Appellate ruling addresses legality of unlimited vacation policies

In the first published appellate court decision on the issue, the California Court of Appeal laid out a path for enforceable unlimited vacation policies in California in a recent decision. Unlimited vacation policies operate how one might expect: instead of having a specific number of hours vest that the employee can use to take paid time off, an unlimited policy provides that the employee can take as much vacation per year as they would like to subject to company approval.

Unlimited vacation policies have gained some popularity and are increasingly being considered and implemented by California employers for many reasons. For example, in California, when vacation vests, it is treated as wages at termination and must be paid out pursuant to Labor Code Section 227.3. However, since under a properly created unlimited vacation policy the vacation does not vest or accrue, there would be no payment due at termination.

In McPherson v. EF International Foundation, Inc., 2020 DJDAR 3008 (Cal. App. 2nd Dist., April 1, 2020), the company had a written vacation policy that provided salaried employees with a set amount of vacation time based on their length of service, and vacation time carried over up to a certain cap. This policy did not apply to the plaintiffs, who worked as exempt area managers for one of EF's divisions. Instead, plaintiffs were subject to an unwritten policy that allowed them to take as much time off as they wanted so long as they notified their supervisors. They were discouraged from taking vacation during peak season. Since the policy was unlimited, plaintiffs did not accrue vacation time.

When their employment terminated, none of the plaintiffs were paid out accrued, unused vacation time. Plaintiffs brought a lawsuit against EF alleging that the company failed to pay them their accrued but unused vacation wages at the time of termination, among other wage and hour claims. Specifically, plaintiffs alleged that the unwritten policy of providing unlimited vacation constituted a "de facto 'use it or lose it' policy." EF's position was that it had a proper unlimited vacation policy such that no vacation vested and no payment was due at termination.

The trial court determined that plaintiffs were owed accrued, unused vacation under because the vacation policy was "undefined," not "unlimited." In other words, although in theory the plaintiffs could take as much time off each year as they wanted, that is not how it worked out in practice. Instead, it appeared that there was an acceptable range of time that plaintiffs could take. The trial court determined that "vacation time vests under a policy where vacation time is provided, even if the precise amount is not expressly defined by the employer in its statements to employees." The trial court determined that 20 hours of vacation vested to each plaintiff annually based on the evidence presented at trial.

The Court of Appeal determined that the specific facts surrounding the employer's unlimited vacation policy rendered it invalid for similar reasons that the trial court did. The employer did not have a written policy stating that vacation time was unlimited, nor did it tell the employees that their vacation time was unlimited and would not be treated as wages. Additionally, testimony showed that the company expected the employees to take vacation in a fixed range (i.e., two to four weeks). As such, the court reasoned that the trial court correctly determined that the employees were owed vacation wages when their employment ended. But notably, the court limited its decision to the specific facts before it.

The most important aspect of the decision for employers, though, is unbinding dicta. In the unpublished portion of the decision, the court lays out the steps that employers should take to ensure that their vacation policy is truly unlimited and does not require employers to pay out vested time at the end of employment:

• The policy must clearly provide that the employees' ability to take paid time off is not a form of additional wages for services performed;

• The rights and obligations of the employee and employer must be clearly outlined, including consequences for failing to take time off;

• The policy must allow sufficient opportunity in practice for the employees to take time off or work fewer hours in lieu of taking time off; and

• It must be administered fairly so that it does not become a de facto "use it or lose it" policy or result in inequities, such as when one employee works many hours, takes minimal time off, while another employee works fewer hours and takes more time off.

This case provides a great opportunity for companies to evaluate their unlimited vacation policies. Although employers should keep in mind that this guidance is unbinding, and courts of appeal in other districts or the California Supreme Court may not agree with this approach, employers should take note of the court's guidance if they maintain an unlimited vacation policy and reach out to legal counsel to discuss the implications of the same. 