California Court of Appeal Issues Warning to Employers with Unlimited Paid Time Off Policies

California is like every other state in that it does not require employers to provide employees with paid time off. Unlike in most other states, however, if an employer does provide employees with paid time off, then employees have a vested right in such time. What this means is that employers are prohibited from enacting “use it or lose it” paid time off policies. It also means that upon separation, California employers must pay out employees for any unused paid time off.

Due to these requirements, and to remain competitive with other employers, some employers have instituted “unlimited” paid time off policies whereby employees do not accrue any specific amount of vacation time but, rather, are free to take (or not take) as much (or as little) vacation as they want. The commonly held belief amongst most employers is that such unlimited paid time off policies benefit employees by providing them with flexible schedules while, at the same time, allowing employers to avoid the obligation to pay out any unused paid time off upon separation. In McPherson v. EF Intercultural Foundation (McPherson), the California Court of Appeal issued a shot across the bow to employers adhering to this commonly held belief by holding that the unlimited paid time off policy at issue did obligate the employer to pay out unused paid time off upon termination.

California Labor Code Section 227.3 provides that if an employer provides paid time off, that employer must then pay out at termination that portion of an employee’s paid time off that is vested but unused. The question in McPherson was whether Section 227.3 applied only to employers offering employees fixed amounts of paid time off or whether it also applied to employers with unlimited paid time off policies.

The Court of Appeal in McPherson held that Section 227.3 applied to the unlimited paid time off policy at issue in that case. The Court’s decision in McPherson was explicitly limited to the facts at issue. To that end, the Court was very careful to state that it was not holding that Section 227.3 applies to all unlimited paid time off policies. As for the policy at issue in McPherson, the Court held that Section 227.3 applied because the paid time off policy at issue was not truly unlimited. This was because the employer failed to (a) communicate to the employees that they had unlimited paid time off or (2) provide its employees with a written policy or agreement communicating that they had unlimited paid time off.

McPherson’s holding was limited to the facts in that case. With that being said, the Court’s holding does provide guidance to employers with unlimited paid time off policies as to the steps they must take in order to avoid accidentally triggering Section 227.3. As held by the Court, unlimited paid time off policies may not trigger Section 227.3 where they are in writing and do all of the following:

1. clearly provide that providing unlimited paid time off is not a form of additional wages for services performed;
2. clearly communicate the rights and obligations of both employee and employer and the consequences of failing to schedule time off;
3. realistically allow sufficient opportunity for employees to take time off, or work fewer hours in lieu of taking time off; and
4. are administered fairly so that they neither become a de facto “use it or lose it policy” nor result in inequities.

Providing employees with unlimited paid time off has never been a riskier proposition in California. For one, and while McPherson did not hold that all unlimited paid time off policies trigger Section 227.3, the case can easily be read as a step in that direction. For this reason, it is not difficult to imagine a subsequent court holding that Section 227.3 applies whether or not an employer adheres to the guidance provided by the Court in McPherson. Moreover, some employers may find that following the Court’s guidance removes some of the factors which made the idea of unlimited paid time off attractive in the first instance. Either way, and to the extent California employers continue to institute unlimited paid time off policies, they should carefully review those policies to ensure that they comply with California law as set forth in McPherson.