California Court Provides Roadmap for Unlimited PTO Policies

A California appeals court ruled that under an employer's unlimited paid-time-off (PTO) policy, an employee actually accrued vacation days as she worked and was entitled to be paid for unused days when her employment ended.

The court, however, limited the ruling to the facts of the case and said that, if done properly, an employer may be able to construct an unlimited PTO policy that will not obligate the employer to pay for unused leave.

California law does not require employers to provide employees with paid vacation. However, if an employer does provide paid vacation, section 227.3 of the California Labor Code requires the employer to pay any vested vacation time an employee has not used at the time employment ends. Accrued vacation time is considered to be earned wages.

[SHRM members-only toolkit: Complying with California Wage Payment and Hours of Work Laws]

The court held that section 227.3 applied to this employer's "unlimited" PTO policy because the company never told the employee—who was suing to recover unpaid vacation days—that she had unlimited paid vacation. That may have been the informal policy for employees in the position held by the plaintiff, but the company had no written policy or agreement to that effect, and its employee handbook did not cover employees who held the plaintiff's job. Other employees who were covered by the handbook accrued vacation that vested over time. In essence, the court said, this employer did not in actuality have an unlimited PTO policy.

The court stressed that its decision was based on the particular facts of this case and went on to say that, "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."

Flexible work arrangements and unlimited paid-vacation policies may be of considerable benefit to employees and to the employers who want to recruit and retain those employees, the court noted, and employees and employers are free to contract for unlimited paid vacation.

Tips on Constructing a Policy 

The court concluded by offering pointers as to how an employer could craft an unlimited paid-time-off policy that might not trigger section 227.3. Such a policy should be in writing and should:

• Clearly explain that employees' ability to take paid time off is not a form of additional wages for services performed but is 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.
• Spell out the rights and obligations of the employee and employer and the consequences of failing to schedule time off.
• Allow sufficient opportunity for employees to take time off or work fewer hours in lieu of taking time off.
• Be administered fairly so that it does not result in inequities, such as where one employee works many hours and takes minimal time off, and another works fewer hours and takes more time off. 

The court stopped short, however, of saying that such a policy would not trigger section 227.3.

McPherson v. EF Intercultural Foundation Inc., Calif. Ct. App., No. B290869 (April 1, 2020).

Professional Pointer: Because unlimited PTO does not "accrue," the theory is that PTO does not "vest" as wages, and so there is nothing to pay out at termination under section 227.3. However, neither the California Division of Labor Standards Enforcement nor any California state court, including this one, has definitively ruled on this issue. This court went out of its way to limit its decision to the unusual facts of this case.  

Joanne Deschenaux, J.D., is a freelance writer in Annapolis, Md.