State Appeals Court Clarifies Unlimited Paid Time Off Policies in California

COVID-19-induced challenges and the resulting work-life balance changes have cut into the time I have had available for posts, but I wanted to pass along an important non-coronavirus related court decision from this past month that ties into one of our previous discussions of PTO policies.

We have discussed “unlimited” paid time off policies in the past, and it remains one of the most consistently searched topics on the blog. This past month, a California appeals court added some important color to these policies to employers based or with employees in the state. The decision applies specifically to California, but since the state tends to be a bellwether for other states and because the case provides useful guidance on factors to consider, it bears consideration for any employer, even those without unlimited PTO policies.

California Paid Time Off/Vacation Law

While California has a paid sick leave requirement, the state does not require employers to provide paid (or unpaid) vacation time. However, if like nearly every employer, you do establish a paid vacation/PTO requirement by policy or agreement, even informally, then California Labor Code Section 227.3 (with few exceptions) will require you to pay any “earned and unused vacation” at separation at the employee’s final rate of pay. Why? The California Supreme Court has held that vacation pay is a form of deferred wages that vest as employees earn vacation during their employment. Under this rationale, California prohibits “use it or lose it” PTO policies or practices outright, as do other states like Illinois, Montana, and Nebraska.

McPherson v. EF Intercultural Foundation Inc. and Informal “Unlimited” PTO

EF Intercultural Foundations’s PTO Policy

The place to start, of course, is with the employer’s vacation policy. The Foundation had a handbook with a vacation policy that, for salaried exempt employees, provided a fixed number of vacation days per month based on the employee’s length of service. The Foundation required employees to track their accrued vacation and request approval to take it through an online HRIS platform. Sounds good, and if that was all you needed to know, the case would never have been litigated. As Paul Harvey used to say on the radio, here’s the rest of the story: the Foundation’s policy did not apply to all salaried exempt employees. That should be the first red flag for you!

According to the court, the Foundation’s handbook covered only those salaried exempt employees in its main office and certain operations managers. The plaintiffs were mostly area managers who worked from home and in the field. The evidence showed that they could take PTO, but did not accrue vacation or track the number of PTO days they took. Instead, they notified supervisors before taking PTO. The only apparent restriction was that these employees were “strongly discouraged” from taking PTO during their peak seasons, and generally did not do so.

The area manager plaintiffs sued the Foundation claiming that it had failed to pay them their accrued but unused vacation under this unwritten “unlimited” PTO policy. For its part, the Foundation argued that since the employees did not technically “accrue” any specific vacation, then nothing “vested” under California law.

The Trial Court Decision

The Foundation argued that the plaintiffs had not actually acrrued anything, since the vacation policy applied to those employees was “unlimited.” Applying California Labor Code Section 227.3 and case law, a Los Angeles County Superior Court disagreed, and held that “offering vacation time in an undefined amount simply presents a problem of proof as to what the employer’s policy was.” In other words, regardless of how the Foundation characterized the leave plan and how much vacation the plaintiffs actually could take under the evidence presented, that vacation was indeed vested under California law and subject to the payout requirements of Section 227.3 of the Labor Code.

The Appellate Court Decision

The Foundation, and amici, tried this argument again with the appeals court, arguing that as an analogy to California Supreme Court precedent on certain types of sick leave, Section 227.3’s language referring to “vested vacation time” does not apply to unlimited vacation policies because no vacation time vests “if there is no fixed vacation bank.” In other words, they contended that an unlimited PTO policy could not implicate the payout at termination requirement because an accrued, fixed amount of vacation time is a precondition to the vesting of vacation wages.

The appeals court disagreed, dismissing the analogy because “paid sick leave is conditional [on the reason for leave]; paid vacation is not.” The court ruled that Section 227.3 applied to the Foundation’s unwritten PTO policy for two key reasons in the record:

1. The Foundation’s label for its leave policy was not determinative; its actual practices were.
   The appeals court noted that while the Foundation called its policy toward the plaintiffs “unlimited” or “uncapped,” the reality was that the record supported a different conclusion. The Foundation’s practice was to approve (and expect plaintiffs to take) vacation “in the range typically available to corporate employees,” and not an “unlimited” amount. Furthermore, evidence showed that the Foundation expected the plaintiffs to take vacation based on their schedules and work demands, which resulted in plaintiffs taking less vacation than many other exempt employees who fell under the handbook’s accrued vacation policy. Even if the policy had been “unlimited” as the Foundation contended, the court found that the Foundation’s practices effectively “capped” or precluded the plaintiffs from taking advantage of it.
   
2. The Foundation’s did not communicate its purportedly “unlimited” PTO policy expressly (or even implicitly).
   The court noted that the Foundation never told the plaintiffs that they had unlimited vacation. Instead, “supervisors had a ‘side conversation'” with area managers (or sometimes an e-mail) that conveyed only general parameters (the lack of accruals, the notification requirement, and the lack of a tracking requirement). As the court observed, if the employer “intended to limit plaintiffs’ ability to earn vacation or treat their paid time off as something other than deferred wages, its ‘unlimited’ policy had to be express and clear.”
   
3. The Plaintiffs did not believe they had unlimited PTO.
   The appellate court also highlighted the practical reality of the area managers’ jobs: “[d]uring the peak season plaintiffs worked more than 100 hours a week, seven days a week, up to 18 hours per day.” Obviously, that meant they could never take substantial amounts of vacation at any one time or even across an entire year.

Fortunately, though, the court did not apply these bad facts to scupper all unlimited PTO policies. Fortunately, instead of the tired adage “bad facts make bad law,” bad facts made only for a bad outcome for this defendant. The court recognized the “persuasive hypotheticals” presented by amici and “by no means h[e]ld that all unlimited paid time off policies give rise to an obligation to pay ‘unused’ vacation when an employee leaves.”

Takeaways for Employers

Three things are quite obvious in this case:

1. “Side conversations” and random e-mails are not a way to notify employees of an important policy affecting their terms and conditions of employment.
2. All policies should be clearly and concisely communicated in writing to your employees, even if you elect to have multiple policies for different employee groups.
3. No “unlimited” vacation or PTO policy is truly unlimited, and no employee expects that it would be. Put some parameters around the “unlimited” policy, and when doing so, see #1 and #2.

The California appeals court did not provide any bright line tests for employers, but it did helpfully provide a list of some factors that it thinks courts should consider (it is not necessarily an exhaustive list). Employers considering a written unlimited PTO policy should take a look at our more in-depth discussion on this topic, but also consider the following factors identified in the McPherson opinion:

(1) Does the policy clearly provide 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) Does the policy spell out the rights and obligations of both employee and employer and the consequences of failing to schedule time off;

(3) In practice, does the policy allow sufficient opportunity for employees to take time off, or work fewer hours in lieu of taking time off; and

(4) Does the employer administer the policy 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.

Again, unwritten or informal policies like the Foundation’s in this case create real risk and costs. So do policies that do not match actual practices. Unlimited PTO/vacation policies are an excellent and inexpensive tool to incentivize productivity. When properly crafted, they can create the helpful expectation that employees take vacations, time to spend with their families, and other opportunities to unplug from work. Take care to review the practical impacts of such policies before and after you have implemented them in light of the McPherson factors, even outside of California.