On April 1, 2020, the California Court of Appeal issued its decision in McPherson v. EF Intercultural Foundation, Inc.  This decision addresses an important issue relating to the payout of vacation wages under California law: Whether an unlimited vacation policy that provides for no accrual of vacation wages is subject to the payout requirements under California Labor Code § 227.3.[1]  While expressly limiting its holding to the particular facts of the case, the court held that the purportedly “unlimited” vacation policy was indeed subject to section 227.3. 

[1] Section 227.3 provides, “Unless otherwise provided by a collective-bargaining agreement, whenever a contract of employment or employer 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 such contract of employment or employer policy respecting eligibility or time served; provided, however, that an employment contract or employer policy shall not provide for forfeiture of vested vacation time upon termination.”

The Parties

EF Intercultural Foundation runs educational and cultural exchange programs between the United States and other countries. Plaintiffs were former employees who worked for EF as area managers running seasonal homestay programs for students in their regions.

EF’s Vacation Policy

EF had a written vacation policy in its employee handbook that provided for a fixed amount of vacation days per month based on an employee’s length of employment. This policy did not, however, apply to the company’s area managers. Instead, plaintiffs were told they could take time off with pay, although they would not accrue vacation time. To schedule time off, plaintiffs were told to notify their supervisors, but they did not have to use EF’s online system to request time off or track the number of days they had taken. Plaintiffs were never told that they were permitted to take an “unlimited” amount of vacation. In addition, they were strongly discouraged from taking time off during the company’s peak season.

Trial Court’s Decision

The trial court found that EF’s policy of providing unaccrued vacation time to plaintiffs constituted an “undefined,” rather than “unlimited,” vacation policy that was subject to section 227.3. The court based its decision on several factors, including that plaintiffs were required to get approval for their time off; there was no evidence that plaintiffs requested or took more time off than is typically provided under an accrued vacation policy; and, no one told plaintiffs that they had a right to take a large amount of vacation.

The court went on to conclude that least 20 vacation days were available to plaintiffs—and vested—annually. The court relied on testimony from plaintiffs about the amount of vacation time they typically took each year in reaching its conclusion.

Court of Appeal’s Decision

EF appealed the trial court’s decision, arguing that its vacation policy did not give plaintiffs vested vacation rights. The Court of Appeal rejected this argument. The court agreed with the trial court that plaintiffs’ vacation policy was not “unlimited,” but rather contained an implied cap. The court reasoned that plaintiffs’ schedules precluded them from taking vacation time in excess of what was available to other employees under the written vacation policy. Indeed, they often took less time off than other employees. The court noted that “one would expect unlimited time off policies at least to afford employees the ability to take longer or more frequent periods of time off than a traditional accrual policy or allow employees to work fewer hours in lieu of having more vacation days.”

Moreover, EF never communicated to plaintiffs the unlimited nature of the vacation policy. No one told plaintiffs that the reason they didn’t accrue vacation was because they could take as much time off as they wanted, or that their ability to take vacation was not part of their compensation. Nor did EF warn plaintiffs of the consequences of failing to schedule a sufficient amount of time off—that they would be leaving money on the table by working more hours for the same pay than those who scheduled more time off.

It is important to emphasize that the court noted at several points in its decision that it was not implying that section 227.3 necessarily applies to “true unlimited time off policies.” EF’s purportedly “unlimited” vacation policy was, according to the court, neither unlimited as conveyed to plaintiffs, nor unlimited in practice.

The court concluded its analysis by providing (in dicta) some limited guidance for employers wanting to adopt unlimited time off policies that won’t trigger section 227.3. The court stated that an unlimited time off policy may not trigger section 227.3 if the policy is in writing and:
• 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;
• Spells out the rights and obligations of both employee and employer and the consequences of failing to schedule time off;
• In practice allows sufficient opportunity for employees to take off work, or work fewer hours in lieu of taking time off; and
• 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.

This guidance touches not only on the express language that should be used in an unlimited vacation policy, but also on how the policy is actually administered. This means that employers must pay close attention to how the policies work in practice to ensure that employees are actually taking time off consistent with a truly unlimited vacation policy. This will require ongoing oversight and review by the employer. While the McPherson decision does not preclude employers from implementing flexible/unlimited time off policies, it highlights the risk that such policies will be viewed as creating vested vacation benefits that must be paid out upon termination of employment. We recommend that employers review their flexible/unlimited time off policies in light of McPherson and consider whether their policies, including any limits placed on time off usage, should be revised.