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CA Court of Appeal Holds Some “Unlimited Vacation” Policies *May* “Vest” and Require Payout Upon Termination

by D. Gregory Valenza | |

“Unlimited vacation” / PTO is a once-popular buzzword from the before time, long since replaced on the buzzword popularity charts by “quarantine,” “social distancing,” “shelter in place,” and other less fun concepts.  We wrote an article about unlimited PTO here.  

Now, the California Court of Appeal has written about unlimited vacation as well.  The Court in McPherson v. EF Intercultural Foundation (here) upheld judgments in favor of EF employees who claimed they were entitled to payout of accrued, unused vacation at the time of their termination.  EF, however, claimed to have an “unlimited vacation” policy.  

As it turns out, one cannot just label any vacation policy “unlimited vacation” and escape accountability under Labor Code section 227.3. That section requires payout of accrued, unused vacation upon termination of employment. 

EF had a written vacation policy in its employee handbook.  It was “traditional” in that it granted specific amounts of vacation pay:

The 2014 handbook contains a vacation policy that provides salaried employees with a fixed amount of vacation days per month based on their length of service.5 Employees could carry over 10 accrued, unused vacation days from one year to the next. If an employee carried over more than 10 accrued vacation days, EF paid the employee 70 to 100 percent of the value of those days.6 Once an employee reached the maximum of yearly accruable vacation plus the 10 carryover days, the employee no longer accrued vacation until he or she used a portion of the accrued time. 

(Ignore that this policy is bad for a number of reasons).  Anyway this policy allegedly did not apply to some of EF’s employees, including “Area Managers” or the “West Coast Manager,” who were the plaintiffs in this case.  According to the Court,

plaintiffs could take time off with pay, but they did not accrue vacation days. Area managers did not use the online system to request time off or to track the number of days they had taken. Instead, they were required to notify their supervisors before taking time off. Taking time off during EHP’s peak season was “strongly discouraged,” but was approved in some circumstances. 

Unfortunately, the EF “unlimited vacation policy” was unwritten and contained no caveats or disclaimers about vesting.  The trial court referred to it as an “undefined” vacation policy, rather than unlimited.  The trial court held that this undefined policy could not be used to escape Labor Code section 227.3, and that the “undefined” amount of vacation due the plaintiffs was simply a problem of proof – how much vacation did the employer and employee really agree to.  The trial court then borrowed from the written “traditional” policy, and deducted an estimate of how much vacation the employees took during their employment. 

On appeal, the Court of Appeal first determined that EF’s “unlimited vacation” policy *was* in fact covered by section 227.3, because it wasn’t in reality an unlimited policy:

we need 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. Not only was EF’s policy not in writing, but the record demonstrates EF never told plaintiffs it had an “unlimited” vacation policy or that their paid time off was not part of their compensation. EF may call its vacation policy “unlimited” or “uncapped,” but substantial evidence supports the trial court’s finding that it was not. 

The Court of Appeal also determined that the policy indeed prescribed limits on vacation and therefore was not really “unlimited.”

EF’s policy in practice was to give plaintiffs some fixed amount of vacation time. … EF expected plaintiffs to take vacation in the range typically available to corporate employees (such as two to six weeks), not an “unlimited” amount—for example, more than would be available under a traditional accrual policy

(emphasis added).  

However, the Court conceded that no employer has to allow employees to take 365 days of vacation a year as part of an unlimited plan.  The Court did say, however, that one sure sign of an “unlimited” vacation plan is the ability to take more vacation than one would be able to under a traditional plan:

By “unlimited,” we do not suggest EF intended to permit area managers to take vacation 365 days a year. After all, the premise behind vacation pay is that it is deferred payment for the employee’s labor. And, as our Supreme Court has acknowledged, section 227.3 “does not purport to limit an employer’s right to control the scheduling of its employees’ vacations.” (Suastez, supra, 31 Cal.3d at p. 778, fn. 7.) But as amici have described them, and the trial court noted, one would expect unlimited time off policies at least to afford employees the ability to take longer or more frequent periods of time off than a traditional accrual policy or allow employees to work fewer hours in lieu of having more vacation days.  

The Court also decided that these additional facts supported the trial court’s conclusion that EF’s plan was not “unlimited” and was really an accrual plan in disguise:

  • workload and actual opportunities to take vacation imposed an “implied cap” 
  • EF never communicated to its employees that there was “unlimited” vacation
    • This is all plaintiffs were told: as area managers they could take paid vacation outside of the busy season, but their vacation did not accrue.20 The only other parameters EF clearly told plaintiffs were (1) they had to notify their supervisor before taking time off and ensure they could complete their work, and (2) they did not need to track their days off in the online system because they did not accrue vacation.  ****no one at EF, for example, told plaintiffs they did not accrue vacation because they—unlike employees subject to the accrual policy—could take as much vacation as they wanted. Although plaintiffs understood they could take time off when their schedule permitted, they testified they did not understand the policy to be “unlimited,” as EF contends it was.

  • A true “unlimited” policy that falls outside the bounds of section 227.3 “must be express and clear.”
  • EF’s policy did not warn employees in advance that if they did not take time off it would be lost to them.   

The Court emphasized that *some* unlimited PTO / vacation plans will not require payout upon termination and do not “vest” benefits:

We by no means hold that all unlimited paid time off policies give rise to an obligation to pay “unused” vacation when an employee leaves. Flexible work arrangements and unlimited paid vacation policies may be of considerable benefit to employees and to the employers who want to recruit and retain those employees. Employees and employers are free to contract for unlimited paid vacation, consistent with the Labor Code and governing case law.

The Court then set out some guidance –  factors that would establish “unlimited vacation” does not create a vested right that is payable upon termination of employment: 

a policy may not trigger section 227.3 where, for example, in writing it

(1) clearly provides 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 time to take off;

(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; and (

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.

Unlimited paid time off under such a policy—depending on the facts of the case—very well may not constitute deferred compensation for past services requiring payment on termination under section 227.3. 

Separately, the Court held that a general release did not apply to claims for unpaid vacation because of Labor Code section 206.5.

Section 206.5 prohibits an employer from requiring an employee to release a claim for wages that are due and unpaid unless it has paid those wages. (§ 206.5, subd. (a).)27 Section 206.5 thus provides an exception to a general release of wage claims—known or unknown. That exception is limited, however. Wages are not considered “due” under the statute if the employer and employee have “a bona fide dispute” as to whether they are owed. (Chindarah v. Pick Up Stix, Inc. (2009) 171 Cal.App.4th 796, 803 (Chindarah).) Section 206.5 therefore does not preclude an employer and employee from “ ‘compromis[ing] a bona fide dispute over wages.’ ” 

At the time one of the plaintiffs signed a general release, she and EF had not engaged in negotiations about vacation pay due, or specified that the consideration in the release was the resolution of a “good faith dispute” about vacation pay.  Therefore, the vacation pay claim survived the general release because vacation pay is a form of wages, subject to section 206.5.

Finally, one of the plaintiffs moved to Virginia, years before her employment ended. She did, however, spend periods of time each year in California.  The Court of Appeal held that California’s vacation law, Labor Code section 227.3, did not apply to true non-residents performing most of their work outside California, and only sometimes working within California. The Court distinguished the California Supreme Court’s decision in Sullivan v. Oracle, which held that California has a strong interest in ensuring its overtime laws apply to non-residents if they perform substantial work in California.  The Court stated that overtime is not the same as vacation, and that Sullivan does not apply to all California wage and hour laws automatically.

The exclusion of a nonresident, temporary worker from section 227.3 does not implicate the same concerns as the exclusion of nonresidents from California’s overtime laws. Although section 227.3 serves the important goal of ensuring California workers do not forfeit vacation wages when their employment ends, it does not protect workers’ and the public’s health and safety or “expand[ ] the job market by giving employers an economic incentive to spread employment throughout the workforce” as do California’s overtime laws. 

To sum up: this case makes it difficult for employers to offer “unlimited vacation” without jumping a number of hurdles.  The Court here provides guidance, but much of it may not be binding because it is considered “dicta.” Certainly the Court is leaving open the possibility that unlimited vacation policies could be upheld without requiring payout at termination. But the Court’s guidance suggests that such policies will be the exception not the rule. 

Employers and their lawyers therefore should review “unlimited vacation” policies to see if they are worth pursuing, and whether they can be drafted to satisfy the Court’s guidance here. 


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