California Court of Appeal Weighs in on Unlimited Vacation Policies

Recently, some employers in California have turned to flexible work arrangements and unlimited paid vacation policies as a tool for recruiting and retaining employees. Before April 2020, however, no California court had addressed whether a nonaccrual, unlimited paid time-off policy was subject to Labor Code Section 227.3, thereby requiring an employer to pay out vested vacation time at the time of an employee’s discharge. Although the California Court of Appeal somewhat sidestepped the issue, its recent decision in McPherson v. EF Intercultural Foundation, Inc., No. B290868 (April 1, 2020), highlighted the potential exposure California employers may face when offering “unlimited” vacation policies that are not clearly communicated to employees. This decision is of particular interest to employers with “unlimited” vacation policies that may be facing substantial vacation payouts in light of terminations, layoffs, and furloughs caused by the COVID-19 pandemic.

Background

Although California law does not require employers to provide employees with vacation, when employers do have paid vacation policies, Labor Code Section 227.3 requires employers to pay out an employee’s vested vacation time as wages upon separation of the employee. In McPherson, three former exempt employees of EF Intercultural Foundation, Inc. brought a claim against their former employer, contending that it had failed to pay them accrued but unused vacation wages.

EF had a written vacation policy that applied to some employees; it did not apply, however, to the plaintiffs. The plaintiffs could take time off with pay, but they did not accrue vacation days. They did not use the company’s online system to request time off or track the number of days that they had taken. Rather, before taking time off, the plaintiffs were required to notify their supervisors, who would then then approve or deny the requests. When each of the employees’ employment terminated, EF did not pay them for any accrued vacation wages.

The case proceeded to a bench trial, in which the trial court found, based on the plaintiffs’ testimony, that between the 40 work years in total among them, they were approved to take between 1 and 20 vacation days per year. On the basis of that testimony, the court concluded that since 20 days’ annual vacation was approved on 1 occasion, at least that much vacation was available to the plaintiffs. The trial court based its conclusion on the “law and equity” standard under Section 227.3, which the court found allowed it “‘in the resolution of any dispute with regard to vested vacation time’” to apply the “‘principles of equity and fairness.’” The trial court entered judgment in the total sum of $88,594.65 and awarded the plaintiffs nearly $400,000 in attorneys’ fees. EF appealed the decision.

Court of Appeal: Employees Entitled to Vested Vacation Wages Under Facts of Case

On appeal, EF framed the issue in terms of whether its practice of permitting the plaintiffs to take uncapped time off without accruing vacation complied with California law. After thoroughly examining the case history related to Section 227.3 as well as the unusual facts of this case, the court of appeal held that the unaccrued paid time off that EF had provided to its employees was subject to Section 227.3’s vesting requirements.

EF contended that vacation time did not vest because the plaintiffs did not “labor ‘in exchange for a promise of a specific amount of vacation.’” The California Court of Appeal held, however, that it did not need to decide whether vacation wages are earned under an unlimited policy, as in this case, despite EF’s position to the contrary, it did not offer uncapped vacation time to the plaintiffs, either in policy or in communications. As to EF’s time-off policy, the court of appeal concluded that, in practice, the policy gave the plaintiffs a fixed amount of vacation time but that the vacation time was not an unlimited amount.

Specifically, EF’s practice reflected that, despite its contention that it offered unlimited vacation, it had an implied cap. As to communications from EF regarding the vacation policy, the court of appeal noted there were only “side communications” from supervisors telling the plaintiffs that they could take paid vacation time outside of the busy season but that the vacation did not accrue. EF’s position was problematic in the eyes of the court because it did not expressly communicate—either in writing or verbally—the obligations and entitlements of the unlimited vacation policy.

Accordingly, the court of appeal held that EF had not established that Section 227.3 did not apply to its policy of providing paid vacation time to the plaintiffs.

Significantly, the court of appeal highlighted that just because it concluded that Section 227.3 “applies to EF’s vacation policy,” it did “not hold that Section 227.3 necessarily applies to truly unlimited time off policies.”

The court of appeal specified that a written policy would not trigger Section 227.3 when the following four conditions were present:

1. The policy “clearly provides that the 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 time to take off”
2. The policy “spells out the rights and obligations of both employee and employer and the consequences of failing to schedule time off”
3. The policy “in practice allows sufficient opportunity for employees to take time off, or work fewer hours in lieu of taking time off”
4. The policy “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”

Key Takeaways

This decision demonstrates the value of having a well-constructed written paid vacation policy that clearly expresses the employer’s obligations and the employees’ entitlements. This issue has recently come into sharp focus for myriad employers grappling with the effects of the COVID-19 pandemic, including necessary layoffs and determinations of what vacation wages, if any, employees are entitled to receive at separation. Thus, now is an opportune time for California employers to reexamine their vacation policies in light of the guidance the McPherson court provided.