California Court Invalidates Employer’s Unlimited Vacation Practice

California Labor Code Section 227.3 requires that employers pay terminated employees wages for any paid vacation time that they have “vested” (accrued but not used). Recent years have seen a growing trend toward “unlimited” or “flexible” vacation policies that theoretically give employees the freedom to take as much paid time off as they want while satisfying job requirements. Employees like the idea of taking vacation if and when it suits them, and employers gravitate to these policies (despite the legal risks) primarily to be relieved of the administrative hardship of tracking earned vacation and the financial burden of accruing and paying out vested vacation at employment termination. Employers and their counsel have long been concerned, however, that employers could be liable for back wages and penalties if de facto usage limits occurred, which would render accrued vacation subject to payout under Section 227.3.

McPherson v. EF Intercultural Found., Inc., 2020 DJDAR 3008 (April 1, 2020), finally gave voice to these long-standing concerns. In McPherson, the employer had a written vacation policy that gave certain of its employees a fixed amount of vacation days. The plaintiffs were former employees who had not been subject to that written policy. Instead they were told that they could take an undefined amount of vacation. Unlike their colleagues subject to the written vacation policy, they did not formally accrue vacation benefits. They were, however, required to notify their supervisors before taking time off and were discouraged from taking time off during the employer’s peak season. They were also expected to take roughly the same amount of time off as their colleagues subject to the written policy. However, they took less vacation than many of these colleagues because of their demanding schedules. The court concluded that the “unlimited” vacation policy applicable to the plaintiffs violated Section 227.3 because it was not unlimited in practice; it had an implied cap.

The court made clear that an employer cannot avoid Section 227.3 by leaving the amount of vacation time undefined in its policy while impliedly limiting the time actually available for approval. Moreover, the employer did not have a written policy or agreement conveying to the plaintiffs that they had unlimited paid vacation. Though it had apparently been discussed in a “side conversation,” it was not express and clear. Nor did the employer warn the plaintiffs in advance that failing to schedule a sufficient amount of time off would mean that they would essentially be leaving money on the table by working more hours for the same pay than those who scheduled more time off. 

While a ruling on the “unlimited vacation” issue has been anticipated for years, the court’s holding is limited in applicability. Indeed, the court expressly limited its holding to the facts of the case, declining to decide as a general matter whether vacation wages are earned under an unlimited vacation policy and whether unlimited time equates to vested vacation. However, the court recognized the benefits and appeal of unlimited and flexible vacation policies and explained that such policies do not trigger Section 227.3 where certain safeguards are in place.

Based on the illustrations provided in McPherson, going forward employers should ensure any “flexible vacation” policy is written, avoids the “unlimited” nomenclature, and, after input of employment law counsel, contains the following features:

• clearly provides that employees’ ability to take vacation is not a form of additional wages for services performed, but part of a flexible work schedule that gives employees the ability to decide when and how much time to take off for vacation;
• spells out the rights and obligations of both employee and employer and the consequences of failing to schedule time off (i.e., the potential for the employee to lose out on additional wages by working more hours for the same pay as those who are subject to accrual-based vacation policies);
• in practice allows sufficient opportunity for employees to take time off, or work fewer hours in lieu of taking time off;
• 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; and
• treats paid sick leave separately so that it is governed by applicable paid sick leave rules.

Employers must be very careful to avoid any practices or policies that might indicate that the unlimited vacation policy is a subterfuge for a de facto system that tracks an employee’s time off or otherwise limits an employee’s ability to take vacation. 

In addition, employers must carefully coordinate any flexible vacation policy with their policies for providing protected leaves of absences to employees such as the Family Medical Leave Act, the California Family Rights Act, the Pregnancy Disability Leave Law, and various federal, state and local paid sick leave ordinances. For example, if state or local paid sick leave is included in the vacation policy, California employers have been instructed that wage statements should denote “unlimited” in the sick leave accrual category required by California Labor Code section 246(i). This designation may conflict with the employer’s written policy describing the program. Employers must also consider how to coordinate any flexible vacation policy with the additional paid sick leave requirements related to COVID-19 under recent federal, state and local laws, including the new Families First Coronavirus Response Act and other COVID-19 Emergency Paid Sick Leave enactments.

Employers with “unlimited” or flexible vacation policies should review their policies in light of McPherson and the other considerations outlined here. A successful challenge to an employer’s unlimited vacation policy can be very expensive and result in liability for unpaid wages plus interest, waiting time penalties, PAGA penalties and liability for attorney fees and costs.