There is no legal requirement in California for an employer to provide its employees with either paid or unpaid vacation time. However, most employers do provide vacation benefit either to ensure its employees get needed relaxation and work rejuvenation or to remain competitive for retention of their employees.

If an employer has a vacation policy, they must understand paid vacation is considered a form of wages under California law and certain restrictions are placed on the employer as to how it fulfills its obligation to provide vacation pay.

California Law on Vacation Pay

The California Labor Code requires an employer to pay an employee upon termination all vested vacation time “as wages.” When employees do not take the full amount of vacation time they could have taken in a year, that amount automatically carries over to the next year. Upon employment separation, the employer must pay out all paid vacation time an employee has accrued over the life of his or her employment.

An employer in California is prohibited from maintaining a policy which provides for the forfeiture of vacation time upon termination, a so called “use it or lose it” policy. The California Department of Labor Standards and Enforcement (DLSE) views paid vacation as “deferred compensation.” Thus DLSE has struck down any vacation policies which try to get around the law. The DLSE has held that other time off that may be taken without condition is equivalent to vacation and therefore subject to California Labor Code’s prohibitions on forfeiture. For example, paid time off (PTO) plans, permitting paid time off for any purpose, are treated as vacation. “Personal days,” and “floating holidays” also cannot be forfeited and must be paid at time of termination.

Employees who earn vacation benefits must be allowed at some future time to either take vacation time off or be paid vacation pay in lieu of time off work. Employers may pay employees for unused vacation rather than letting vacation carry over from year to year. But this has increasingly become an issue where the employee is dependent upon the vacation pay and does not want to use his or her benefit of vacation.

Is there anything employers can do to limit the amount of accrued vacation?

California employers are allowed to have a policy that places a cap on how much vacation an employee may accrue at any one time -- a so called accrual cap. Both California courts and the DLSE are not firm on what limits are allowable on the accrual cap, but it appears an accrual cap of 1.25 to 1.75 times the employee’s annual vacation entitlement is allowable.

Employees’ Claims for Unpaid Vacation

A recent California Appeals Court decision, Church v. Jamison (2006) 143 Cal.App.4th 1568, issued a significant ruling on when a vacation pay claim under California law accrues and what the applicable statute of limitation is for such a claim. The Court in Church ruled a claim for unpaid vacation does not accrue until the employee’s employment has ended without the employee using all his or her vested vacation time. Thus, any lawsuit filed by a current employee seeking payment for unused vacation would be premature and would be dismissed.

Further in Church, the Court held plaintiffs who sue for unpaid vacation are not limited to recovering any sums that were accrued during only the last four years of employment, but instead are entitled to recover any vacation pay they lost throughout their entire employment. For example, a long-term employee who was employed for fifteen years can recover for his or her entire fifteen years’ worth of unpaid vacation.

The Court in Church opined employers would improperly have an advantage of a “dual” statute of limitations over employees in a vacation pay case: (1) a limit on how soon a lawsuit must be filed in relation to the employment termination and (2) a limit on how far back an employee may recover unpaid wages.

The ruling in Church is in direct contradiction to another Court of Appeals case, Sequeira v. Rincon-Vitova Insectaries (1995) 32 Cal.App.4th 632, which upheld a DLSE enforcement decision and limited plaintiff’s recovery to a “look back” period of four years prior to an employee’s termination. However, until the California Supreme Court issues a definitive ruling on this issue employers should assume there is no “look back” recovery limitation.

Finally, the Court in Church considered the applicable statute of limitations for vacation pay claims under California law. The Court did not definitively decide but listed the possibilities for how soon after an employee’s termination the employee must bring suit: two years for a vacation policy based on an oral contract, three years as a liability created by statute, and four years if the vacation policy is based on a written document.

Practical solutions for a sound vacation policy and avoid the sting in Church

An employees’ vacation pays lawsuit and the latest ruling in Church increase an employer’s exposure to liability. Employers should evaluate their current policy and determine if any revisions should be made.

Consider a vacation policy where you pay off at the end of the year any vacation which has been earned but not taken, a cashing out system. This prevents an employer from growing a substantial bank of unused vacation time. While forfeitures of vested vacation time are unlawful, an employer may place a cap on the number of vacation hours an employee can earn. Once the employee reaches the cap, they can earn no vacation until they have taken time off and reduced their leave bank below the maximum. This measure also caps an employer’s potential obligation for unpaid vacation pay.

In drafting or restructuring a vacation policy or concerns about liability for vacation pay claims, an employer should consult an experienced employment law attorney to ensure their policy is compliant with the law.

This article appeared in the October 15, 2007, issued of the San Diego Business Journal