What counts as paid “vacation” that vests as it is earned and cannot be forfeited under California law? The distinction between leave that is and is not deemed vacation is significant. The law generally requires payment of unpaid wages, including unused, earned vacation pay, on the employee’s termination date. Untimely payment of wages can result in significant “waiting time” penalties under Labor Code Section 203.

The 6th District Court of Appeal in Paton v. Advanced Micro Devices (AMD), 2011 DJDAR 11831 (6th Dist Aug. 5, 2011), considered whether a paid “sabbatical” is a form of vacation. Along the way, the court defined the term “vacation.” The court’s definition may affect the circumstances under which employer-provided paid leave, like vacation, may not be taken away once it is given.

As background, Labor Code Section 227.3 requires employers to pay all vested vacation as wages at the employee’s final rate upon termination of employment. Section 227.3 also prohibits “forfeiture of vested vacation time upon termination.” The California Supreme Court held in Suastez v. Plastic Dress-Up Co., 31 Cal. 3d 774 (1982), that vacation “vests” as an employee performs services. There, the court held the employer’s policy, providing that vacation was not earned until an employee’s anniversary date, was illegal.

Suastez and the Labor Code make clear that employers must pay out unused, earned vacation upon separation from employment, and that vacation is earned as each day of service passes. But employers grant a variety of paid time off benefits to employees, such as holiday pay, sick leave, personal days, floating holidays, and “PTO.”

Which of these are equivalent to “vacation,” triggering Section 227.3?

The courts and the state Division of Labor Standards Enforcement have analyzed a variety of employer time-off benefits to determine whether they are deemed vacation under Section 227.3. Several principles have emerged, including the following: First, the employer does not have to offer paid vacation at all. The employer also may decline awarding any vacation to employees until they complete a certain length of service, e.g., after completion of an introductory period. The employer can set the vacation pay rate, which need not be the same as the pay rate for active work. And the employer may control the timing and amount of vacation that an employee is permitted to take.

Second, once the employer grants vacation, it cannot take it away via a “use it or lose it” policy. Third, the employer may (up to a point) limit how much vacation an employee may earn before using it, under what is known as a “cap” on accrual. Fourth, paid days off that depend upon the occurrence of a condition (like holidays and sick days) do not “vest” under the law. However, paid days off that are not tied to a given event (such as “floating” holidays and personal days) more likely are deemed vacation.

In the Paton case, the court considered Eric Paton’s claim that Advanced Micro Devices paid sabbatical leave program was just another form of vacation pay granted to long-term employees. The policy afforded salaried employees with seven or more years of service an eight-week, paid “sabbatical.” The employer intended the program to “encourage continued employment with [AMD] by providing time away from work for enrichment and revitalization.” Of note, AMD had a separate “vacation” policy.

Paton resigned from AMD before using the sabbatical for which he was eligible. The policy provided unused sabbatical leave would be forfeited if employment terminated before the employee used it. Paton sued on behalf of himself and a class of about 1400 others, claiming that the sabbatical leave was a form of vacation that was earned over time and could not be forfeited if not used before the end of employment.

After certifying the class, the trial court granted the employer’s motion for summary judgment, holding the sabbatical was not the same as vacation. The Court of Appeal reversed.

The appellate court first confronted the question: what is a vacation? After considering Section 227.3, Suastez, and other authorities, the court synthesized the following definition: “It is paid time off that accrues in proportion to the length of the employee’s service, is not conditioned upon the occurrence of any event or condition, and usually does not impose conditions upon the employee’s use of the time away from work.” Employment lawyers familiar with wage-hour law likely will not be surprised by this definition.

The court then analyzed how a “sabbatical” could escape the definition of “vacation.” A true sabbatical, unlike vacation, is “conditioned” on use for a particular purpose, and it also is an incentive to retain long-term, qualified employees. As the court noted, if an employer grants a sabbatical conditioned on the employee’s participating in an activity away from work, such as charitable endeavors, writing a manuscript, etc., the leave would not be vacation.

The court considered the more difficult issue of how to analyze sabbaticals that do not specify the employee’s activities during the leave. The trial court relied on the state Division of Labor Standards Enforcement’s test for when sabbatical leave would not be considered vacation. In the years following Suastez, the Division issued opinion letters explaining that a bona fide sabbatical would not be considered vacation if it is (1) longer than typically granted for vacation (2) in addition to normal vacation awarded to employees (3) granted only to high-level managers and professionals and (4) granted infrequently (such as every seven years).

The Court of Appeal modified this formulation. In addition to the state Division’s test, a bona fide sabbatical must include provisions showing the employer expects the employee to return and perform services upon the sabbatical’s conclusion. The court also decided that a sabbatical need not be limited to upper-level employees. “The fundamental question,” the court noted, “is whether the leave is compensation earned over the course of the employment, the enjoyment of which is deferred, or whether the leave is intended to retain the most experienced or valued employees and to enhance their future service to the employer.”

Applying this test to AMD’s program, the court reversed the summary judgment. The court noted that there was no evidence of the industry’s “normal” vacation benefit for longer-term employees, and insufficient evidence of AMD’s purpose for offering the sabbatical. In addition, the program did not impose conditions upon earning the sabbatical.

Paton provides employers with a concise and clear definition of “vacation,” which will help employers and their lawyers draft effective paid leave policies. It also remains possible for employers to offer paid sabbaticals over and above vacation time, without incurring unanticipated liabilities.