Vacation Policies - Are You Giving Away the Bank?
By: INGRID N. CULP
September 2004
Do you have a sound vacation policy that is both clearly stated and protective of the company's interests? Consider the following:
Your policy states that an employee with three years of service is entitled to 15 days of paid vacation per calendar year. It also states that employees will be paid for any earned but unused vacation upon termination of employment. Susan Smith has worked for the company for just over three years. On January 1, 2004, the company credited her vacation bank with 15 days of vacation. On January 2, 2004, she resigned and, in addition to her final paycheck, requested payment for those 15 days.
Is the company required to pay Ms. Smith for all 15 days of vacation even though she worked only one day in 2004? Probably yes, at least according to its policy. With some skillful redrafting, the company could avoid this result and address other potential problems. There are several important issues every employer should consider before adopting and/or revising a vacation policy.
Are Employers Required to Provide Paid Vacation to Employees?
Contrary to what many employees believe, neither federal nor Minnesota law requires employers to provide paid vacation. Because of the significant benefits both employers and employees realize as a result of time away from work, however, it is customary for employers to provide it. Many employers find that paid vacation bolsters both recruitment and retention. Although the law does not require paid vacation, once an employer makes it available, it must carefully draft its policy to avoid ambiguity and comply with state law. Complaints regarding vacation time often arise as breach of contract claims, which can be costly and time-consuming to defend. This article addresses vacation policies drafted under Minnesota law.
When is Vacation Actually "Earned"?
A critical component of any vacation policy is an explanation of when vacation time becomes "earned." Once that occurs, an employee has a much stronger claim of entitlement to payment for any earned but unused vacation at termination or year-end. Many employers draft their policies so that vacation time is earned (or accrued) over time as opposed to credited to an employee's vacation bank all at once. Consider again Ms. Smith's situation:
Susan Smith is eligible for 15 days of paid vacation in calendar year 2004. Employer A credits Ms. Smith's vacation bank with 15 days of vacation on January 1, 2004 and this vacation is deemed "earned" as of that date. Ms. Smith may take this vacation at any time in 2004. Employer B does not credit vacation to employees at the beginning of the year but instead requires Ms. Smith to accrue her vacation over time at the rate of 1.25 (15 days divided by 12 months) days of vacation per calendar month.. Therefore, on the last day of each month, Ms. Smith's vacation bank is credited with 1.25 days of vacation. Her vacation is not deemed "earned" until it has been accrued.
On January 2nd, when Ms. Smith resigns and demands payment for her earned but unused vacation, Employer A will have to pay Ms. Smith for 15 days of earned but unused vacation. Employer B, on the other hand, owes Ms. Smith no vacation pay because she has not "earned" any as of her last day of employment.
Paid Time Off vs. Vacation/Sick Leave Policies
Some employers provide employees "Paid Time Off" as opposed to vacation time and sick leave. Under vacation time and sick leave policies, the employer typically provides a certain number of paid vacation days and a certain number of paid sick days. The employer requires that the employee actually be sick or caring for a sick family member when using the latter. These policies require the employer to police the employee's reason for being absent and may cause employees to feign sickness.
Other employers adopt policies (commonly referred to as Paid Time Off or PTO) that grant a pre-determined amount of paid time off to be used for any reason. Because employees are not required to give the reason for their absences, the employer need not police PTO's use. In addition, it is the employee's responsibility to monitor PTO use to ensure that enough is saved for illness or emergency. Once an employee exhausts available PTO, any additional time off is unpaid, or may result in discipline or discharge, depending on the circumstances.
Calendar vs. Anniversary Year
Some vacation policies simply state that employees will be entitled to a certain amount of vacation time "per year." Without additional clarification, this can cause confusion. Employers should structure their vacation policies based on either a calendar or anniversary year system and should clearly state how vacation will be handled in any partial year. For example, the employer should state that vacation time will be prorated based on the employee's start date and end date in the first and last years of employment.
Carry-Over of Vacation From Year-to-Year
Vacation policies should clearly state rules regarding carry-over of earned but unused vacation. Some employers adopt "use-it-or-lose-it" policies to encourage employees to take time off each year. Others pay employees for any earned but unused vacation at year-end or allow them to carry it over from year-to-year with no restrictions. Still others allow employees to carry over some portion (e.g., a maximum of one week) up to a stated cap (e.g., you may carry over all earned but unused vacation but at no time may your vacation time exceed XX days). For employers who pay out vacation upon termination, the least costly approach is to adopt a "use-it-or-lose-it" policy, though this may be unpopular with employees and illegal in some states.
Payment of Vacation Upon Termination
Whether an employer must pay out earned but unused vacation upon an employee's separation from employment largely depends on company policy and state law. Minnesota courts have mostly honored company policy (although not always), though its provisions will be reviewed critically and any ambiguity exploited. Accordingly, employers should address this issue very plainly in their vacation policies. Because some states require payment of earned but unused vacation upon termination regardless of the employer's policy, those with employees in multiple states must check applicable state law. Although most employers adopt an all-or-nothing approach, some adopt a policy that earned but unused vacation will be paid out only if the separating employee satisfies certain conditions (e.g., gives at least a two-week notice of resignation or is terminated without cause). These types of policies also should be reviewed under applicable state law for enforceability.
Revising the Company's Current Vacation Policy
Before revising a current vacation policy, the employer should make good on any prior promises for the current calendar or anniversary year. If revision arguably results in some loss of benefit for an employee, he or she potentially could assert a breach-of-contract claim. Err on the side of giving the employee the benefits of the current policy and only implement a new policy with sufficient prospective notice.
Other issues the policy should address include amount of paid vacation offered, any eligibility criteria, vacation use rules, borrowing against future vacation, and treatment of vacation in connection with other leaves of absence. Employers are advised to consult with employment law counsel concerning their vacation policies.