Labor & Employment Law Daily Is ‘unlimited’ PTO payable upon termination under California law?
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Friday, April 10, 2020

Is ‘unlimited’ PTO payable upon termination under California law?

By Lisa Milam, J.D.

The short answer is “maybe.” The appeals court “by no means” held that all unlimited PTO policies will give rise to a mandatory payout when an employee departs.

California employees working under “unlimited paid time off” policies may be entitled to pay for unused vacation time upon termination, a California appeals court held in a partially published opinion. The court declined to rule out the prospect as a matter of law, and set forth the relevant factors that would shape the inquiry. In the case at hand, however, the employer’s vague PTO policy was not limitless, as a factual matter, and the trial court properly held that vacation pay was due (McPherson v. EF Intercultural Foundation, Inc., April 1, 2020, Egerton, A.).

Labor Code quandary. The questions posed, according to the appeals court, were as follows: “When an employer’s policy allows an employee to take an unspecified amount of paid time off without accruing vacation time, does the employee’s right to that paid time off vest so the employer must pay her for unused vacation under Labor Code section 227.3 when her employment ends? Or does section 227.3 apply only to policies providing a fixed amount of vacation that accrues over time?”

As “unlimited” PTO policies gain in popularity, the issue of whether they are subject to section 227.3 is of growing importance, as reflected in the fact that California employer organizations weighed in as amici in this case. According to the employer and amici, California Labor Code section 227.3, which references an employee being terminated “without having taken off his vested vacation time,” does not apply to unlimited vacation policies because no vacation time vests “if there is no fixed vacation bank.” The employer is not obliged to pay vacation wages at termination because “nothing ‘vested’ in the first place,” the employer urged. The appeals court was not convinced.

California law. Labor Code section 227.3 does not require employers to grant paid vacation, but when an employer does provide paid vacation, any vacation time that has “vested” is payable upon termination. The California Supreme Court, in Suastez v. Plastic Dress-Up Co. (1982), held that vacation vests when it is earned. Vacation pay is simply a form of deferred compensation, like pension benefits, the state high court reasoned; as such, it vests when the labor is provided, even if the right to receive the compensation does not arise until a later point in time. Therefore, under section 227.3, a pro rata share of unused vacation time is due at termination. However, no California authority has addressed whether a nonaccrual, unlimited PTO policy is subject to the provision.

Unwritten vacation policy. This suit involved three former managers for a nonprofit educational exchange organization who alleged, among other claims, that the employer failed to pay them for accrued but unused vacation, in violation of section 227.3. The employer had granted them an unspecified amount of PTO (the appeals court used the terms “vacation” and “PTO” interchangeably), and it contended that their PTO was unlimited. However, there was no written policy stating how much time off they were allowed. The employees understood that they could take PTO in the off-season when their work allowed for it (and with advance supervisory approval) but they did not believe they were entitled to unlimited PTO. It was not their understanding that PTO was not a part of their compensation, and no one told them they did not accrue vacation time by virtue of being able, in theory, to take as much as they wanted, or because they did not need to track their days off in the employer’s timekeeping system. Consequently, the state trial court had found this was not a truly unlimited PTO policy, and there was no legal doubt that section 227.3 applied.

Undefined, not “unlimited.” Although the employer called its vacation policy “unlimited” or “uncapped,” the trial court concluded the policy was merely “undefined.” As such, it said, it was simply presented with “a problem of proof” as to the actual contours of the policy. In the absence of a precise statement of how much vacation time is granted, the court said it would look to the circumstances and the employer’s conduct to determine the amount of vacation time actually made available to the plaintiffs. In doing so, the court said, it would apply principles of “equity and fairness” (the statute calls for the Labor Commissioner to apply this standard to section 227.3, and the court saw fit to follow suit).

Here, the evidence suggested that the plaintiffs had taken the usual amount of approved vacation time during their tenure, and that no one ever told them they could take an extraordinary amount of PTO. To the court, it appeared that “the parties proceeded on an understanding that the policy was that plaintiffs had the right to take an amount of approved vacation that was within the amounts typical of most jobs at the company—perhaps the amount in the employee handbook—even if there was no precise amount expressly stated or agreed upon.”

Vested. “Because vacation time vests under California law if an employee is told the precise amount she has a right to (e.g., ‘two weeks annually’), it does not make sense that vesting can be avoided if the employee would in fact receive the same amount if she asked for it, but is simply not told that precise amount would be approved. Either way, the employer has a policy of providing at least that much vacation., the trial court reasoned. “If a policy of undefined vacation could avoid vesting, an employee could lose compensation that another identically situated employee was given, contrary to California law that vacation is to be treated as a wage.”

Trial court award. Without recordkeeping, there was no way for the trial court to determine “with certainty” the amount of vacation each actually took. But the plaintiffs, who had worked a combined total of nearly 40 years for the defendant, presented evidence that they took, on average, about two weeks of vacation each year, and never sought or received more than four weeks (20 workdays). The trial court credited this evidence, as well as evidence that their work schedules precluded them from taking advantage of the purportedly unlimited PTO. After reviewing the actual time they had taken off over the years, and construing what their employer would likely approve as PTO in any given year, the court awarded pay for their unused vacation time in the combined sum of $88,595 (along with nearly $398,000 in attorneys’ fees). The vacation wages were based on an estimated 44.27 days of accrued vacation for one employee, and 199.7 and 106 days, respectively, for the other plaintiffs.

Affirmed, mostly. On appeal, the employer argued that California law does not prohibit unlimited time off policies, and that its policy did not give the plaintiffs vested vacation rights because they did not work “in exchange for a promise of a specific amount of vacation.” But the appeals court adopted the trial court’s finding that the policy in question did not, in fact, provide unlimited time off but included an implied cap. And once the employer chose to provide paid vacation, that time off, by default, “constituted additional wages attributable to the services plaintiffs rendered during the year.”

While amici discussed the rationale behind unlimited PTO policies and their benefit to employer and employee alike, there was no evidence the plaintiffs reaped any such benefit. In fact, they took less vacation than many other employees who were covered by an employee handbook, and whose accrued vacation expressly vested as they worked month after month. As the lower court found, if the PTO policy was indeed “unlimited,” it was not expressly conveyed as such to the plaintiffs. This was especially troubling to the appeals court—the employer offered no real direction to employees of their rights under the ostensibly unlimited PTO policy. It did not warn them of the consequences of not scheduling time off—that they “essentially would leave money on the table by working more hours for the same pay than those who scheduled more time off.”

Substantial evidence also supported the trial court’s calculation of vacation wages due: its finding that 20 days vested annually was proper based on an implied agreement that the plaintiffs were entitled to at least 20 days’ paid vacation annually under its undefined policy; the amount of vacation time each plaintiff actually used; and the amount of vested time each had not yet used at the time of her termination. With one exception.

Application to out-of-state plaintiff. As to one plaintiff, the appeals court reversed and remanded the amount of vacation wages due. She had relocated out of state and, as a matter of law, the appeals court held—in a lengthy discussion—that section 227.3 does not apply to vacation wages earned out of state. The lower court’s contrary finding was a misapplication of Sullivan v. Oracle Corp., a 2011 California Supreme Court decision which held that the state’s overtime law applied to nonresident employees who performed full days and weeks of work in California (and elsewhere) for a California-based employer. But the state high court expressly cautioned that “one cannot necessarily assume the same result would obtain for any other aspect of wage law.” And the employer in this case was Massachusetts-based.

Here, the plaintiff temporarily resided in California for more than two months during the summer, and she regularly traveled to California for meetings during other times of the year. Moreover, the work she performed out of state was focused on “activities and people actually in California.” Yet Sullivan does not support the trial court’s implicit finding that California wage laws should be applied to work performed outside of California by a nonresident, even if that work is “focused on activities and people actually in California.” There was no basis in the legislative history to suggest that section 227.3 was meant to apply extraterritorially.

That left the question whether section 227.3 applied to the vacation time that the plaintiff earned while she worked temporarily in California each year. No California decision has considered whether the provision applies to a nonresident employee of a non-California employer who periodically works in California. Taking on the question, the appeals court was not inclined to expand the application of the vacation pay provision outside the state.

Although the trial court referenced the state’s interest in applying its wage laws, the appeals court refused to conclude that “California intended section 227.3—a law that governs the payment of unused vested vacation time when an employee’s employment ends—to apply under the circumstances here: 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.”

As a practical matter, the vacation provision applies differently to nonresidents. California’s wage laws governing overtime, meal and rest breaks, etc. apply to nonexempt employees and the work they perform within the state. Their application is mandatory unless a statutory exception applies, and the employer and employee may not contract around the right to overtime pay. In contrast, the right to paid vacation is not a requirement of California law, it is solely a creature of contract. Thus, in the appeals court’s view, excluding a nonresident employee from section 227.3 in this context simply did not “implicate the same concerns as the exclusion of nonresidents from California’s overtime laws.”

The guidance is in the dicta. Because the employer’s PTO policy was neither unlimited in practice nor conveyed as such, the appeals court didn’t have to take up the larger question of whether section 227.3 applies to unlimited PTO policies. But it had much to say on the matter, nonetheless. “We by no means hold that all unlimited paid time off policies give rise to an obligation to pay ‘unused’ vacation when an employee leaves. Flexible work arrangements and unlimited paid vacation policies may be of considerable benefit to employees and to the employers who want to recruit and retain those employees. Employees and employers are free to contract for unlimited paid vacation, consistent with the Labor Code and governing case law,” the court wrote.

Depending on the facts, a truly unlimited time off policy may not trigger section 227.3 liability where the policy, in writing:

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 “very well may not constitute deferred compensation for past services requiring payment on termination under section 227.3.”

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