While the United States and California legal worlds remain (understandably) focused on issues arising out of the COVID-19 global pandemic, California courts continue to issue important, and potentially policy-altering, rulings in cases affecting employment law. One such case, McPherson v. EF Intercultural Foundation, Inc., finds the California Court of Appeal opining for the first time on the intersection of the growing trend of California employers offering at least their exempt employees “unlimited” vacation time (meaning employees do not accrue or vest in a set number of hours) and California Labor Code Section 227.3, which provides that employees must be paid out for any accrued but unused vacation time at the termination of employment. While McPherson does not purport to outlaw the practice of offering unlimited vacation, it does put in place some significant potential restrictions on such policies, ones which employers that have or are contemplating unlimited vacation policies should be aware of. McPherson also contains an important reminder regarding releases of employment-related claims and the statutes of limitations. We note that the defendant in McPherson has now filed a petition for review of the case with the California Supreme Court which, if granted, would render the case non-binding and non-precedential, but still citable for its persuasive value only pending review.
What Does McPherson Say About Unlimited Vacation?
In McPherson, three former employees sued EF Intercultural Foundation (“EF”) seeking payment for accrued but unused vacation they alleged EF failed to pay at the time of each plaintiff's termination of employment. EF argued that while it had a written accrual-based vacation policy for most of its employees, the policy applicable to the plaintiffs, each of whom occupied an area manager position, was an unwritten unlimited vacation policy where the plaintiffs could take days off with pay as long as they notified their supervisors of the time requested and received approval.
The trial court held, and the appellate court affirmed, that EF did indeed owe the plaintiffs payment for accrued but unused vacation under Section 227.3. The court found that EF’s policy allegedly applicable to the area managers was not in writing and not formally communicated to the area managers, who thus had no reason to understand that vacation time was not included in their compensation. According to the court, while EF referred to its vacation policy applicable to plaintiffs as “unlimited” or “uncapped,” substantial evidence showed that it was neither.
The trial court, and later the appellate court, determined that EF’s vacation policy applicable to area managers did in fact have an implied limit. EF “expected plaintiffs to take vacation in the range typically available to corporate employees (such as two to six weeks), not an “unlimited” amount.” Moreover, the court found, the plaintiffs’ work schedules precluded them from being able to take advantage of supposedly unlimited vacation. Plaintiffs and other EF area managers indicated that they had no understanding that they could take off as much time as they wanted, and they indeed used the written policy contained in the Employee Handbook – which did provide for specific amounts of vacation, accrual, and usage limits – as guidance for their vacation usage. All of this, according to the court, supported a finding that the plaintiffs were owed vacation pay under Section 227.3.
A Roadmap for Unlimited Vacation Policies Going Forward?
The appellate court was careful to try and limit the scope of its holding. “In any event, we need not decide whether vacation wages are earned under an unlimited policy—whether “uncapped time off equate[s] to ‘vested vacation’”—as that is not the policy here.” The court cited with seeming approval the benefits and appeal that unlimited vacation policies potentially offer. The court then laid out a variety of factors that might allow an employer to avoid the requirements of Section 227.3 while offering unlimited vacation. Viewed from another angle, however, these factors can also be read as demonstrating what a successful unlimited vacation policy might need to have to avoid triggering Section 227.3.
According to the court, an unlimited vacation policy may successfully avoid the obligations of Section 227.3:
where, for example, in writing it (1) clearly provides that employees’ ability to take paid time off is not a form of additional wages for services performed, but perhaps part of the employer’s promise to provide a flexible work schedule – including employees’ ability to decide when and how much time to take off; (2) spells out the rights and obligations of both employee and employer and the consequences of failing to schedule time off; (3) in practice allows sufficient opportunity for employees to take time off, or work fewer hours in lieu of taking time off; and (4) is administered fairly so that it neither becomes a de facto “use it or lose it policy” nor results in inequities, such as where one employee works many hours, taking minimal time off, and another works fewer hours and takes more time off.
This is hardly a bright line standard, but it does provide guidance to employers who currently have or are contemplating unlimited vacation policies. Important to note is that factors 3 and 4 look at how the policy operates in actual practice versus just what the written policy purports to offer. Employers claiming to offer unlimited vacation but who know employees could never in practice take more than two weeks due to job and/or industry demands may want to consider if a court would consider their policy truly “unlimited.” Clearly, this guidance from the court is likely to be used by employees and their attorneys as a roadmap to challenge unlimited vacation plans for employees who have taken little vacation but are not being paid out anything at termination.
Bonus Concern: When Is a Release of Claims Not a Release?
While the court’s opining on unlimited vacation policies is the main focus of McPherson, the court also made other conclusions about releases and wage claims that are worth reviewing as a reminder that releases are not always completely effective against certain wage claims.
One such finding deals with general releases of claims. We note that this section of the court’s opinion is not certified for publication, but it is instructive nonetheless. One of the plaintiffs had signed a release in exchange for severance at the time of her termination. The release specifically provided that it was a release of claims under any state or federal labor law and that the employee understood that “[n]o additional payments will be due or made to you for salary, bonus, commissions, benefits, severance, vacation, personal days, or otherwise other than as specified in this agreement.” EF argued that this release precluded this particular plaintiff’s claim for vacation wages. The trial court, and the appellate court, disagreed.
According to the trial court, California Labor Code Section 206.5 “prohibits an employer from requiring an employee to release a claim for wages that are due and unpaid unless it has paid those wages.” However, wages “are not considered “due” under the statute if the employer and employee have “a bona fide dispute” as to whether they are owed.” Here, however, according to the court, there was no dispute over the vacation pay at the time the plaintiff signed the release of claims. Indeed, according to the court, at the time the plaintiff signed the release, “neither she nor EF knew EF owed her unpaid vacation wages. No conflict existed between them over vacation pay or any other earned, but unpaid wages, for that matter.” Thus the court held the plaintiff’s release was void under Section 206.5 as to vacation pay.
The court stated that it was not saying that an employee could never release unknown claims, just that “there must exist at least a “bona fide” or “good faith” dispute between the parties at the time the employee releases a claim for past wages for the release to be valid under section 206.5.” We note as well that most courts agree that in order to effectively waive claims under the federal Fair Labor Standards Act (“FLSA”), settlements must be supervised by either a court or the U.S. Department of Labor.
While the McPherson court construes this holding as dictated by precedent, it certainly seems to place more restrictions around when a release of a wage claim is valid than has long been thought.
Bonus Concern: How Far Back Does a Claim for Vested Vacation Go?
In affirming the amount of damages awarded to two of the three plaintiffs, the trial and appellate courts held that the plaintiffs’ claims for vacation pay that vested more than four years prior to their terminations were not barred by the statute of limitations. Like the section discussed above, this section of the court’s opinion is not certified for publication, but it is again instructive. The court noted that another Court of Appeal in an older case had held that claims for vacation pay were limited by the applicable statute of limitations back from the filing date of the claim. That court based its decision on a Division of Labor Standards Enforcement (“DLSE”) interpretive bulletin that applied the statute of limitations in a similar way. The McPherson court, however, stated that it was not bound by Sequeira and observed that more recent cases did not apply this “look-back” statute of limitations to claims for vacation pay. Rather, a claim could encompass all the vacation earned but untaken during an employee’s full term of employment or, in this case, dating back to the start of each plaintiff’s employment in the Area Manager position.
For employers who currently have or are considering unlimited vacation policies, the concept that they could be held liable for some amount of vested vacation back to the beginning of employees’ employment is troublesome. While the McPherson court claims not to be holding anything about unlimited vacation policies in general, as discussed above, it seems highly likely that unlimited policies that do not meet the factors laid out by the court could be challenged if not invalidated, putting employers on the hook for what could be years of vacation pay.
Bonus Concern: Can Vacation Policies Lead to Lawsuits in M&A Transactions?
The McPherson decision highlights how unlimited vacation policies are not without potential risk. In an M&A transaction, how to treat vacation pay is often a source of contention and the added complication of unlimited vacation may create additional risk. Illustrating the issues a vacation policy and how it is treated in a transaction can create is a lawsuit against General Electric Corp., filed in Pennsylvania state court by a purported class of up to 1,100 former GE Transportation workers whose employment was transferred to Wabtec Corp. when General Electric Corp. sold the GE Transportation division to Wabtec Corp. in February 2019. According to the employees, they should have been paid out for their accrued but unused vacation hours in accordance with a provision in their contracts. According to the complaint, employees who transferred to other divisions within GE, or stayed with GE and then left post transaction, either kept or were cashed out for their accrued but unused vacation. The employees who went to Wabtec, however, did not receive a cash out despite having been technically terminated as GE employees. These employees are now suing for that unpaid time, plus additional liquidated damages equal to 25% of their unpaid time or $500, whichever is greater, alleging that GE did not act in good faith when it failed to cash out its former employees.
This lawsuit highlights the importance of ensuring that vacation pay is handled correctly in corporate transactions, so that companies are not subject to unanticipated claims that neither the buyer nor the seller has taken into account in the transaction. McPherson found that an unlimited vacation policy actually wasn’t unlimited while also holding that vacation pay was not subject to a statute of limitations. If this type of finding was made in connection with a corporate transaction involving a large number of employees, the costs could be significant. Companies involved on both sides of a transaction should do their due diligence on all vacation policies and understand the various implications of how vacation pay will be handled when a transaction closes.
Employers should consider the McPherson findings and stated factors about when an unlimited vacation policy is truly unlimited and then assess their existing or planned policy to ensure that all of the factors – which include how the policy actually plays out in practice – are satisfied. Otherwise, employers may find themselves paying for vacation pay it did not plan, or budget, for, or subject to a lawsuit, as seen in the Pennsylvania case. Of course, as noted above, if the California Supreme Court accepts the case for review, McPherson will no longer be binding, though it would be citable for its persuasive value, and we will follow it for a potentially definitive ruling from the Court.
 260 Cal. Rptr. 3d 640 (Ct. App. 2020).
 260 Cal. Rptr. 3d at 646.
 The Court did reverse one aspect of the trial court’s ruling; namely, the amount of damages the trial court awarded to one plaintiff, who moved to Virginia from California during the course of her employment.
 McPherson, 260 Cal. Rptr. 3d at 655.
 McPherson, 260 Cal. Rptr. 3d at 654-55.
 McPherson, 260 Cal. Rptr. 3d 640, section not certified for publication.
 While most courts do take this view, there have been some decisions finding that a pre-litigation waiver of FLSA claims is effective. See, e.g., Martin v. Spring Break '83 Prods., L.L.C., 688 F.3d 247, 250 (5th Cir. 2012); Gaughan v. Rubenstein, 261 F. Supp. 3d 390 (S.D.N.Y. 2017), order withdrawn, No. 17-2490, 2017 WL 7532583 (2d Cir. Dec. 6, 2017).
 Sequeira v. Rincon-Vitova Insectaries, Inc., 32 Cal.App.4th 632, 637, 38 Cal. Rptr. 2d 264 (1995).
 Id. at 635.
 The McPherson court cited Church v. Jamison, 143 Cal.App.4th 1572 (2006) and Soto v. Motel 6 Operating, L.P. 4 Cal.App.5th 385 (2016).