Unclear Does Not Equal Unlimited: How Employers Can Avoid Uncertainty about Their Vacation Pay Obligations to California Employees


I. Introduction: An Employer Cannot Escape Its Obligation to Pay Accrued Unused Vacation Pay by Having an Unclear Policy; Steps to Comply

In McPherson v. EF Intercultural Foundation, Inc. (Apr. 1, 2020) 2020 WL 1543339, the California Court of Appeal settled two issues of first impression:

(1) an employer’s paid-time-off (PTO) policy that is unclear about how much vacation may be taken but does not state that it is unlimited is not an unlimited PTO policy under which PTO pay does not accrue; therefore, section 227.3 of the California Labor Code obligates an employer with such a policy to pay all accrued and unused PTO pursuant to that policy upon an employee’s termination; and

(2) section 227.3 does not apply to a non-resident employee who works in California for a limited period of time for a non-California employer.

According to the McPherson Court, an ambiguous PTO policy does not preclude recovery by a terminated employee of accrued PTO, but rather raises issues of proof of the amount accrued and unused, and therefore owed to the terminated employee. In dicta, the Court also strongly suggested that an employer with a clearly written policy providing unlimited PTO not as a form of deferred compensation but more in the nature of, or as part of, a flextime policy, would not be subject to the requirement under section 227.3 to pay accrued PTO upon termination of employment.

[Note: I use the terms “vacation” and “PTO” interchangeably throughout this post.]

How Employers Should Respond: In light of McPherson, employers with California employees should review their PTO policies to make sure they bear the following attributes:

  1. Unless an employer has a clear, written policy offering unlimited PTO to employees that is not a form of compensation, (a) the employer’s PTO policy should clearly state how and in what amount PTO accrues, and (b) the employer should carefully record how much accrued PTO has been used by employees.
  2. Where an employer wants to offer unlimited PTO to employees and avoid the obligation of paying accrued PTO upon an employee’s termination under section 227.3, the employer’s policy and practices should comply with the following:

(a) The policy should be in writing and include the following: (i) a clear statement that employees’ ability to take PTO is not a form of additional wages for services performed, but rather part of other employment policies, like a flexible work schedule that includes employees’ ability to decide when and how much time to take off; and (ii) clear provisions that spell out the rights and obligations of both employee and employer and the consequences of failing to schedule time off;

(b) The employer’s practices should (i) allow sufficient opportunity for employees to take time off, or work fewer hours in lieu of taking time off; and (ii) be administered fairly so that the unlimited PTO policy 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.

II. The Employer’s PTO Policy in McPherson and the Requirement to Pay Accrued and Unused PTO to Terminated Employees as a Result

A. EF Intercultural Foundation’s PTO Policy

In McPherson, the employer, EF Intercultural Foundation, Inc. had a vacation policy in its employee handbook that applied to some exempt employees but not to the plaintiffs, who were “area managers” and classified as exempt. EF provided other salaried employees with a fixed amount of vacation days per month based on length of service. It allowed those employees to carry over from year to year up to 10 accrued unused vacation days and paid employees for the value of the accrued unused vacation days that exceeded the 10-day carryover limit. The policy also put a stop to vacation accrual when an employee reached the annual maximum number of annual vacation days plus 10 carryover days.

EF contended that its PTO policy for area managers allowed for unlimited vacation time, but the evidence did not support that contention. The policy applicable to area managers was unwritten and informally communicated to them. EF “never told plaintiffs it had an ‘unlimited vacation policy or that their paid time off was not part of their compensation.” EF supervisors informally told new area managers that “they could take paid vacation outside the busy season, but their vacation did not accrue,” and that (1) they had to notify their supervisor before taking vacation and ensure they could complete their work, and (2) that they were not required to track their vacation in the system used by other employees. Supervisors did not tell area managers that they could take as much vacation as they wanted.

EF’s practices clearly contemplated limits on the vacation its employees could take. In practice, EF’s policy was “to give plaintiffs some fixed amount of vacation time,” in a range “typically available to corporate employees” – two to six weeks. On average, the plaintiff had taken only about two weeks of vacation a year annually. They certainly did not “reap[] the benefits that . . . unlimited time off policies provide to employees.”

EF described its vacation policy applicable to area managers as unaccrued paid time off. But the Court determined, based on the evidence, that the number of days permitted was not unlimited and that, under California law, vacation days did accrue.

B. Under an Ambiguous PTO Policy that, in Practice, Limits the Amount that Can Be Taken, Days of PTO Do Accrue, and Section 227.3 of the Labor Code Requires Payment for Unused PTO upon Termination.

The appellate court concluded that the trial court correctly held the employer liable for the area managers’ vacation pay under section 227.3 of the California Labor Code. Section 227.3 provides that, except as provided by a collective bargaining agreement, where an employment agreement or policy “provides for paid vacations, and an employee is terminated without having taken off his vested vacation time, all vested vacation shall be paid to him as wages at his final rate in accordance with” the agreement or policy “respecting eligibility or time served . . . .” Section 227.3 prohibits an employer that offers paid vacation from providing “for forfeiture of vested vacation time upon termination.”

In Suastez v. Plastic Dress-Up Co. (1982) 31 Cal.3d 774, 784, the California Supreme Court had characterized the right to paid vacation under an employer’s policy or an employment agreement as “deferred wages for services rendered,” and concluded, therefore, that “a proportionate right to a paid vacation ‘vests’ as the labor is rendered.” Section 227.3 protects that vested right from forfeiture and requires payment of an employee’s pro rata share of his vacation pay upon termination of employment.

Thus, the Suastez Court explained, even where, under an employer’s policy employees did not become eligible to take a paid vacation until they had been employed for a year, an employee whose employment terminated before the anniversary of his start date was entitled to his pro rata share of accrued vacation at termination. Vacation pay under that policy was akin to deferred compensation (like pension or retirement benefits), which vested upon acceptance of employment, notwithstanding that the right to immediate payment did not mature until a subsequent condition occurred (like the anniversary of employment or retirement, depending on the benefit). An employee “has earned some vacation rights ‘“as soon as he has performed substantial services for his employer,”’” and the fact that the subsequent condition to taking the vacation has not occurred does not preclude the right to payment for the vacation accrued upon termination of employment.

The Court contrasted such a policy with an employment policy under which vacation did not begin to accrue until the employee had worked for the employer for a specified period of time. In the latter circumstances, an employee whose employment terminated before the specified time had elapsed would not be entitled to vacation pay, because none would have accrued.

Under the circumstances in McPherson, “[o]nce EF opted to provide plaintiffs with paid vacation, by default that paid time off constituted additional wages attributable to the services plaintiffs rendered during the year, vesting as they labored under Suastez.”
Where an employer’s policy leaves the amount of vacation undefined but the employer “impliedly limit[s] the time actually available for approval,” it cannot avoid the obligations imposed by section 227.3 of the Labor Code. “If EF intended to limit plaintiffs’ ability to earn vacation pay or treat their paid time off as something other than deferred wages, its ‘unlimited’ policy had to be express and clear.”

III. An Employer with a Clear Unlimited PTO Policy that Is Tied to Policies Other than Compensation, such as a Flextime Policy, May not Be Subject to Section 227.3 Obligations.

As explained by the Court in McPherson, the attributes of a truly “unlimited time off” policy that might not be subject to section 227.3 – attributes that EF’s policy for area managers lacked – include the following:

“Such a policy may not trigger section 227.3 where, for example, in writing it (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 employees’ 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 (4) 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. Unlimited paid time off under such a policy—depending on the facts of the case—very well may not constitute deferred compensation for past services requiring payment on termination under section 227.3.”

IV. Section 227.3 of the Labor Code Does Not Apply to Employees Who Are not California Residents and Who Live and Work for Part of the Year in California.

The other issue of first impression in McPherson related to one of the plaintiffs, who had moved from California to Virginia and continued to work for EF, including coming to California during the busy summer season and continuing to manage California staff from her home in Virginia. The Court held that section 227.3 did not apply to work she performed in Virginia or during her periodic stays in California.

As the Court explained, “where a nonresident, exempt employee of a non-California employer has periodically performed work within California, has received no California wages, and has paid no California income taxes on any wages earned,” section 227.3, “a law that governs the payment of unused vested vacation time when an employee’s employment ends,” does not apply. California had no interest in “ensuring an employee who voluntarily leaves California to become a resident of another state is paid vacation wages at the end of her employment by a non-California employer when she worked temporarily within the state.” From the time she left California until her retirement, she was never again a California resident, even when she worked in California during EF’s busy summer season.

The state did not have the same concerns about accrued unpaid vacation for nonresident employees who worked temporarily in California as it had in enforcing the state’s overtime laws for such employees. The California Supreme Court, in Sullivan v. Oracle Corp. (2011) 51 Cal.4th 1191, had held that California’s overtime law requires California employers to pay nonresident employees who worked in California and other states for their work in California. Not applying the overtime laws to such employees would incentivize employers to hire nonresident employees to avoid California’s overtime laws.

The overtime laws have an immediate impact on an employee’s pay, in contrast to the obligation to pay accrued unused vacation pay upon termination of employment. And requiring an employer to pay overtime for work performed in California during a pay period does not create the practical record-keeping and allocation problems of enforcing, upon termination of employment possibly years after having worked temporarily in California, payment of unused vacation accrued by a nonresident while working there.


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