Tony Oncidi and Cole Lewis analyze the enforceability of an “unlimited” vacation or PTO policy in California in the wake of a new court case (McPherson v. EF Intercultural Foundation) for publication in Law360.

In a groundbreaking decision in McPherson v. EF Intercultural Foundation Inc., addressing the growing trend of providing unlimited paid time off (but no accrued monetary benefits) to certain exempt employees, the California Court of Appeal’s Second Appellate District has weighed in with some important new restrictions, which could have significant implications once COVID-19 recedes and everyone heads back to work.

In the modern employment setting, many salaried employees who are exempt from overtime (i.e., certain executives, professionals and managers) can and often do work remotely regardless of the location or time of day. With the advent of laptops, smart phones, email, text and internet access, very few of these employees ever have an undisturbed day off.

Few employers expect their exempt employees to refrain from checking email, voicemail and texts (even while they’re on vacation); and most employees enjoy the relative freedom associated with working remotely while still being connected (lightly tethered?) to the office — whether they’re in Maui or Manhattan.

In states like California, vacation benefits accrue and vest as the labor is rendered, and any accrued but unused paid time off/vacation must be cashed out and paid to the employee in the form of wages upon termination or resignation from employment.

So, how does an employer that must keep track of and pay an employee upon separation for all accrued but unused PTO determine how many hours an employee has withdrawn from his or her bank of accrued PTO benefits?

In an effort to enhance employee flexibility while avoiding the administrative headache of determining exactly how many hours were vacation and how many hours were worked remotely, many employers have shifted to so-called unlimited vacation policies for their exempt employees: Simply put, these employees may take as much or as little vacation as they wish, and vacation hours neither accrue nor are they cashed out upon separation from employment.

In McPherson, a case of first impression, the California Court of Appeal affirmed the trial court’s judgment (except for the amount of damages and attorney fees awarded) and held that the unlimited vacation policy at issue in this case was not as described and that the employer (EF Intercultural Foundation) owed the plaintiffs for certain accrued but unpaid vacation benefits.

Importantly, however, the court did not determine that an unlimited vacation policy (if correctly applied) would necessarily violate California law: “We by no means hold that all unlimited paid time off policies give rise to an obligation to pay ‘unused’ vacation when an employee leaves.”

In fact, the court noted, “We appreciate the benefit and understand the appeal the unlimited time off policies … may have to some employees.” One hypothetical employee (a surfer-skier) may prefer to work more than 50 hours per week for part of the year and take two or three months of PTO, while another employee (a parent) may prefer to work fewer hours throughout the year in order to free up evenings and weekends.

The defendant, EF Intercultural Foundation, is a nonprofit that runs organizational and cultural exchange programs between the U.S. and other countries. Three former employees — area managers who ran seasonal homestay programs for international students and who worked from home and in the field — brought an action against EF Intercultural, claiming that they were entitled to accrued vacation pay upon separation under EF Intercultural’s ostensibly unlimited vacation policy.

While EF Intercultural included a vacation policy in its handbook, which provided a specified number of vacation days for certain salaried positions, the vacation policy that applied to these particular plaintiffs was untracked and unwritten. The employees did not accrue vacation days and were only required to notify a supervisor before taking time off. EF Intercultural argued that this was an unlimited vacation policy that did not result in any accrual of benefits or require any payment upon termination.

The evidence presented during the bifurcated bench trial indicated that plaintiffs were informed about the unlimited vacation policy by a supervisor who had a “quite informal … side conversation” with them about the policy. The employees were informed they could take time off outside of the busy season (April through August) but that no vacation accrued. They were not expressly told that they could take as much vacation or PTO as they wanted.

The trial court determined that EF Intercultural’s vacation policy was not unlimited but that it was instead undefined. The lower court framed the lack of specificity as to the amount of vacation benefits as simply a problem of proof as to what EF Intercultural’s policy actually was and held that the plaintiffs were entitled to wages for accrued but unused vacation.

In this appeal, the court distinguished EF Intercultural’s policy from a truly unlimited vacation policy and essentially sidestepped the question of whether a properly administered unlimited vacation policy would require payout of anything upon termination: “We need 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 appellate court held that although EF Intercultural characterized its policy as unlimited, its actual practice was to give plaintiffs a fixed amount of vacation time with an implied limit of two to four weeks, which was really no different from the amount of PTO provided to other corporate employees under the policy set forth in the handbook.

The court also noted that the plaintiffs’ schedules precluded them from taking advantage of a purported unlimited time off policy, citing a Division of Labor Standards Enforcement letter that stated that an employee must be given a fair opportunity to take vacation.

Furthermore, there was no evidence that EF Intercultural would have approved a substantial amount of vacation had it been requested. Therefore, the appellate court affirmed the lower court’s finding that EF Intercultural’s vacation policy had an “implied ‘cap’ and was by no means ‘unlimited'” and thus, the plaintiffs were owed vacation pay upon separation.

Even though the court limited its holding to EF Intercultural’s specific vacation policy and practice, noting the “particular, unusual facts of this case,” it provided helpful guidance for employers that already have implemented or are considering adopting an unlimited vacation policy.

The court determined that such a policy may relieve an employer from having to pay out any accrued vacation benefits upon separation if, in writing, it:

1. 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;
2. spells out the rights and obligations of both employee and employer and the consequences of failing to schedule time off;
3. in practice allows sufficient opportunity for employees to take time off, or work fewer hours in lieu of taking time off; and
4. 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.

The practical effect of the court’s ruling is to call into question the viability of unlimited vacation policies — especially if they are unwritten or informal. In view of McPherson, employers that have or are considering adopting such policies need to pressure test them and make sure they cannot be characterized as a subterfuge for depriving employees of PTO benefits. For example, the court concluded that plaintiffs in this case “appear to have received fewer benefits under the ‘unlimited’ time off policy than if the handbook’s accrual-based vacation policy had applied to them.”

Another problem with EF Intercultural’s policy was its informal nature — it was not described in writing and was instead communicated informally by way of side conversations between employees and their supervisors. If an employer is going to maintain an enforceable unlimited vacation policy, it must be memorialized in writing and should fully describe the benefits to the affected employees as well as the potential that they will leave money on the table by working more hours for the same pay than those who scheduled more PTO.

Drafting an enforceable unlimited PTO policy in the wake of McPherson is certainly possible, but it requires careful analysis of the affected employees, their particular schedules and the productivity and scheduling demands of the job. The policy must be fully transparent and clearly written so as to navigate around the shoals and pitfalls identified by the court in this instructive new opinion.

Reproduced with permission. Originally published April 3, 2020, Law360.