California employers should take heed of yet another reminder about the need to carefully craft and administer employee leave and benefits programs such as a paid vacation policy.

In a decision made public on August 28, 2010 (Molina v. Lexmark Int’l, Inc., Cal. Super. Ct., No. BC339177), Judge Gregory Alarcon of the Los Angeles County Superior Court ordered Lexmark International, Inc. to pay nearly $8.3 million in damages resulting from the company’s longstanding (and illegal) “use-it-or-lose-it” vacation policy.

The class action suit involved 178 current and former Lexmark employees in California.  Lexmark was found to have violated Labor Code Section 227.3 by implementing a policy under which its California employees forfeited vacation benefits if their vacation time was not taken within a specific timeframe.  California law treats accrued vacation benefits as a form of deferred wages, which vest as the employee renders services.  Once vested, vacation pay becomes the property of the employee, and employers are prohibited from requiring employees to forfeit accrued vacation for any reason.  Thus, the “use-it-or-lose-it” policy adopted by Lexmark is unlawful in California, and any vested vacation benefits should have been paid upon termination of employment.

Exacerbating the liability and resulting damages for Lexmark, the Court found that the statute of limitations on the employees’ Labor Code claims should be tolled in this situation, resulting in an extension of the company’s liability to all employees who worked for Lexmark in California since the policy’s implementation 19 years ago in 1991.

Accrue It, Not Lose-It

This case clearly demonstrates the potential for large-scale liability awards arising from an improper vacation pay policy.  California employers are not required to provide employees paid vacation time off, but if they choose to do so, the policy must be implemented in compliance with California law.  While a “use-it-or-lose-it” policy is impermissible, employers may impose a reasonable cap on the amount of vacation time employees may accrue.  Under such a policy, vacation ceases to accrue once the employee reaches the cap and will only resume accruing once some of the previously accrued vacation has been used.  Employees are not entitled to vacation time that they would have earned during the period the vacation benefit was at the cap.

The vacation benefits cap set by the employer must be reasonable considering factors such as the amount of vacation offered, the opportunities for employees to take vacation during the year, and the type of business involved.  California employers commonly cap vacation at one-and-one-half to  two times the annual accrual rate established by their vacation policies.  Employers seeking to revise their vacation policy or wishing to verify their current compliance with California’s unique vacation policy rules should consult legal counsel to avoid potential liability pitfalls.