April 8, 2020 California Court of Appeals Sheds Light on Unlimited Vacation Policies

On April 1, 2020, the California Court of Appeal issued a published decision in McPherson v. EF Intercultural Foundation, Inc., addressing for the first time whether an employer’s unlimited vacation policy, which is sometimes called an “honor system” policy, may create an obligation to pay employees for “unused” vacation when their employment ends. The Court of Appeal held that whether an employer must pay for “unused” vacation under this type of policy must be determined on a case-by-case basis. Assessing the employer’s policy at issue in this case, the Court of Appeal held the employer was required to pay its employees for unused vacation at the end of employment.

Background

California law does not require employers to provide employees with paid vacation time. However, if an employer does provide employees with paid vacation time, it must pay out all unused vacation time when an employee is terminated or resigns.

Discussion

The McPherson plaintiffs were full-time, salaried employees working as area managers who claimed their employer, EF Intercultural Foundation, failed to pay them accrued but unused vacation wages in violation of Labor Code section 227.3 (denial of vacation wages).  

Although EF provided a fixed amount of vacation days for certain salaried positions, its area managers were subject to an unwritten policy where they could take paid time off as they and their supervisors deemed appropriate, but they did not earn, accrue or track vacation days. 

In a bench trial, the trial court held that EF’s vacation policy was neither unlimited in practice nor conveyed as unlimited. The Court found that EF provided plaintiffs with paid vacation, but never promised them a specific amount of paid vacation that they would accrue over time nor expressly limited the amount of paid time off they could take. Yet the Court also found that EF impliedly limited the amount of vacation time that its area managers could actually take and therefore ruled that EF owed plaintiffs’ vacation wages under section 227.3. The Court reasoned that because EF failed to clearly and effectively inform plaintiffs they had unlimited paid vacation and instead implicitly limited plaintiffs’ vacation time, EF’s purported “unlimited” vacation policy was no different than an accrual-based vacation policy.

The Court expressly limited its holding to the facts of the case. It did not decide whether a truly unlimited vacation policy would give rise to an obligation to pay “unused” vacation at termination. The court also acknowledged the benefits and appeal of flexible time off and unlimited vacation policies.

Importantly, the Court explained that an unlimited vacation policy would likely not trigger an obligation to pay vacation wages under section 227.3 if the policy is in writing and:

  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 employee’s 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

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 and takes minimal time off, and another works fewer hours and takes more time off.

What This Means

This decision was limited to the facts of this specific case, so its ruling is probably best viewed as cautionary. However, the decision makes clear that not all unlimited vacation or “honor system” vacation policies necessarily eliminate the risk of accrued vacation banks that must be cashed out at termination.  As a result, employers should review and evaluate their vacation policies to confirm that they fit within the Court’s new direction.

AUTHORS
 
Mary Allain Joe Connaughton