Unused vacation time can represent a substantial liability on the books for many employers. Therefore, the extent to which you can control the payout of unused vacation time upon an employee’s separation from employment is an area of significant interest. The following case may provide new ammunition for enforcing restrictive policies on vacation payouts, including limiting such payments to employees who are not involuntarily terminated or who voluntarily depart with sufficient advance notice.

CWCA governs payout of unused vacation time

The Colorado Wage Claim Act (CWCA) provides that when an employer discharges an employee, “the wages or compensation for labor or service earned, vested, determinable, and unpaid at the time of such discharge is due and payable immediately.” The CWCA includes vacation pay in its definition of wages and makes clear that if an employer provides a paid vacation benefit, it must pay a departing employee all vacation time that’s earned and determinable “in accordance with the terms of any agreement between the employer and the employee.” The CWCA further states, “Any agreement, written or oral, by any employee purporting to waive or to modify such employee’s rights in violation of this article shall be void.”

But Colorado law doesn’t give employees a substantive right to payment for unused vacation time. Rather, as the Colorado Court of Appeals clarified in Barnes v. Van Schaack Mortgages, “[an] employee’s substantive right to compensation [for accrued vacation time] and the conditions that must be satisfied to earn such compensation remain matters of negotiation and bargaining, and are determined by the parties’ employment agreement, rather than by the statute.”

Operating under this law, employers are free to set the terms and conditions under which payment of unused vacation time may occur upon employees’ separation from employment. However, the limits on your right to set such terms and conditions are an issue that’s still developing both in Colorado and around the country.

Court of appeals OK’s employer’s restrictive rule

On June 27, 2019, the Colorado Court of Appeals decided a case involving an employer policy that revoked employees’ right to payment for unused vacation time if they were discharged or voluntarily quit without giving two weeks’ notice. Affirming the district court’s judgment, the court of appeals held that the policy didn’t violate the CWCA.

Facts. While working for Clark’s Market, Carmen Nieto accrued vacation time pursuant to the policy in its employee handbook. The market’s policy explains how vacation time accrues, how (and when) it can be used, and whether and under what circumstances employees are entitled to payment for accrued but unused vacation time when they leave their employment.

Addressing the latter issue, the policy says an employee is entitled to payment for accrued vacation time if she voluntarily resigns and gives at least two weeks’ notice, but if the market discharges the employee for any reason or for no reason or if she fails to give two weeks’ notice before quitting, she “forfeits all earned vacation pay benefits.” When the market discharged Nieto, it refused to pay her for the vacation time she hadn’t used, in accordance with its policy.

Nieto sued, seeking payment for her accrued vacation time and alleging the market’s forfeiture policy violated the CWCA by denying her payment for earned wages. The district court dismissed her claim, concluding the Act “clearly and unambiguously gives [an employer] the right to enter into agreements with its employees regarding vacation pay.” The Colorado Court of Appeals affirmed.

Court’s decision. In reaching its decision, the court of appeals relied on its decision in Barnes, in which it held that the CWCA didn’t entitle the employee to payment for loans he originated that closed in the month following his termination because his employment agreement “expressly and unequivocally provide[d] that [he was] entitled to incentive fee commissions only if he generated loan applications that resulted in loan closures during the calendar month when his employment terminate[d].” As in the Barnes case, the court held the forfeiture provision at issue in Nieto’s case didn’t violate the CWCA because she hadn’t fully earned the vacation-related compensation under the employment agreement.

The court also relied on decisions outside Colorado in which courts applied wage payment statutes similar to the CWCA in cases challenging the validity of employers’ paid time off (PTO) policies. For instance, in Lee v. Fresenius Medical Care, Inc., a Minnesota court reasoned that because vacation pay is “wholly contractual,” employers are permitted to “set conditions that employees must meet in order to exercise their earned right to vacation time with pay.” The policy in that case stated that terminated employees weren’t eligible to receive payment for earned but unused PTO. Similarly, in Indiana Heart Associates, P.C. v. Bahamonde, an Indiana court upheld a policy saying an employee was ineligible for payment for accrued PTO if the individual was “involuntarily terminated” for unsatisfactory work, gross misconduct, or violation of any rule.

The court held that Nieto wasn’t entitled to payment for her unused vacation time because the market’s policy unequivocally said her pay wasn’t vested under the circumstances in which she left her employment. Nieto v. Clark’s Market, Inc.

Ramifications for employers

The Nieto case strongly affirms that Colorado employers are free to set the terms and conditions for paying unused vacation time upon employees’ separation from employment. The policy at issue in the case was certainly restrictive in that it essentially gave the employer the unilateral right to write off unused vacation time for every employee it fired, even if the termination occurred because of a mass layoff or for financial reasons out of the employee’s control. In other states (e.g., Illinois), such an adverse action is expressly prohibited by statute.

Whether the court’s ruling withstands a potential appeal to the Colorado Supreme Court will be worth watching. In the meantime, you should review your policies on paying out accrued vacation time and consider updating them to limit your liability in the future.