement of Section 227.3

It should also be noted that, in a series of opinion letters, the state Division of Labor Standards Enforcement (DLSE) has indicated that it will treat paid leave provided without condition as vacation time for the purposes of Section 227.3 in order to defeat employer subterfuges intended solely to avoid Section 227.3 or the holding in Suastez.

Carefully Drafted Policies May Pass Additional Scrutiny

Although not entirely without risk, employer policies that meet the criteria outlined by the court may pass the scrutiny of the California courts and the DLSE. Employers should, however, consult with counsel regarding numerous issues including issues related to coverage of nonexempt employees, the nature of the time as time off with pay or merely connected time away from the office, interaction with statutory leaves, and other issues that may impact a court’s analysis of the fairness of the policy.

Implications of McPherson in a Time of Pandemic

In response to the COVID-19 pandemic, Congress recently enacted the Families First Coronavirus Response Act (FFCRA) to provide employees with different kinds of paid and unpaid leave. Other jurisdictions continue to enact statutes and local ordinances to provide employees, including those working for larger employees and not covered by the FFCRA, with additional leave benefits during the emergency.

Because some of these statutes and ordinances allow employees to substitute paid vacation or personal leave for the unpaid leave otherwise available, even employers with “truly unlimited time off policies” under McPherson should carefully review the specific terms of their vacation policies and evaluate the possible interactions of these policies with other types of leave.

Action Item for Employers

Employers with “unlimited” vacation policies should promptly review their policies to determine if they are in compliance with Section 227.3 and McPherson, to ensure that their policies are not at risk of being considered to be “uncapped time off [that] equate[s] to ‘vested vacation’.”

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If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

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John S. Battenfeld
Max Fischer
Douglas R. Hart
Kathryn McGuigan
Jennifer Zargarof

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Carrie A. Gonell
Daryl S. Landy
Barbara J. Miller

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Eric Meckley

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