By Shaw Law Group

“Reprinted with permission from the Daily Recorder, a Daily Journal Corp. publication”

Some California employers offer, or may be considering, “unlimited” paid time off plans (“unlimited PTO”) in lieu of traditional accrued vacation or PTO. The perceived benefits to employers of unlimited PTO include reducing the burden of tracking accrual and usage, as well as avoiding large lump-sum payouts at employment termination. However, unlimited PTO also comes with significant potential risks of liability. Some of the most common concerns and possible ways to address them follow.

Traditional Vacation and PTO

Vacation and PTO are not required by law. Employers that offer traditional vacation or PTO benefits (e.g., two weeks of paid time per year), however, incur obligations under California law. Traditional paid time generally is earned, or accrued, over time. Thus, a small portion of the “two weeks per year” is earned – or “vests” – each day during the year.

Once vested, PTO or vacation are considered earned wages and cannot be forfeited. That is why, in California, a “use it or lose it” policy is illegal. And Labor Code section 227.3 requires employers to pay out unused, accrued vacation or PTO, at the employee’s final rate of pay (i.e., not the rate at which the employee earned it).

Unlimited Vacation

Under an “unlimited” plan, an employee does not earn specific amounts of PTO. Rather, the worker may take time off with pay when desired. The employee in theory will not abuse the privilege, because of job requirements, client demands, conscientiousness, peer pressure, etc. Employers retain the right to hold employees to performance and productivity requirements as well.

Because unlimited PTO does not “accrue,” the legal argument is that PTO does not “vest” as wages, and there is nothing to pay out at termination (whether voluntary or involuntary).

However, neither the Division of Labor Standards Enforcement (“DLSE”) nor California state courts have decided whether these plans are valid under the Labor Code. Courts in other contexts have disapproved plans deemed a “subterfuge” to avoid section 227.3. And the statute requires application of principles of “equity and fairness” to vacation policies. An “unlimited” PTO policy therefore is risky in California until the courts weigh in.

Boundaries, Not Limits

Apart from section 227.3, unlimited PTO raises other potential concerns. Leave laws (e.g., the Family and Medical Leave Act and California Family Rights Act) generally require employers to treat employees on protected leave as favorably as those not taking protected leave. Additionally, leave laws permit employees to elect to use or “substitute” available paid time during leave. A policy allowing unlimited time for vacation, but not for medical leaves of absence, raises concerns not yet addressed by courts under California’s leave laws.

Limiting time off for leaves may undermine the argument that the policy actually is “unlimited”. An employee therefore may argue that such exceptions mean the policy is indeed a “subterfuge” to deprive employees of earned “wages” upon termination.

As discussed above, “unlimited” PTO does not mean that employees may simply stop showing up to work without consequence. The key for employers is to set boundaries based on performance criteria, scheduling with sensitivity to business needs and others’ schedules, and the like rather than expressly limiting the time off available.

Disciplining employees for taking too much time off, or suggesting that a certain amount of time off is “reasonable,” appears to be inconsistent with the concept of “unlimited.” On the other hand, holding employees to deadlines or other performance standards may limit “unlimited” PTO as a practical matter, while ensuring employees get their jobs done.

Additional Considerations

Employers should consider additional, practical considerations associated with unlimited PTO. For instance, employers should still have a separate sick leave policy to comply with California’s state and local sick leave laws. That is because employers seeking to include paid sick leave within PTO plans would have to ensure policies do not impose any restrictions on use (such as advance notice) that the laws do not require.

To address the issues discussed above and others, employers must draft policies to explain the interaction between protected leaves, unlimited PTO, and other wage replacement benefits (e.g., state disability benefits or sick leave). The policy should address coordination of overlapping paid benefits as well. Given that administration of these laws are complex on their own, policies should be drafted with the assistance of competent employment law counsel.

Good policies must address scheduling time off. Offering unlimited time off should not result in a business grinding to a halt. At the same time, denying “unlimited” PTO too frequently may cause morale problems, and may support the “subterfuge” argument discussed above.

Unlimited plans may also not be appropriate for all employee classifications. High-level, exempt employees, vested with the discretion and judgment to balance work obligations may be appropriate candidates. On the other hand, “unlimited” PTO may not make sense for commissioned-based employees, or non-exempt workers.

Employers switching to an unlimited plan from an accrual system should also pay out any accrued, unused time under the previous plan before the switch, or at termination. Although the new plan provides “unlimited” time off, hours accrued under the former, traditional plan are vested, as explained above.

Finally, as stated, employers must carefully consider the risks and benefits of implementing “unlimited” PTO plans before California’s courts decide whether these programs are lawful. The potential penalties for an invalid PTO or vacation policy are severe, particularly because they will include “waiting time” under Labor Code section 203. It may be wiser to wait than to be the test case.

Our thanks to Shaw Law Group for this article. Please contact them for more information.