California Labor Code Section 227.3—which requires “earned and unused vacation” paid at separation of employment—may apply to an informal, nonaccrual, “unlimited” paid time off policy. In McPherson v. EF Intercultural Foundation Inc., the California Court of Appeal held that under the particular facts of the case, the requirement to pay at separation can apply to a seemingly unlimited paid time off policy. The court, however, did not hold that all unlimited paid time off policies trigger an obligation to pay at separation of employment.

California Law on Paid Time Off/Vacation Policies

California does not require employers to provide its employees with either paid or unpaid vacation time. If an employer does have an established policy, practice, or agreement providing paid vacation, then Labor Code Section 227.3 requires that employers pay as wages all earned (or “vested”) and unused vacation at the employee’s final rate of pay upon the termination of employment. In other words, Section 227.3 prohibits any “use it or lose it” policy or agreement that would require an employee to forfeit earned vacation wages.

The Paid Time Off Policy

The vacation policy in the employee handbook provided salaried employees with a fixed amount of vacation days per month based on length of service. Employees subject to this policy were required to use an online scheduling tool to keep track of their accrued vacation balance and to request approval for vacation time.

However, this written, accrued vacation policy did not apply to area managers, including plaintiffs. Instead, plaintiffs were subject to an unwritten policy that did not require them to track their vacation time. Plaintiffs did not accrue vacation days, but could take paid time off and were required to notify their supervisors before taking time off.

Plaintiffs sued EF claiming that EF failed to pay them accrued but unused vacation wages upon separation under EF’s ostensibly unlimited vacation policy, contending it was a “de facto ‘use it or lose it’ policy.” The employer argued that its practice of permitting the plaintiffs to take unlimited and “uncapped” time off without accruing vacation wages complied with California law because nothing “vested” in the first place.

The McPherson Court Decision

The court ruled that Section 227.3 applied to the employer’s purportedly “unlimited” paid time off policy based on the “particular, unusual facts of this case.” The court focused on two key factual findings made by the trial court:

  1. In practice, the employer's policy had an implied "cap" and was not truly "unlimited." 
    The court pointed out that plaintiffs were prohibited from taking paid time off in an unlimited manner, and that vacation was taken based on plaintiffs’ schedules and work demands, which resulted in plaintiffs taking less vacation than many other managers and exempt employees whose accrued vacation vested as they worked month after month, as is covered by the written policy in the handbook. The court also pointed out that an unlimited paid time off policy would at least afford employees the ability to take longer or more frequent time off than would traditional accrual policies.

  2. The employer failed to set out its purportedly unlimited vacation policy—or any limitations it imposed on earning vacation wages—in a clear, express writing.
    The court emphasized that the employer had no written policy or agreement, and instead, the employer communicated its “unlimited” PTO policy to plaintiffs informally through side conversations with supervisors. The court stated that 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.”

The court did not hold that all unlimited paid time off policies always trigger an obligation to pay “unused” time at separation of employment.

  • The court did not decide “whether vacation wages are earned under an unlimited policy—whether ‘uncapped time off’ equate[s] to ‘vested vacation’—as that is not the policy here.”
  • The court pointed out that employees and employers “are free to contract for unlimited paid vacation, consistent with the Labor Code and governing case law.”
  • The court stated that it “by no means hold[s] that all unlimited paid time off policies give rise to an obligation to pay ‘unused’ vacation when an employee leaves.”

The court provided guidance on an unlimited paid time off policy that may not trigger the requirement to pay accrued time at separation of employment. The policy must be in writing and must:

  1. 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. Spell out the rights and obligations of both employee and employer and the consequences of failing to schedule time off;

  3. In practice, allow sufficient opportunity for employees to take time off, or to work fewer hours in lieu of taking time off; and

  4. Be 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.

Key Takeaways for Employers

The decision does not prohibit the use of unlimited paid time off policies that do not trigger the obligation to pay accrued time at separation. However, employers with these policies should ensure compliance with the requirements spelled out by the McPherson court.

An unlimited time off policy—and any benefits, limitations, and consequences of such a policy—must be written and clearly communicated to employees. Unwritten or informal policies create risk, as do policies that do not match reality. Employers should review the practical impacts of the unlimited time off policies, ensuring that employees actually have the opportunity to take time off and that their schedules or work demands are not preventing them from doing so.