Vacation Pay Obligations, Quirky Question # 103

Quirky Question # 103:

We recently opened operations in California and are concerned that our current PTO policy does not meet California state standards.  We were caught unawares by the new Massachusetts Supreme Court case on vacation pay and know that the law on vacation policies differs from state to state.  What should we be doing to protect ourselves from employee vacation claims in California?

Dorsey’s Analysis:

You would think the rules on how employers must administer their vacation plans would be settled law, simple and straight forward. However, just in the last month, courts in both Massachusetts and California issued new decisions interpreting state law as to valid vacation policies. These cases show that the issues surrounding vacation pay are neither settled nor straightforward. Here’s what the law is currently in California:

Employers are not required to offer their employees time off with pay. The decision to do so is essentially part of the employer’s contract with the employee. Which employees are eligible for vacation, and how much vacation employees will earn each year (if any) is normally set by company policy. The recent appellate case in California (Owen v. Macy’s Inc., Second Appellate District, B207719, June 29, 2009) affirmed these principles, as well as clarifying that the employer also may determine whether vacation begins to accrue immediately upon hire or only after a waiting period (often 6 months) so long as there is a clear policy in place that states employees will not earn or vest vacation pay during this period. However, the waiting time can’t simply be a pretense to not pay vacation to a short-term employee, i.e., the policy should not be structured to give an employee two days of vacation at the end of his or her probationary period. Either vacation begins to accrue at the date of hire, or it begins to accrue later.

However the policy is structured, vacation pay constitutes a form of “wages” under California law that is earned on a daily basis. This has several consequences for the employer. First, California does not allow “use it or lose it” policies. Once vacation is earned, it cannot be taken away or be forfeited. Thus, for example, an employer may not have a policy that provides that any vacation not taken by December 31st will not be “rolled over” to the following year. Likewise, a requirement that an employee be employed on his or her “anniversary date” to be eligible for vacation pay would be considered a forfeiture. Vacation must vest on a pro rata daily basis once vesting begins.

On the other hand, the California Labor Commission has approved reasonable caps on accrual. Under this kind of plan, once a certain level of accrued vacation is earned but not taken, no additional vacation will accrue until some of the “banked” vacation is taken. Once some vacation is taken, accrual begins again at the usual rate, but the employer does not owe the employee the amount of vacation that would have been earned during the time the vacation was at the cap. The general rule of thumb is that a cap that is 1.5 or 2.0 times the annual accrual rate is “reasonable.” This gives the employee a reasonable amount of time after the accrual of vacation to use it before the cap takes effect. In addition, an employer may have a “cash out” policy in which it either offers employees the option or requires employees to accept pay for accrued vacation that has not been taken.

Because accrued vacation is treated as wages, on termination all accrued but unused vacation must be paid to the employee at his or her final rate of pay. Payment of wages on termination must be made on the last day of employment if the employer is ending the relationship, or within 72 hours if the employee is resigning, unless the employee has given at least 72 hours notice of his or her intention to quit, in which case the employee is entitled to wages at the time of quitting. Willful failure to pay wages on termination pursuant to these guidelines subjects the employer to “waiting time penalties” which means that the employee’s wages continue as a penalty from the due date at the same rate until paid for a period of up to 30 days.

Some employers have “paid time off” or PTO policies that combine vacation, sick leave, personal days, etc., and allow employees to use the time for whatever purpose they see fit. This is certainly allowable, and in some ways easier for the employer to administer, but the California Labor Commissioner takes the position that since an employee has the discretion to use the allotment for whatever purpose and at whatever time they choose, the entire sum will be treated as “vacation” and must be paid out on termination. In contrast, if an employer has separate sick leave and vacation policies, the sick leave need not be paid out on termination.

Other rules apply as to whether an employer can require an employee to use accrued vacation for certain other types of leave. For example, an employer cannot require a woman to use vacation or PTO during a pregnancy leave covered by the California Pregnancy Disability Leave Act. On the other hand, an employer may require an employee to use accrued vacation to cover family care leave taken for any purpose.

Every state will have its own laws interpreting the use of vacation policies. As noted above, the Massachusetts Supreme Court recently held that if an employee is involuntarily discharged by his or her employer, the employer must pay vacation time earned through that date, regardless of the employer’s written vacation pay policy (which in the case before the court stated that vacation time was not an earned benefit payable upon discharge). Still, in so holding, the Massachusetts court did not address whether vacation pay must be paid out to employees who voluntarily quit their jobs. (The case is Electronic Data Sys Corp v. AG, 454 Mass. 63, June 11, 2009).

This confusing litany of rules in different states means two things for employers: first, all employers should have clear written vacation policies that have been reviewed by counsel to make sure they comply with the law of the state in which the employer is operating. Second, because vacation policies are subject to state law and the law varies from state to state, employers with multiple-state operations face particular challenges and must be sure that they comply with the laws of each state in which they have employees.

Dorsey & Whitney

Dorsey & Whitney

Dorsey is a business law firm, applying a business perspective to clients' needs. We make it our first priority to know the context in which you do business - your market, your competitors, your industry.

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