©2023 Seyfarth Shaw LLP www.seyfarth.com 2023 Cal-Peculiarities | 251 unused vacation pay must be paid on termination of employment, at the final rate of pay, vacation pay is deemed to be earned daily, “use it or lose it” policies are unenforceable, and “paid time off” is treated as vacation. Section 227.3’s vacation rules apply “[u]nless otherwise provided by a collective bargaining agreement.” The Court of Appeal has interpreted this exemption narrowly, holding that section 227.3 rules apply even to unionrepresented employees unless their CBA “clearly and unmistakably waives” section 227.3 rights.422 7.19.1 Accrued vacation pay is a form of wages An employer need not provide any paid vacation at all. But if the employer does so, then California treats vacation pay as wages earned on a daily basis and not subject to any forfeiture and requires that all earned, unused vacation be paid upon termination of employment at the final rate of pay, regardless of when the vacation was earned or whether the employee had become eligible to use the vacation.423 The basis for this peculiar doctrine is a California statute, Labor Code section 227.3, which provides that “all vested vacation shall be paid” to terminating employees “as wages at [their] final rate” and that no employer policy shall provide for “forfeiture of vested vacation time upon termination.”424 Because the right to be paid for the amount of vacation time offered by an employer constitutes deferred wages for services rendered, the employee is entitled to receive pay, at the time of termination, for the pro rata share earned during the time that the employee rendered services to the employer. According to a recent unpublished Ninth Circuit ruling in Mills v. Target Corporation, the “final rate” means the employee’s “final wage rate,” as opposed to the final base hourly rate.425 The Mills Court held that this includes an employee’s base pay and any pay differentials at the time of termination. However, the decision did not address whether an employee’s regular rate of pay must be used for the final payout if the employee receives other compensation, other than shift differentials, that would potentially impact their regular rate of pay. As a result, some uncertainty around that issue exists. Section 227.3 also empowers the Labor Commissioner to “apply the principles of equity and fairness” “in the resolution of any dispute with regard to vested vacation time.” Pursuant to this broad, vague mandate, the DLSE has promulgated interpretations that employers may find arbitrary and capricious. 7.19.2 Impermissible “use it or lose it” policies and permissible caps Many employers provide that paid vacation time, if not used within a given time (such as a calendar year), is forfeited. You must “use it or lose it.” In California it’s different. Because California law deems vacation pay to be a form of wages that vests daily, it is not subject to forfeiture. Accordingly, “use it or lose it” vacation policies are not enforceable in California.426 Nonetheless, employers can approximate the result of a “use it or lose it” policy by implementing a “no further accrual” policy. That policy permissibly may provide that once employees accrue a particular number of vacation days (an accumulation “cap”), they no longer continue to earn vacation until they take vacation to reduce the accumulated number of unused vacation days below the cap.427 The DLSE has opined, however, that the level of the cap must be reasonable. The DLSE has withdrawn an opinion letter that arbitrarily required the cap to be 1.75 times the annual vacation accrual rate.428 7.19.3 Problems with denying vacation pay to short-term employees Vacation pay is deemed to have been earned from the first day of employment if the vacation pay plan provides that an employee has earned a given amount of vacation pay (e.g., two weeks) upon completion of the first six
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