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California court addresses unlimited PTO policies

Benefits Administration and Outsourcing|Executive Compensation|Health and Benefits
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By Rich Gisonny and Ben Lupin | April 28, 2020

A Court of Appeals set forth guiding principles for determining whether an “unlimited” PTO policy requires payout at termination of employment.

On April 1, 2020, a California Court of Appeals issued a ruling in a case that is reportedly the first to address whether, under a purportedly unlimited time off policy, an employer must pay for unused vacation time or paid time off (hereinafter collectively referred to as PTO) at termination of employment. In McPherson v. EF Intercultural Foundation, Inc., the court held that such a determination must be made on a case-by-case basis and issued guiding principles to consider (among other facts and circumstances) when determining whether a PTO policy is actually “unlimited” or whether it requires accrual or payout at termination.

Background

Although PTO policies are not mandatory in California, employers that choose to implement such policies must comply with California Labor Code requirements that the employer pay as wages any vested (accrued but unused) PTO at termination of employment.

Under “unlimited” or “flex” PTO policies, employees are generally allowed to take an unspecified amount of PTO without actually accruing any days off and to take PTO whenever and for whatever amount of time they would like, subject to completing assigned work. Employers have generally taken the position that an unlimited PTO policy requires neither accrual nor payout at termination.

The court’s decision

In McPherson, the employer’s policy — which was not in writing — provided that certain employees could take PTO but would not accrue paid days off. These employees were not required to request to take time off or to track it; instead, they were required to notify their supervisors before taking time off — but “highly discouraged” from doing so during busy season.

The evidence in the case showed:

  • Employees “had the right to take an amount of approved vacation that was within the amounts typical of most jobs at the employer (i.e., at least 20 days’ paid vacation per year) even if there was no precise amount expressly stated or agreed upon.”
  • The employer did not make clear that such PTO was not part of the employees’ compensation, even though the employer may have referred to its vacation policy as “unlimited” or “uncapped.”
  • The employer did not expressly convey or document the “unlimited” nature of its PTO policy.

Based on these facts, the court determined that the employer’s policy was not an unlimited vacation policy because, while the amount of PTO time was not defined, the time actually available for approval was impliedly limited. The Court of Appeals affirmed the trial court’s conclusion that the employees were due as wages the amount of PTO implied to be provided in the policy (i.e., 20 days per year), less the PTO actually taken, at termination of employment.

However, the court also recognized that, as long as unlimited PTO policies are properly designed, administered and communicated, they are permissible under California law.

Guiding principles for unlimited PTO policies

The following are the guiding principles set forth by the court for establishing unlimited time off policies (they assume the policy is in writing):

  • The written policy should clearly provide that employees’ ability to take PTO is not a form of additional wages for services performed but 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.
  • The written policy should spell out the rights and obligations of both employee and employer and the consequences of failing to schedule PTO.
  • The written policy, in practice, should allow sufficient opportunity for employees to take PTO or work fewer hours in lieu of taking PTO.
  • The written policy must be administered fairly so that it neither becomes a de facto “use it or lose it policy” nor results in inequities.

Going forward

California employers that have “unlimited” PTO policies should review those policies with legal counsel, keeping in mind the court’s guiding principles. Note that some of the guiding principles focus on the policy document, while others address how to apply the policy in practice. To mitigate risk, employers should conduct ongoing administrative oversight to ensure their written policies work in practice.

All employers (whether in California or not) that maintain “unlimited” PTO policies or are considering implementing such policies should ensure they are in compliance with applicable state laws (including wage payment laws at termination).

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