Use it or lose it? Court rules on vacation plans

Dean Harris

The Colorado Supreme Court recently issued perhaps the most-awaited employment decision in years.  In Nieto v. Clark’s Market, the court ruled that “use it or lose it” vacation policies are illegal under the Colorado Wage Claim Act (CWCA), which requires employers to pay all wages due at the time of termination, including vacation pay “earned and determinable in accordance with the terms of any agreement between the employer and employee.” Consequently, once an employee has “earned” vacation, it can’t be forfeited.

Clark’s Market had an interesting vacation policy stating, “Vacation time is earned during the anniversary year previous to [when] it is taken.”  The policy provided that vacation time did not carry over from year to year. Upon termination, the employee would receive pay for “vacation benefits earned as of your last anniversary date, but not taken by the date of separation.”  

Nieto sued Clark’s Market when it didn’t pay her for 136 hours of accrued, but unused, vacation leave when her employment was terminated. The trial court dismissed her case because her vacation pay had not vested — or yet earned. The Colorado Court of Appeals agreed and rejected Nieto’s appeal. The Colorado Department of Labor and Employment (CDLE) responded by passing an emergency rule that equated the terms “accrued” and “earned,” although the CWCA doesn’t define the term “earned.”  

The Colorado Supreme Court overturned the Court of Appeals decision. The Supreme Court held that once vacation is earned, it can’t be forfeited. So-called “use it or lose it” vacation policies that take away vacation already accrued but not used within a specific time period violates the CWCA. The Supreme Court held it wasn’t required to give deference to the CDLE interpretation of the CWCA, but adopted the CDLE rationale in holding “any vacation pay Nieto accrued prior to her termination was “for work [she] already performed” and, thus, ‘earned.’”  

However, the Supreme Court addressed a narrow issue and left unaddressed some issues on which employers and employment attorneys hoped the court would provide guidance.  In one sense, the court kicked the can down the road by equating “accrued” and “earned.” I can already hear the gears turning as employers and employment lawyers ponder vacation plans in which vacation is made available, but does not “accrue.”

A significant issue that was not before the court was how paid time off (PTO) is treated under the CWCA. The Court of Appeals decision left an opening for the Supreme Court to address this issue by citing PTO cases from other states as persuasive authority on whether conditional payment provisions pertaining to vacation pay are enforceable. But the Supreme Court didn’t take the bait  — reasonably so, since addressing the PTO issue wasn’t necessary to decide the case before the court.

In recent years, many employers have moved from traditional leave plans that award separate sick and vacation leaves to PTO plans that can be used for a wide variety of absences, including sickness, vacation and personal needs. While an employee may use all of their PTO balance for vacation, it’s equally true an employer could use all their PTO balances for sickness or injury and none for vacation. If the employee can use any or all of their PTO balance for vacation, is an employer required to pay all accrued but unused PTO leave upon termination as it must for vacation balances? Or may an employer pay out only a portion of PTO it calculates was awarded for vacation rather than sickness or other personal needs?

Many employers simply take the conservative approach to managing financial risk and pay all earned but unused PTO upon termination, just as they would do if they offered traditional vacation benefits. But on the other end of the spectrum, it’s difficult to imagine a Colorado court would allow an employer to escape all liability for payment of PTO simply by eliminating a vacation plan and renaming it a PTO plan.  

In the Nieto ruling, the court reinforced the longstanding rule an employer isn’t obligated to offer vacation at all, and the agreements between employers and employees may address how and when employees earn vacations. An employer with a PTO plan could conceivably state PTO leave is available for vacation, sickness, injury or other personal absences, but explain how the employer allocates PTO for each circumstance. The employer would then pay out upon termination that percentage of amount of leave awarded to allow for vacations. An employer considering this type of plan to reduce unfunded liabilities should contact legal counsel before implementing such a plan since this approach is untested in Colorado.  

Whether an employer offers vacation or PTO, the best way to avoid large unfunded liabilities is to never create them in the first place. An employer must pay accrued but unused vacation upon termination, but employers may limit the amount of vacation employees are permitted to accrue and how employees use vacation.  Employers may impose a cap on how much vacation an employee may accrue and restrict employees who hit that cap from accruing more leave until the employee falls below the allowable accrual limit. Where staffing allows, an employer can require employees to use vacation time to draw down balances. This is particularly effective for industries that experience seasonal fluctuations.

Attorneys at the Employers Council are glad to discuss vacation and other leave policies with Employers Council members and help draft effective policies that make financial sense for employers while promoting employee satisfaction.