California law does not require employers to provide paid vacation. But if a California employer does choose to give paid vacation time, state legal requirements apply regarding accrual and compensation. For example, vacation may not be on a “use it or lose it” basis, and all vested but unused vacation is considered earned compensation that must be paid to the employee when their employment ends. Cal. Labor Code section 227.3. These rules apply to any unrestricted paid time off (PTO), including floating holidays and PTO plans that combine vacation and sick time into a single policy.

To avoid these restrictions and increase employee flexibility, many California employers have implemented what are colloquially referred to as “unlimited” vacation plans. In such plans, employees receive vacation time that does not accrue and is not subject to specified limits. Instead, an employee’s use of vacation is conditioned on management approval and business- or performance-related factors (for example, not interfering with business operations, completion of job duties, etc.). However, a recent decision from a California Court of Appeal, McPherson v. EF Intercultural Foundation, Inc. (April 1, 2020), calls into question the legal and practical viability of these “unlimited” vacation plans.

In McPherson, the court addressed whether vacation “vests” (in which case it must be paid at termination under Cal. Labor Code section 227.3) under a policy that permits employees to take an unspecified amount of paid time off or, alternatively, whether section 227.3 applies only to policies that provide a fixed amount of vacation that accrues over time. The court concluded, based on the specific facts in McPherson, that section 227.3 applied to the employer’s purportedly “unlimited” vacation policy.

Although the court eschewed creation of a blanket rule on unlimited vacation plans in general, its analysis raises serious questions regarding the structure of many existing unlimited plans.

The McPherson employer’s policy and practice

In McPherson, the employer had a written, accrual-based vacation policy for some employees, but no such policy for the plaintiffs in the case. Nor did it otherwise convey to plaintiffs that their vacation was unlimited. Rather, the plaintiffs were told that they could take vacation outside of the “busy season.” They had to notify their supervisor before taking time off and ensure that they could complete their work, and they did not need to track days off because they did not accrue vacation.

Generally, the plaintiffs took an average of two weeks of paid vacation each year, but never sought or received more than four weeks. Plaintiffs often took less vacation and received fewer benefits than other employees who were subject to the employer’s accrual-based vacation plan.

Additionally, the record indicated that the plaintiffs’ work “precluded them from taking advantage of [the employer’s] purported unlimited time off policy.” For example, there was “no evidence plaintiffs’ schedule permitted – or [the employer] would have approved – 10 or 15 weeks off (or even three or four weeks at a time), significantly reduced hours during the off-peak season, or months of vacation spread throughout the off-peak season.”

Section 227.3 applied to the employer’s vacation plan

 In evaluating the employer’s vacation plan, the court noted that “[n]o California authority has addressed whether a nonaccrual, unlimited paid time off policy is subject to section 227.3.” Nevertheless, it declined to address whether vacation is earned and vested under an unlimited plan because it concluded that based on the above facts, the employer’s policy was not “unlimited.” Rather, there was an “implied limit,” as the employer “expected plaintiffs to take vacation in the range typically available to corporate employees…, not an ‘unlimited’ amount…[or] more than would be available under a traditional accrual policy….”

The court reasoned 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.” It rejected the employer’s argument that an “accrued, fixed amount of vacation time is a precondition to the vesting of vacation wages.”

Moreover, the court noted that for a policy to avoid the application of section 227.3, the terms and limitations on vacation must, at the very least, be “in a clear, written policy from the get-go.” In this case, the policy was not in writing, and the employer “did not warn plaintiffs of the consequences of failing to schedule a sufficient amount of time off, e.g., that they essentially would leave money on the table by working more hours for the same pay than those who scheduled more time off.”

Because section 227.3 applied to the employer’s policy, the plaintiffs had vested vacation and were entitled to payment for any unused benefits at separation. The amount of vacation the plaintiffs accrued annually was undefined. However, based on the testimony, the court affirmed the trial court’s conclusion that employees accrued 20 days of vacation each year.

What does this mean for “unlimited” vacation policies in California?

The court stated that it was not holding that section 227.3 necessarily applies to truly unlimited vacation policies. Indeed, it identified the following features of an “unlimited” vacation policy that may not implicate section 227.3:

  1. A written policy;
  2. That clearly provides that employees’ vacation is not a form of additional wages, but is instead an employer policy for a flexible work schedule
  3. That allows employees sufficient opportunity to take time off, or to work fewer hours in lieu of taking time off; and
  4. That spells out the rights and obligations of the employee and employer and the consequences of failing to schedule time off;
  5. That is fairly administered to ensure that the unlimited vacation plan does not become a de facto “use it or lose it” policy nor result in inequities, such as where one employee works many hours, taking minimal time off, and another works fewer hours and takes more time off.

While these directives are useful, they are dicta and unfortunately lack the requisite specificity for employers seeking to safely craft or modify existing unlimited vacation plans in light of McPherson.

The potential liability for mistakenly classifying a vacation plan as “unlimited” can be substantial. Multiple courts have held that the statute of limitations on a claim for unpaid vacation does not begin to run until the plaintiff’s employment is terminated without payment for their unused time. See, for example, Church v. Jamison, 143 Cal. App. 4th 1568 (2006). Thus, long-term employees who were subject to a putatively unlimited vacation plan could have years or even decades of accrued time that should be paid at termination and that could be the subject of litigation, all within the statute of limitations.

Employers with “unlimited” vacation plans should work with counsel to closely review their policies and practices to ensure that employees who are subject to these plans do not accrue time off that the employer must pay at separation. And, due to the ambiguity in the court’s decision, employers seeking legal certainty should consider implementing accrual-based rather than unlimited vacation plans.