California court confirms employers may deduct from exempt employee leave banks

The San Diego division of the Court of Appeal has confirmed that California employers may deduct from exempt employee leave banks for partial-day absences, without destroying the employee's exemption.

General Atomics provided its employees with a set amount of paid annual leave determined by the employee's length of service. Employees could draw upon the paid leave for absences caused by illness, vacation, and personal and family obligations. The company deducted from the accumulated leave for any partial-day absences. Lori Rhea filed a lawsuit challenging the company's practice as a violation of the salary-basis requirement for several recognized exemptions from the wage and hour laws. The Court of Appeal rejected her argument. Rhea v. General Atomics, Case No. D064517 (Jul. 21, 2014).

It is a requirement of many of the exemptions under federal and state law that the employee earn a salary, which means the receipt of a pre-determined amount per pay period that "is not subject to reduction because of variations in the quality or quantity of the work performed." Kettenring v. Los Angeles Unified School District, 167 Cal.App.4th 207 (2008). Rhea argued that her employer's practice resulted in her not receiving a salary, because unauthorized deductions from her leave bank for partial-day absences constituted a forfeiture of wages that she had earned. The Court of Appeal rejected the argument, because the employer was not taking away something that Rhea had earned. It was just applying the rules it had established for how Rhea could enjoy the fruits of what she earned.

The Court of Appeal in San Francisco reached the same result in Conley v. Pacific Gas & Elec. Co., 131 Cal.App.4th 260 (2005). Rhea sought to distinguish that case because PG&E had only deducted for partial-day absences that exceeded four hours. The Rhea Court could see no basis in California law for distinguishing among partial-day absences based on the length of the absence.

The California rule stated in Conley and Rhea matches the interpretation of federal law that the Department of Labor stated in a January 19, 2009 opinion letter, and the interpretation of California law that the Labor Commissioner stated in a November 23, 2009 opinion letter.

ERISA Preemption Of Vacation Policies

Federal law preempts all state laws that relate to "any employee benefit plan" covered by the Employee Retirement Income Security Act. Employers may use the preemptive effect of ERISA to avoid California law on the accrual and vesting of vacation benefits, if they observe the rules for making vacation pay part of an ERISA benefit plan.

Under California law, vacation benefits are considered part of an employee's wages. Vacation pay accrues and vests day by day over the course of the employee's employment. Once the employee has earned the vacation pay, it cannot be forfeited. Use it or lose it policies are illegal. For a full explanation of the California rules on vacation pay, see Section 15 of the Labor Commissioner's Enforcement Policies and Interpretations Manual.

In  Massachusetts v. Morash, 490 U.S. 107 (1989), the Supreme Court held that ERISA did not preempt Massachusetts law that required employers to pay employees all accrued vacation and holiday pay upon termination of employment. Congress did not intent "to subject to ERISA's reporting and disclosure requirements those vacation benefits which by their nature are payable on a regular basis from the general assets of the employer and are accumulated over time only at the election of the employee." However, vacation pay plans that have assets independent of the employer's general assets might constitute ERISA benefit plans.

A plan that merely establishes a trust fund that reimburses the employer for vacation payments is not sufficient to bring the plan under ERISA, even if it qualifies as a tax-exempt Voluntary Employee Beneficiary Association (VEBA) trust under the Internal Revenue Code. See Millan v. Restaurant Enterprises Group, Inc., 14 Cal. App. 4th 477 (1993). By contrast, the Morash decision recognized that a trust created under multi-employer plan that was the actual source of vacation benefit payments probably would fall under ERISA. For a full explanation of the U.S. Department of Labor's interpretation of the relevant principles, see Advisory Opinion No. 2004-10A.

Vacation Pay

California employment law requires special treatment of vacation pay. Although employers are not required to offer vacation pay at all, if they do, they must adhere to certain rules.

By operation of California Labor Code section 227.3, vacation pay is treated as part of an employee's wages, which vests as it is earned. Because it vests, it can never be forfeited. Use it or lose it policies are prohibited.

Because these rules only apply to vacation pay, it is important to understand what that is. The California Labor Commissioner considers any leave time that is offered without condition. Personal time off and personal and floating holidays are examples of benefits that are considered to be vacation. Thus, an employer who provides 10 days of paid vacation plus a paid personal day has actually provided 11 days of what the Labor Commissioner considers vacation. The benefit accrues at a regular rate throughout the year.

Paid leave that is tied to an objective standard is not vacation. Holiday pay is not vacation, because it is tied to the occurrence of the holidays recognized by the employer. Bereavement leave is not vacation, because it is tied to the death of a family member. Sick leave is not vacation, because it is tied to the employee becoming ill. Note, however, that an employer that lumps sick leave and vacation together as paid time off must treat all that leave time as vacation.

Although an employer may not impose it a use it or lose it policy, it may impose accrual caps. An accrual cap is a limit on the amount of paid leave that an employee may accumulate. After the limit is reached, no further paid leave accrues until some is used. But, the employer must set the accrual cap high enough so that the employee has a realistic chance of taking the entire vacation and still continuing to accrue vacation. A cap of two times the annual allotment is considered fair. Thus, if the employer offers two weeks of vacation, it should set the accrual cap at four weeks.

Employers may also control when vacation starts to accrue and when it may first be used. Thus, it is permissible to require employees to work six months before they begin to earn vacation, or to prohibit the use of earned vacation within the first six months of employment. The employer may not accelerate accrual. For example, a policy that postponed the accrual of vacation for six months could not then vest each employee who passed the six month mark with a week of paid leave.

There are two limited exceptions to California's vacation pay rules:

1. Employees covered by a collective bargaining agreement are limited to the vacation pay provisions in the collective bargaining agreement.
2. The requirements of section 227.3 are preempted by federal law if the employer offers paid leave as part of a legitimate ERISA plan. For further explanation of this exception see Czechowski v. Tandy Corp., 731 F. Supp. 406 (N.D. Cal. 1990) and Section 15 (Vacation Wages) of the DLSE Policy and Interpretations Manual.

Vacation or Sabbatical?

In most jurisdictions, it would not matter whether an employee's paid absence from work was considered vacation or a sabbatical. But, in California, if an employer's policy establishes vacation, the right to paid leave accrues day by day and is never lost. If the policy establishes a sabbatical, the employer can impose conditions and impose a forfeiture if the employee does not use it before employment terminates.

A recent case from the Sixth District Court of Appeal in San Jose explains the difference. See Paton v. Advanced Micro Devices, Inc., Case No. H034618 (Aug. 5, 2011). California Labor Code section 227.3 provides that, if an employee is terminated without having taken his vested vacation time, “all vested vacation shall be paid to him as wages at his final rate” and the employer's policy “shall not provide for forfeiture of vested vacation time upon termination.” In Suastez v. Plastic Dress-Up Co., 31 Cal.3d 774, 647 P.2d 122 (1982), the California Supreme Court explained what "vested vacation" means. Paid vacation is part of an employee's wages. The consideration for the vacations days is the employee's year long labor. Although the time for receiving those wages is postponed until the employee takes vacation, the right to them vests as they are earned. The employer's imposition of a condition subsequent, such as that the employee remain employed for a year in order to take advantage of the accrued vacation, did not prevent the benefit from vesting.

By contrast, a sabbatical is extended paid leave granted infrequently to allow employees to recharge their batteries and devote themselves to self-improvement. In the academic world where the concept originated, a faculty member would engage in a project intended to promote his or her professional development and, in turn, enhance the institution's status as an institute of higher learning.

Because sabbaticals in the business world can serve similar purposes to vacations, the California Labor Commissioner was concerned that employers would label their policies sabbaticals in order to avoid the vesting of vacation pay. In three opinion letters, the Labor Commissioner laid down principles to be used for determining whether paid time off amounted to a true sabbatical. See Opinion Letter Nos. 1986.12.13, 1987.07.13 and 1987.10.06. From those letters and its own analysis, the Court of Appeal in Paton distilled the following factors to be utilized in determining whether paid time off qualifies as a sabbatical: (1) a sabbatical can only be granted infrequently, presumptively no earlier than after seven years of service, although shorter periods may be appropriate in particular situation, (2) the duration of a sabbatical must extend beyond what is normally offered as vacation, (3) the employer must offer regular vacation in addition to sabbaticals, and (4) there must be a feature that demonstrates that the employee taking the sabbatical is expected to return to work for the employer after the leave is over.

The Paton opinion reversed the summary judgment that the trial court had granted to the employer, because a reasonable jury could have concluded that the employer's policy did not establish a true sabbatical. The Court of Appeal was concerned about the true purpose of the program, noting: "It would not be unreasonable for a jury to decide that a four-week sabbatical is not 'normally' longer than vacation of four-weeks, or that an eight-week sabbatical is not longer than that 'normally' allowed for vacation where eight-weeks equals the length of time an employee could be gone on vacation if he took the maximum amount he could accrue all at once. And, although we know that defendant also offered a vacation policy, we do not know how defendant's vacation policy compared to vacation benefits offered by defendant‟s competitors."

Further information about the Labor Commissioner's views appear in the Division of Labor Standards Enforcement, Enforcement Policies and Standards Manual, at page 15.4.