Most employers doing business in California know that California law requires (in most cases) that all of an employee’s accrued and unused vacation time must be paid out to the employee when his or her employment ends. This is because of Labor Code § 227.3:
Unless otherwise provided by a collective-bargaining agreement, whenever a contract of employment or employer policy provides for paid vacations, and an employee is terminated without having taken off his vested vacation time, all vested vacation shall be paid to him as wages at his final rate in accordance with such contract of employment or employer policy respecting eligibility or time served; provided, however, that an employment contract or employer policy shall not provide for forfeiture of vested vacation time upon termination. ….
There have been a multitude of court decisions interpreting this statute. While full payout of accrued vacation is required, these earlier court decisions have recognized that the statute does not mandate that employers actually offer vacation time to employees, or in any particular amounts. The law also does not require employers to continue awarding new vacation time to employees ad infininitem while those employees already sitting on a huge bank of unused time; the company is free to set an “accrual cap.” to prevent the endless accumulation of vacation time.
This week, a new California decision, Bell v. H.F. Cox, Inc., addressed two other interesting questions associated with Labor Code § 227.3 and the vacation requirements under California law: (1) is Labor Code § 227.3 preempted by ERISA; and (2) whether current employees must receive vacation pay at their regular rate.
The answer given by the court in Bell, at least on the facts of that case, was no to both questions.
The vacation policy at issue in the Bell case was a bit unusual. Employees would be awarded a certain number of weeks of vacation time each year, based on their length of service. But when they took the vacation, they would be paid at a flat rate of $500 per week (later increased to $650 per week), instead of at their regular rate of pay. When the employees left employment, their unused time was forfeited.
A group of employees sued, arguing that the policy violated Labor Code § 227.3 both as to terminated employees, and as to current employees because of the flat payment provision. The plaintiffs argued that Section 227.3 of the Labor Code requires all vacation time – including vacation time taken by current employees – to be paid out at the employee’s regular rate of pay.
First, ERISA preemption.
The policy’s provision requiring a forfeiture of vacation upon termination appears at first blush to be an obvious violation of Section 227.3, which prohibits vacation policies which “provide for forfeiture of vested vacation time upon termination.” Yet the employer in Bell argued that Labor Code § 227.3 in this instance was preempted by ERISA because its vacation policy was actually an ERISA plan.
This sort of arrangement – an ERISA vacation plan that preempts state law – is indeed possible, as the U.S. Supreme Court discussed in a case called Massachusetts v. Morash, 490 U.S. 107 (1989). But as reflected by the Morash case (and other cases since then), in order for the ERISA vacation plan concept to work, the vacation plan must meet the requirements of an ERISA plan. Among other things, this means that the plan must be funded–the company must dedicate a pile of money for the payment of vacation benefits, and vacation benefits can only be paid from this pile. If the company pays for vacation benefits out of its general checkbook, it’s not an ERISA plan and there is no ERISA preemption.
And that was the problem in the Bell case. The employer offered testimony that it had set up and funded an irrevocable trust to pay vacation benefits and that all benefits were paid by this trust. That might have been enough to show ERISA preemption–if it were the only evidence on the subject. Alas, it was not. The company had also filed a few tax forms which stated that employee vacations were paid from “[g]eneral assets of the sponsor.” Whoops. The company argued that the statements about vacation pay in these tax forms were a mistake, but as far as the court in Bell was concerned, the language of those tax forms created a jury question about whether or not there was truly a separate and dedicated trust for the payment of employee vacations, or whether vacation was paid from the “general assets” of the company. Hence, the trial court’s grant of summary adjudication on the ERISA preemption question was found to be improper.
Next, the “regular rate” issue.
The plaintiffs in the Bell case also argued that the company’s practice of paying out vacation time to current employees at a flat rate of $500 (or $650) per week, rather than at the employee’s regular rate for a week of pay, was a violation of Labor Code § 227.3. They pointed to the portion of Section 227.3 which requires payouts of vacation time to be at the employee’s “final rate in accordance with such contract of employment.”
The problem with this argument, according to the court, was that the rate provision of Section 227.3, by its terms, does not kick in until an employee’s employment as been terminated, and thus the provision could not have no effect upon current employees:
Labor Code section 227.3, by its express terms, applies only to the situation where an employee is terminated without having taken off his or her vested vacation time. Neither Labor Code section 227.3 nor any other authority cited by plaintiffs supports the proposition that, apart from the situation where an employee is terminated with unused vacation time, a vacation benefits policy must provide for payment of vacation time at an employee’s regular rate of pay. [Ed. note - italics in original.]
In other words, it’s only at the end of employment where an employee must be paid out accrued vacation “at his final rate in accordance with such contract of employment or employer policy respecting eligibility or time served” (to use the language of Section 227.3). While employment is still ongoing, Section 227.3′s rate provision has no application.