Employment Law Alert: “Unlimited Vacation” Legal Landscape Continues to Evolve

As time draws near for employers to update their employee handbook policies to comply with new laws effective January 1, 2024, we want to highlight the evolving legal landscape concerning unlimited vacation policies, so that employers with such polices can make informed decisions about continuing with and/or modifying those policies going forward.

State Laws Requiring Payout of Unused Vacation Upon Employee Separation

A key legal question regarding unlimited vacation policies is whether they can effectively enable employers to avoid state law requirements to pay unused vacation to separating employees. States requiring payout of unused, accrued vacation to separating employees include California, Colorado, Illinois, Maine, Massachusetts, Montana, Nebraska, and Rhode Island. A growing number of these states have now addressed specifically the subject of whether these requirements apply to unlimited vacation, including the states we discuss below.

California

Dating back to 1987, a California Labor Commissioner opinion letter advised that if an employer’s management communicates to an employee that they can customarily take at least a certain amount of vacation (e.g., 3 or 4 weeks) under an unlimited policy, then the employer must comply with California’s vacation accrual/carryover/separation payout laws as to the stated amount of vacation. This has made it necessary for employers to train managers carefully to avoid referring to any specific amount of unlimited vacation that may be taken, and to instead advise that requests to take unlimited vacation will be approved based upon business needs. This need for such ambiguity comes at a cost: employees tend to dislike the uncertainty of the business needs standard. In addition, the ambiguity of the business needs standard creates risk of differential treatment of similarly-situated employees (and potential claims of discrimination). There’s also the risk of “he said, she said” disputes regarding what managers say to employees about unlimited vacation, e.g., allegations of managers verbally mentioning a specific amount of customarily acceptable vacation.

In 2020, the California Court of Appeal published the first California court ruling on the subject of unlimited vacation in McPherson v. EF Intercultural Foundation, Inc., 47 Cal. App. 5th 243 (Cal. App. 4th 2020). The McPherson court affirmed a trial court’s award of substantial vacation payouts to three former employees whom were supposed to be covered by an unlimited vacation policy, including 21 weeks of vacation to one of the employees (and despite that employee having signed a severance and release agreement).

The McPherson court based its ruling on two independent grounds. First, the court held that the employees’ de facto reality was that they could not take more than a traditional level of 2 to 6 weeks of vacation, e.g., because of their workloads. In essence, the court held that to avoid California law’s separation payout requirements, vacation cannot be unlimited in name only. For vacation to be considered truly unlimited, employees must be able to take substantially more time off (the court gave an example of 10-15 weeks off), and there cannot be an “implied cap” that limits vacation to a traditionally available amount.

Second, and separately, the McPherson court rejected the employer’s unlimited vacation defense because the employer had not published a written unlimited vacation policy. The court indicated that in order to avoid separation payout requirements, employers need to publish written policies with a variety of robust provisions explaining and supporting employees’ rights to take unlimited vacation. We have reviewed in detail the court’s ruling on necessary policy provisions in several webinars in the past few years, including our On-Demand Webinar: Employee Handbooks in California: Key Compliance Requirements & Judgment Calls.

Colorado

In an interpretive notice and formal opinion, the Colorado Department of Labor & Employment interprets Colorado law as follows:

“To be payable upon separation, the amount of vacation must be “determinable” – able to be calculated. The calculation can be from a written document, verbal policy, or informal practice. If an employer provides ‘unlimited PTO,’ that ordinarily is not payable upon separation, because the amount isn’t ‘determinable.’ But if an employer says it offers ‘unlimited PTO,’ yet actually doesn’t let employees take more than a certain amount of paid time off, then what it provides isn’t really ‘unlimited’ PTO; it’s PTO with a specific, determinable amount.”

“Example 3: Company C states that it provides ‘unlimited’ PTO, but doesn’t actually let employees take over 120 hours in any year. What Company C provides isn’t actually ‘unlimited’ PTO, it’s 120 hours of PTO per year. So departing employees must be paid any unused portion of their 120-hour allotment.”

The Colorado approach appears to create much legal uncertainty for employers. In many cases, it would be difficult to predict whether a state government agency, court, or jury would interpret an employer’s “informal practice” (presumably based upon how other employees’ vacation requests were handled) to reflect an upper limit on how much vacation employees can take. Further complicating employers’ multi-state legal compliance requirements, Colorado’s focus on an upper limit of vacation differs from the focus of the 1987 California Opinion Letter and Maine (discussed below) on the minimum allowed amount of vacation.

Illinois

The State of Illinois appears to take the most strict position. State of Illinois Department of Labor FAQ (#1) advises:

“If an employer has a vacation policy, which allows employees to take reasonable amount of vacation during the course of the calendar year subject to business needs and the employee’s own judgment and the policy does not provide for the employee receiving a defined number of days after a defined period of employment, is the employer obligated to pay an employee who separates from employment a monetary equivalent equal to the amount of vacation pay to which the employee would otherwise have been allowed to take during that year but had not taken?

Yes, but the employer would not be obligated to pay any monetary equivalent for earned vacation for a future calendar year.”

We consider the State of Illinois’ position to be the most strict because separation payout of unlimited vacation explicitly does not depend on whether the employer had communicated that a “defined number of days” of vacation could be taken. And, employers face legal uncertainty in attempting to estimate correctly how much vacation the employee otherwise would have been allowed to take (i.e., in the absence of a defined number of days).

In addition to Illinois state law requirements, the City of Chicago’s Paid Leave and Sick and Safe Leave Ordinance (effective December 31, 2023) includes provisions requiring separation payout of unlimited time, under certain circumstances.  The Chicago law specifically states that if an employer is relying on an unlimited policy to satisfy Chicago’s paid leave requirements, the employer must pay such unlimited time to separating employees (and employees who transfer outside of Chicago) in the amount of 40 hours minus the paid leave hours taken during the prior 12 months.  Notwithstanding Chicago’s minimum 40-hour payout, an employer would be required to pay the higher of the amounts dictated by Illinois or Chicago law.  As by far most employers with unlimited plans would be expected to provide more than 40 hours of vacation or PTO in a year, the State of Illinois’ position generally would be expected to produce a higher potential payout figure.

Maine

State of Maine guidance indicates that payout upon termination would be required if the employee has a defined amount of time that is available to them at any given time. This closely resembles the position taken by the 1987 California Labor Commissioner Opinion Letter.

Unlimited Vacation Use During Protected Leaves of Absence

We occasionally see unlimited policies that purport to deny employees the right to use their vacation during legally protected leaves of absence (e.g., medical or family care leaves), an approach that risks violating federal, state, and local leave laws nationwide (i.e., not limited to the states discussed above). Many leave laws explicitly say that employers must allow employees to use otherwise available vacation (or words to that effect) during protected leave. And, generally all leave laws prohibit discrimination or retaliation against an employee for taking leave. Employees often base claims of discrimination and/or retaliation on differential treatment of similarly-situated employees. For example, it would be a high-risk decision to deny unlimited vacation to an employee for use during leave for a surgery, while granting unlimited vacation for vacation travel to a similarly-situated employee (e.g., based upon job duties and amount of time requested). This is not to say that employers must allow employees to receive unlimited vacation during the entirety of a long leave of absence. To avoid differential treatment of similarly-situated employees, requests for using unlimited vacation during protected leaves should be considered using the same “business needs” criterion as with other types of unlimited vacation use (i.e., which may result in granting unlimited vacation for a reasonable portion of an extended leave of absence).

Unlimited PTO as Unlimited Protected Sick Leave

We also occasionally see unlimited policies set up as unlimited paid time off (“PTO”), rather than unlimited vacation, with the employer not having realized the important distinction between PTO and vacation. PTO is a hybrid benefit that can be used for either vacation or sick leave purposes. If an employer provides unlimited PTO, that means it is providing unlimited, legally protected paid leave for absences covered by sick leave laws (which are often unpredictable, and particularly subject to abuse in a jurisdiction like California that does not permit employers to require a doctors’ note to use sick leave). The California Labor Commissioner takes the position that if an employer provides unlimited sick leave (or PTO in lieu of sick leave), the employer must specifically state that sick leave or PTO is “unlimited” on employee pay stubs (or a separate document provided to employees each pay day).

To avoid the serious potential downsides of providing unlimited PTO/sick leave, an employer can instead provide unlimited vacation (with separate, limited accrued sick leave in accordance with state/local law requirements).

Non-Exempt Employees

There’s a broad consensus that unlimited policies should not apply to non-exempt (hourly) employees. While exempt (salaried) employees tend to have more flexibility in their schedules (their focus is on completing projects, rather than working a schedule), employers generally need non-exempt employees to work scheduled hours. Generally, it would be unrealistic to advise non-exempt employees that they can take an unlimited, indeterminate amount of vacation, given their need to work a schedule of hours.

Other Pros & Cons of Unlimited Policies

We recommend that employers consider carefully a variety of other pros and cons of unlimited policies. Many employers cite the cost saving advantage of not having to pay unused unlimited vacation to separating employees. As discussed above, however, a growing number of jurisdictions may require such payout in particular cases. We also note that employers can draft accrued vacation or PTO policies to avoid any requirement to pay out unused vacation or PTO to a separating employee in most U.S. jurisdictions (not including California).

Some consider unlimited policies easier to administer because there is no need to keep track of accrual balances. In jurisdictions that may require payout of unused, unlimited vacation to separating employees, however, accrued policies will likely prove easier to administer (i.e., because the accrual balance provides clarity as to the required payout amount). Payroll applications are designed to automate tracking of accrual balances, such that the ease-of-administration perception of unlimited policies may be overstated. Accrual policies also simplify the vacation approval decision-making process as to what is a reasonable amount of vacation for an employee to take, because employers can base the decision mainly on the objective variable of the employee’s accrual balance (i.e., rather than the more subjective variable of business needs).

We see continuing evolution in employees’ perceptions of unlimited policies. An undeniable employee advantage of unlimited policies is the ability to take significant vacation early in employment without having to wait for accrual (although accrual policies can be adjusted to account for this, e.g., through accrual advances). A common concern is that many employees do not like the lack of certainty regarding how much vacation time they can take, and many say that they end up taking less time off.

Particularly hard-working employees may feel that an unlimited policy leaves them with less to show for their efforts, as compared to being able to see on a pay stub their vacation or PTO accrual balances. There is at least some perception that less motivated employees take more advantage of unlimited policies.

Conclusion

As part of updating policies for 2024, we recommend that employers with unlimited policies carefully consider and discuss with their counsel the evolving legal landscape. Employers seeking further guidance may contact any of the firm’s attorneys.