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May 17, 2017
Permanent Vacation: ‘Use It or Lose It’ Policies and Payout of Vacation at Termination
By Holly Jones, JD, Senior Legal Editor

In part one of this article, I addressed the benefits of offering paid vacation to your employees. While offering vacation isn’t required under federal law—once an employer has made the decision to offer vacation time—local state laws and court decisions can come into play. State laws addressing vacation typically fall into three categories—those that prohibit any forfeiture of vacation time; those that are silent on the subject (typically interpreted to allow forfeiture of earned time); and those that fall somewhere in between.

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Vacation shaming now plaguing workplaceEssentially, the issue is whether vacation time is considered a form of wages. Except in very limited circumstances, employees’ wages cannot be forfeited and must be promptly paid out when earned and on termination. So, in states where vacation is considered an alternative form of wages, this time cannot be forfeited, whether from one year to the next or at the employee’s discharge.

Some states, such as California, Montana, and Nebraska, leave no room for doubt—vacation time is wages, period, end of sentence. In these states, once employees earn vacation, then that time cannot be forfeited for any reason.

Other states, such as New York, North Carolina, and Ohio, will also treat vacation time as wages by default; however, employers in these states are also permitted to draft policies to the contrary. As long as the employer’s policy clearly sets forth that, for example, earned but unused vacation will not be paid out at termination or will not roll over from year to year, then the employer’s policy will take control.

Then there are states such as Alabama, Florida, and Texas, which have few or no laws addressing payout of vacation at termination. In these states employers are also generally permitted to adopt “use-it-or-lose-it” policies, whether in annual rollover or at termination, but there is one important caveat here, too. (Isn’t there always?) Even when the law doesn’t require payout of vacation, if an employer’s policies or practices suggest otherwise, then the policy may create an entitlement to those vacation hours at termination, just as if they were wages.

In other words, even when state laws are silent on the issue, state courts have interpreted employee policies and handbooks to create a type of implied contract or promise, under which employees have become entitled to their earned vacation time. (If you’re not sure which category your states are in, check out the State Law Chart Builder for a quick reference.)

As with any policy, the key, here, is to be unequivocal in your drafting. If you want to pay out earned vacation to employees on discharge, say so. If not (and assuming you’re not in a state that forbids such policies), then say so—and say so in the clearest terms possible. Courts will nearly always interpret policies in the manner most favorable to the employee, so if there’s any vagueness, it’s going to work against you.

Notwithstanding the existence of a specific “use it or lose it” law, many employers still opt to pay out such time upon termination. One reason is that employers with operations in multiple states may simply find it easier to adopt the same payout policy across the board—it raises fewer questions and potential legal issues.

Additionally, and as a practical benefit, when employees know they will receive equivalent compensation for any accrued vacation when and if they leave your company, workers who may already have one foot out your door have less incentive to stick around longer than necessary just to use up their vacation.

Would you rather have a disenchanted employee take 2 weeks of paid leave only to return and announce, surprise, that he is leaving—or would you rather the same employee give his notice sooner, enabling the search for a replacement to begin and reducing the disruption and awkward downtime. The honesty and efficiency of transition may be worth far more than the wage equivalent of that employee’s unused vacation.

Alternative Vacation Policies and Strategies—Accrual Caps

It is important to note that, even in states where earned vacation may not be forfeited, the key to this right is that the vacation has been earned—in other words, a wage right has vested in that time.

If vacation is not earned—and no right vested in it—then no payout or nonforfeiture right exists. If an employer had no vacation policy at all, then even in the most employee-friendly states, that employer would have no requirement to pay out vacation time at termination—because no such time had been earned.

Why is this significant? Because caps that prevent employees from accruing/earning additional vacation time above a set maximum are one way that employers can curtail liability for wage payout upon vacation.

Let’s say you have employees who are banking up hundreds of vacation hours—perhaps they’ve been with your company for years and simply accrue leave faster than they can reasonably use it. If these employees leave your company before using that time, it could create a pretty hefty wage payout at discharge, which may be an unpredictable expense your organization would prefer to avoid.

An employer in California cannot place a limit on the number of hours these workers can carry over from year to year. If Ann has earned 160 hours of vacation, you can’t tell her that she will lose anything over 80 hours if not used by the end of the year. This would be an unlawful wage forfeiture.

However, you can place a cap on further accrual of leave. In other words, you can specify that, once an employee has accrued 80 hours (or more) of earned vacation time, then additional hours will not accrue until the balance is reduced below the maximum cap.

The difference is nuanced and requires careful and clear drafting, but when executed properly, these policies meet the statutory needs because the employees never forfeit earned leave. Rather, they cease earning additional leave—and how and to what extent leave is earned in the first place is one of the policy areas that lies completely in employers’ control.

Alternative Vacation Policies and Strategies—Open and Unlimited Leave Policies

For similar reasons, more employers are also experimenting with open or unlimited leave policies, which can offer the same benefit. The general idea of an open or unlimited vacation policy is that the employee doesn’t really accrue or earn a set amount of leave per pay period or year. Rather, leave is unlimited and may be subject to few, if any, restrictions beyond supervisor approval and a reasonable assurance that assigned duties, projects, clients, and other workload-related details are managed during the worker’s absence.

Here, because employees are not accruing a set number of wage-equivalent hours per pay period, no compensation interest vests. After all, you can’t very well pay out “unlimited” vacation at termination.

Open and unlimited leave policies are not without their downsides, though, so employers that wish to experiment with these policies should do so carefully and thoughtfully. If approval of leave requests will be at the sole discretion of management, then managers will need some guidance on reasonable leave use and consistent and fair approval of requests.

For example, should requests for more than 3 consecutive weeks require HR approval? Equally important, managers must ensure that employees—particularly those same employees who keep leaving unused vacation on the table each year—are actually taking leave.

Bottom Line

When it comes to vacation, generally your policy is king. As noted in part one in this article, this gives employers a great opportunity to really get creative and offer a customized paid leave package that serves the needs of the workplace and the standards in your industry—while also motivating (and medicating) your employees with a few days of palm trees and piña coladas.

But with great power comes great responsibility. While drafting your policy and putting those terms into practice, be mindful of the precedent you set and the terms you choose and the expectations—and potential promises—they may create. Particularly in the states that don’t specifically prohibit “use it or lose it” policies, whether you’re required to pay out vacation at termination could be a matter of interpretation of your company policy—or even your established practices.

If in doubt, it’s always a good idea to have local legal counsel review your policy for language that may create an unintended promise of leave (and, from that, create a wage equivalency). You may also wish to check with your state departments of labor for specific guidance on how your policy could be interpreted in the event of a wage claim.

Related Resources

HollyHolly K. Jones, JD is a Senior Legal Editor for BLR’s human resources and employment law publications. She understands the existing and emerging needs and challenges of human resources professionals thanks to several years of experience managing, writing, and editing key legal and compliance publications for BLR. Prior to joining BLR, Ms. Jones worked for the Tennessee Legislature's Office of Legal Services.

She graduated magna cum laude and Phi Beta Kappa with a BA in English Rhetoric and Writing, Political Science, and Psychology from the University of Tennessee in Knoxville, Tennessee, where she also received a 2001 Citation for Extraordinary Academic Achievement. She received her law degree from Vanderbilt University Law School and is licensed to practice law in Tennessee.

Follow Holly Jones on Google+

Questions? Comments? Contact Holly at hjones@blr.com for more information on this topic

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