California employers, under federal wage-hour law (the Fair Labor Standards Act) have no requirement to offer or pay for vacation time off.

California employers, under state law, have the freedom to determine (a) whether to offer paid vacation, (b) the amount of paid vacation, and (c) the rate at which vacation is paid. Once an employer has a paid vacation policy, the law imposes specific restrictions on how an employer may implement that policy.

A. Use It Or Lose It Policies Are Illegal:

Employees who have paid vacation benefits, accrue (i.e., earn) vacation on a daily basis. An employee who has worked only one day under an available vacation policy has already earned a pro-rata portion of vacation. Labor Code §227.3; Czechowski v. Tandy Corp., 731 F.Supp. 406 (N.D.Cal. 1990).

A policy that allows employees to earn vacation, but disallows payment for that vacation unless the employee has worked to a specific date, is an illegal policy. Suastez v. Plastic Dress-Up Co. (1982) 31 Cal.3d 774.

Example: ERA has a probationary period of three months during which Debbie earns no vacation pay. After three months, she earns one half day per month. ERA has a policy that Debbie must stay until the end of her first year, or ERA will not pay for any partial year's vacation earned. This policy is illegal in California.

A policy that requires employees to use the vacation they have earned, or to risk losing that vacation if they terminate before using all of it, is an illegal policy. Suastez v. Plastic Dress-Up Co. (1982) 31 Cal.3d 774.

Example: Raul earns vacation during each year of employment. ERA has a policy that Raul forfeits any vacation earned, but not taken, during any year. This policy is illegal in California.

B. Capping Already Accrued Vacation is Legal, If Reasonable:

Employers may place maximum caps on the total vacation an employee may accrue/earn. Employers often have this policy because they want to encourage / force employees to take time off. Such caps on vacation accrual must be reasonable, and must not act to cause a forfeiture of vacation the employee has already earned. Boothby v. Atlas Mechanical Inc. (1992) 6 Cal.App.4th 1595.

Example: ERA has a policy that varies vacation earnings from one to two to three weeks per year, depending on the length of service to the company. ERA also has a policy that says the employee's vacation is capped at 40 hours beyond her annual accrual. This policy is legal. In each year, the employee can freely accrue vacation time, use that time during a reasonable period in the following year, and never face the loss of the ability to earn vacation.

Example: ERA provides one week of earned vacation during the first year, two weeks of earned vacation in the following years. ERA also places a two week cap on accrued vacation, so that employees do not earn any new vacation pay until they reduce their vacation below the two week limit. This type of policy is both legal and illegal. See Boothby above.

During the first year, Juanita has earned one week of vacation, and she is not up against the two weeks accrual cap. Most likely Juanita will take her one week of vacation during the second year. At the end of the second year, she has earned another two weeks. However, at the end of the second year, Juanita is immediately penalized by the fact that she cannot earn any new vacation in year three because she has not taken the previously earned two weeks. In other words, if Juanita's one year term ended on December 31st, she earns no vacation during her third year, until she takes vacation time off in the summer. She therefore suffer s a substantial penalty under this unreasonable cap to vacation time. This policy is probably legal only during the first year.

A. Paid Sick Leave Differs From Paid Vacation Time:

Under California law, employers do not have to pay for potentially accrued paid sick leave, but employers must pay for accrued vacation time. This distinction occurs because the obligation to pay for sick leave does not exist, until after what the law terms a “condition precedent” occurs, namely the employee (or family member in some cases) actually has an illness or injury. If an employee never gets sick, the possibility exists she will never use a portion, or all, of her available paid sick leave. See DLSE Interpretive Bulletin 86-3.

In contrast, vacation is considered a form of hourly pay, and is considered earned whether the person ever reaches a particular milestone, e.g., staying employed for an entire year.

This distinction allows employers to maintain a “use it or lose it” policy with regard to sick leave, when employers may not have such a policy with regard to vacation pay.

B. Personal Time Off (“PTO”) Is Treated As Vacation Pay:

California employers often combine their types of leave together and offer workers the right to take time off either for illness or for personal reasons. The combined leave is called Personal Time Off or some similar term.

Personal Time Off is treated as vacation pay, because the employer has no stringent requirement that a “condition precedent” (e.g., illness) occur before the employee may get paid for their PTO days off. See DLSE Enf. Manual, Oct. 98, Op.Ltr 1986.11.04; DLSE Enf. Manual, Oct. 98, Op.Ltr 1986.10.28.

Example: ERA elects to mix sick pay and vacation pay together to call the joined time, Personal Time Off. ERA allows employees to use PTO for illness, personal reasons, vacation time, or any other personal time off. It is illegal to refuse payment for accrued PTO on the argument that ERA “intended” employees to use part of that time for illness.

C. Floating Holidays Are the Same as Vacation Pay:

Some employers make various holidays available to employees for their own personal, selective use. In other words, the employer does not require that a specific event happen (e.g., July 4th) before the employee is eligible for that payment. Some employer make the floating holidays available for birthdays, anniversaries, religious events, or whatever holiday the employee believes important. Such days are essentially the same as vacation pay, because no particular event (“condition precedent”) must occur before the employee is eligible to take the floating holiday time off. DLSE Enf. Manual, Oct. 98, Op.Ltr 1986.10.28.

Example: ERA offers 8 paid holidays and 2 paid floating holidays per year. Ismael quits on July 10th, but has not taken his 2 paid floating holidays. ERA agrees to pay for July 4th, but not for the two unused floating holidays. It is probably illegal to refuse payment for those 2 unused floating holidays.

D. Sabbatical Leave, In Most Cases, Is the Same as Vacation Pay:

Sabbatical leave is generally intended to compensate long term, special employees for a specific period of time off. In many cases, the sabbatical leave is granted to allow the employee to engage in specialized study, a special seminar, or a trip of special interest to that employee's career. As one example, some employers grant sabbatical leave after six full years of employment, to those in certain professional jobs.

For bona fide sabbatical leave, no pro rata entitlement to such leave occurs during employment. However, the Division of Labor Standards Enforcement has established a definition for bona fide sabbatical leave. See DLSE Ltr of Oct. 6, 1987. DLSE Enforcement Manual, Oct. 98, §13.4. That definition requires that the sabbatical leave be:

Example: ERA provides sabbatical leave for those with tenures of more than six full years. ERA provides separate vacation pay. ERA is generous and makes the sabbatical leave available to everyone, regardless of rank or job. The sabbatical leave is not restricted to certain specific persons and may become treated exactly like vacation pay for accrual purposes.

E. Federal Law Does Not Control Vacation or Other Forms of Similar Pay:

The Fair Labor Standards Act does not require employers to have vacation pay, paid time off, sick leave pay, or sabbatical pay. When an employer has contractually agreed to provide these forms of compensation, the FLSA does not enforce those compensation contracts.

A. Employers May Not Ignore Incentive Pay When Computing Vacation Pay

Employers may establish whether they will pay for vacation (or other forms of time off equivalents), and employers may establish the amounts they will pay for vacation (or its equivalents).

Employers, however, often create problems for themselves by designation that they provide “paid” vacation, but failing to designate how that “pay” is calculated. Again, under California law all ambiguities in the compensation bargain are interpreted against the drafter (the employer in most cases).

Example: General Company tells its employees that the company allows employees to take vacation time off, but the company specifies that all employees are paid “Zero” during their vacation time off. When Harold takes two weeks off from his sales position, the company pays him nothing for the two weeks. In addition, General fails to credit him for the two weeks of purchase orders that arrive during the two weeks, asserting it agreed to pay him “Zero” for those two weeks. It is illegal for the company to cause a forfeiture of the commissions during those two weeks for all the reasons specified elsewhere. The ambiguity in “Zero” must be interpreted against General, and its “taking” of the commissions violates Labor Codes §§ 200, 221, and 223.

Example: Prescient Company tells all its employees that the company allows employees to take vacation time off, but the company specifies that all sales employees are paid “only their base amount” during the vacation time off. When Kuldip takes two weeks off from his sales position, the company pays him his $500 per week base for each of the two weeks. Prescient does credit him for the two weeks of purchase orders that arrive during the two weeks. Prescient has acted legally.

B. Employers May Not Substitute Employee Earnings for Employer Obligations

Vacation pay is a form of supplemental employer payment for contributions made by an employee. The presumption is that the employee is not rendering his/her regular duties to “earn” the vacation pay being given. Some employers assume improperly they may take credit as payments to the employees, the earnings that the employee is generating during the vacation period.

Example: Hegemony Corporation tells its employees that the company allows employees to take vacation time off, but the company “Pays” for their vacation time off. The policies do not specify what is meant by “Pays.” When Tawana takes two weeks off from her sales position, the company pays her the $500 base for the two weeks, and also credits her for the two weeks of purchase orders that arrive during the two weeks. Hegemony pays nothing more. By failing to define “Pays” Hegemony has left itself open to the interpretation of that word as being the total of both base and average commissions for the weeks prior.

Reasoning: In this Hegemony example, the company may not assert that when it permitted Tawana to receive both base and purchase order commission credits, the company met its obligations. In reality, Tawana earned the commission she was paid during those two weeks. Hegemony never paid her, as unearned income, a vacation equivalent for her commissions. Since vacation pay is compensation for time off, not for services rendered, Hegemony may not take credit as having paid for vacation compensable commissions through the commissions Tawana earned during that period of time.

A. Employers Have the Entire Burden for Justifying the Forfeiture of Earned Wages:

Employers often pay commissions, bonuses, “Spiffs,” “push money,” incentives, or other forms of extra compensation which are often determined by sales results. Since such forms of income are strictly construed to be “wages,” these incentives are tightly controlled and regulated under California law.

In general, a laborer deserves to “enjoy the fruit of the tree he has shaken.” That laborer deserves the benefit of that fruit, even if it falls after he has terminated his employment. Zinn v. Ex-Cell-O Corporation (1944) 24 Cal.2d 290.

Most employers fail to properly construct a valid, enforceable commission, incentive forfeiture agreement (i.e., one that allows the employer to cease paying commissions to an employee on the date of that employee's termination). A valid wage forfeiture agreement must:

B. Forfeiture of Future Compensation Creates an Assignment Under Labor Code §300:

Labor Code §300 provides that no assignment by an employee, of his/her present or future wages, is valid unless certain stringent requirements are met. Among those Labor Code provisions are the following:

Employers are themselves bound by the provisions of Labor Code §300 when they attempt to become the assignees of future wages. A written agreement that an employee will assign the receipt of certain future commissions, including commissions received after termination of employment, constitutes an assignment subject to Labor Code §300. Fitch v. Pacific Fidelity Life Ins. Co. (1975) 54 Cal.App.3d 140. The purpose of §300 was to protect wage earners from themselves, i.e., from the possibility that “either from improvidence or under the stress of immediate necessity, they may go too far in sacrificing the future to the needs or desires of the present ...” Id. at 147.

Example: After Tom quits, his employer informs him that, per “industry custom,” Tom has forfeited his last month's commissions to his successor salesperson, i.e., his replacement. The employer cites the fact that when Tom started with the company, five years previously, he received the benefit of his predecessor's final month's commissions. Because Tom received a month's commission at the start of his employ, and industry custom is to give residuals to the successor salesperson, Tom has to give up his final month's commissions. Tom never signed anything in writing agreeing to this policy, nor did the company notify him of this policy. The company's forced forfeiture of earned commissions is illegal under Labor Code §300.

C. Ambiguous Incentive Pay Language Works Against the Employer:

Since most employers draw up their incentive compensation plans, they are the ones who have constructed the language in those comp plans. Any ambiguous language is interpreted against the person who drafted the language and failed to make the language clear. Dana Perfumes v. Mullica, 268 F.2d 936, 937 (9th Cir. 1959); Civil Code §1654.

Example: The written commission agreement says only the following about when commissions are no longer paid: “The employee's right to commissions stops on the date of termination.” In another place, the agreement says: “No commission shall be payable on sales or shipments on orders subsequent to termination of employment for any reason.” Gail argues that her employer must issue commission checks beyond Gail's last date of employment, because her commission agreement's language was ambiguous as to whether the right to commission “earnings” or the right to commission “payments” actually stopped on her last day of work. She thought her “earnings” stopped on her last day. If her story is credible, the courts will award her the commissions based on her argument.

D. Employers May Not Manipulate Payment of Incentive Pay:

Where an employer retains unilateral control over (a) whether an employee is credited with a customer payment, and (b) the date of employee termination (or transfer from sales job), the employer must exercise its unilateral control to the benefit of the employee. To do otherwise, is conduct in violation of public policy. McCollum v. Xcare.net, Inc., 12 F.Supp.2d 1142.

Example: Anne's written comp agreement said the following: “Your employment is at will. The company is free to transfer or discharge you at any time. You are not entitled to receive any commissions after your last day of work in the territory, regardless of how that work ended. When any dispute arises over whether a commission should be paid, the company retains full unreviewable authority to resolve that dispute.” Knowing a customer will submit a payment to Anne's territory, the company transfers her and does not credit her with the payment. Although the company complied with its incentive compensation contract, the company acted in bad faith by using its authority under the contract to deny Anne her commissions.

Example: The written commission agreement ends December 31. On January 1st, the employer promises LaToya a new compensation plan for the calendar year “soon.” LaToya continues working, and in response to LaToya's repeated inquiries, the company keeps promising a new plan “soon.” Over the last four years, the employer has always delayed 2 to 8 weeks into the year in providing the new comp plans, but each plan has offered a substantial increase in LaToya's compensation. On April 15, her new plan arrives, but the commission rate drops 25%, and the drop is retroactive to January 1st. The employer never suggested that her compensation might go down with her new plan. Because the employer has unilateral control over LaToya's comp plan, which he has used in bad faith to frustrate her legitimate expectations, the employer has violated the implied covenant of good faith and fair dealing.

Note: This last example could also implicate Labor Code §221, if LaToya has been paid on a draw more than the amount to which she is entitled under the new, lower commission rate. The employer could not force her to repay him any of her earned wages. Also, LaToya might have a cause of action for breach of the implied-in-fact contract guaranteeing her old commission rate through at least April 15.

E. Employers May Not Prevent Accrual of Incentive Pay:

Where an employer has control over the timing of a customer payment, the deposit of a payment, or any other aspect of a customer payment that results in a commission, the employer must exercise that control to the benefit of the employee. To do otherwise, is conduct in violation of public policy. Ellis v. McKinnon Broadcasting Co. (1993) 18 Cal. App.4th 1796.

Example: The written commission plan said the following: “You must generate $500,000 in gross sales for the fiscal year ending on September 30th to obtain your bonus. In addition, you must still be employed on December 31st to earn that bonus.” Sarwat sold over $1 million by September 30th. He sold another $200,000 before he quit on November 1st. He insists on being paid his bonus when those checks are issued on December 31st. The court should require the company to pay Sarwat the bonus, since he completed all sales work essential to “earning” the bonus, and the Dec. 31st date was an arbitrary date set by the employer to try and keep employees for as long as possible.

Reasoning: To demand an additional three months of work after an employee has completed all terms of a bonus agreement constitutes a form of bad faith conduct and would therefore be unconscionable. McCollum v. Xcare.net, Inc. 12 F.Supp.2d 1142.

Example: The written commission agreement said the following: “You have no entitlement to receive any commission payments after your last day of employment. When customers make payments to the company from your sales efforts after your employment is terminated (whatever the reason for your termination), you will receive no commissions from such post-employment payments.” Knowing that a customer has submitted a purchase order and will be paying some 30 days later, Judy gets into a fight with her supervisor over his alleged sexual harassment, and Judy quits. She also demands the commission on the customer sales order whose payment will arrive after her termination. If the court finds Judy voluntarily quit and was not the victim of a constructive discharge, the court will most likely allow the company to avoid paying Judy the commission, since she voluntarily abandoned her right to the amount.

Example: The written commission plan establishes quotas for each calendar quarter as follows: Q1 - $250,000, Q2 - $500,000, Q3 - $750,000, Q4 - $1 million. By June 1, Jose had already hit the following: Q1 - $250,000, Q2 - $900,000. On June 15, Jose's employer says he has to reach $1.5 million each, in Q3 and Q4. Jose states his strong disagreement, but keeps working for the company. When he narrowly misses the $1.5 million mark for Q3, his employer refuses to pay his commissions. Jose quits and sues.

The employer cites DiGiacinto v. Ameriko-Omserv Corp. (1997) 59 Cal. App. 4th 29 to say Jose is out of luck, because his continued performance on the job equaled his acceptance of, and consideration for, the unilateral contract with higher quotas. The employer should lose, though, because he has manipulated Jose's plan in bad faith in order to defeat his legitimate expectations, and thus is in breach of the implied covenant of good faith and fair dealing. See McCollum above.

Labor Code Provisions:

Labor Code §221 provides that is unlawful for an employer to collect or receive from an employee any part of the wages already paid to that employee.

Labor Code §223 provides that it is unlawful to pay less than any contract or statute requires, while purporting to pay the required wage.

Labor Code §224 provides a list of deductions which an employer may lawfully make from an employee's wages. Those deductions include amounts:

Labor Code §226 provides that employers must provide an itemized breakdown each time the employer makes deductions from an employee's paycheck.

A. Employers May Recover Losses Only in Defined Situations

Employee wages in California have a special status, beyond that of revenue derived from any other type of contract. Because wages are given special consideration, they are particularly and especially protected. Wages are generally beyond the reach of claims by an employer. Kerr's Catering Service v. Dept. of Industrial Relations (1962) 57 Cal.2d 319, 325.

As a result, employers must treat those wages, once earned, as the employee's property. Because wages belong to the employee, employers cannot capture (i.e., make deductions from, or use self-help repossession of) wages except under very stringent and controlled conditions.

Example: Alisa, the salesperson, discovered someone had broken into her car and stolen a box of 500 diskettes and software licenses. The total value of the loss was $50,000. Alisa's boss had repeatedly said to park the car in a safe area when that proprietary software was in the car. It is illegal to deduct the $50,000 from Alisa's paycheck for any breakages, losses, equipment breakdowns, or shortages caused by simple negligence.

Example: Ted, the salesperson, left his car open at a friend's house, walked away intentionally, and came back after receiving a cell phone call that the “merchandise was home.” The total value of the stolen software was $50,000. Despite the owner's insistence, the DA's office will not prosecute the alleged “theft.” It is legal to take the $50,000 in losses from Ted's paychecks, so long as the business can prove Ted's culpability by a preponderance of the evidence. An employer need not wait for a criminal conviction to make a paycheck deduction.

B. Employers May Deduct Salary Advances But Not Accelerated Loan Payments

Example: Edward took a salary advance of $3,000 so that he could buy some computer equipment from his own company, and he signed a salary advance form. After 10 weeks of $100 payroll repayments to the company, Edward quit, and the HR Manager deducted the final $2,000 from his final paycheck. It was legal to deduct the payroll advance from the final paycheck, because the company had already paid the $2,000 to Edward as a wage advance.

C. Business Losses Cover a Wide Variety of Sources

An employee cannot be made, in effect, an “insurer of the employer's merchandise.” Kerr's Catering, supra at 327. Therefore, an employer may not make deductions from pay checks for (a) shortages, (b) breakages, (c) loss of equipment, (d) inventory errors, (e) pilferage, (f) paper errors, (g) “inevitable” losses to the business operation, or (h) losses passed on to the consumer. Kerr's Catering, supra.

Commission and commission type payments are wages under California wage law. Labor Code §201. Deductions from commissions and other forms of incentive pay operate under the same rules as to other deductions. Employers may not deduct their customary costs of doing business from commissions, when those costs are not created by an employee's intentional misconduct intended to harm the employer.

Example: A retail store suffers losses from bad customer credit cards, intentional giveaways of merchandise by employees, and employee “discounts” which personnel have improperly given to their friends. Since the store cannot tell which employee caused these losses, the store simply deducts the losses from the gross amounts used to calculate commissions for all employees. It is illegal to take such deductions from employees, because the losses are part of the cost of doing business, and the employer has never identified which specific employee caused which specific intentional loss. Hudgins v. Nieman Marcus (1995) 34 Cal.App.4th 1109.

Example: A software sales company suffers losses from (a) customers who failed to pay, (b) customers who became dot bombs via bankruptcy, (c) losses of merchandise, (d) returned or damaged merchandise, (e) credits given to customers dissatisfied with the performance of the software. The software firm deducts all these losses from Jeraldo's gross sales figures and then calculates commissions using the net sales figures. It is illegal to calculate commissions in this manner, because doing so makes Jeraldo bear part of the customary losses from doing business, i.e., an insurer of the company's profitability. It is illegal to make these calculations, even if Jeraldo has signed a written agreement authorizing the deductions.

To induce employees at hire, or to retain employees after hire, employers sometimes offer either “sign-on” or “retention” bonuses. Generally, the employer fails to put into writing the specific consideration the employee is providing in return for the bonus. In fact, the agreements generally fail to even indicate that the employee's provision of services for a defined period of time constitutes the consideration for the bonus. Instead, the agreements generally refer to the fact that the employee will pay back the sign-on or retention bonus, if the employee's employment ends for any reason before a specified date.

Often the parties reach an agreement regarding the year in which that income is credited to the employee for tax purposes. (This paper does not examine the tax related issues pertaining to such prepaid sign-on or retention bonuses). Sometimes the employer requires a promissory note, separate from the employment agreement, recharacterizing the “bonus” instead as a “loan.”

A. Employers Retaining the Right to “Recover” Bonuses Violate Labor Code §221

When an employer makes a payment up front and retains the ability and legal authority to demand the return of that payment, such demand for payments already made violates Labor Code §221. Since employers are free to make payments of sign-on or retention bonuses on a weekly or monthly basis, the payment of the full amount up front constitutes a payment of full wages up front.

Example: Advantage company learns its key engineer, David, has been given a job offer, including a sign-on bonus, from another company. To retain David, Advantage orally offers him a $24,000 retention bonus. David turns down the other job, but never receives the retention bonus. After 3 months of requests go nowhere, David finally receives a “promissory note” to sign for $24,000 which he agrees to repay if he leaves before providing 24 months work. David completes 4,000 hours of work in one year, another 2,000 hours in the following six months, and quits, after finishing the engineering project scheduled to take 24 months. He quits after 18 months. The BAP has ruled David has to pay the entire $24,000 back to the company. Plaintiffs' attorneys should disagree with this conclusion.

B. Employers Retaining the Right to “Recover” Bonuses Violate Labor Code §223

When an employer makes a payment up front and then retains the ability and legal authority to demand the return of the payment, such a scheme is, in reality, a violation of Labor Code §223. Employers who claim they are free to recover sign-on or retention bonuses are, in effect, generating a “kickback” scheme illegal under California law.

Example: Advantage company hires key engineer, David, and orally offers him a $24,000 sign-on bonus. Advantage requires David to sign a “promissory note” for the $24,000 under which he agrees to repay the amount if he leaves before providing 24 months work. The “promissory note” is a form of “kickback” disallowed under California law. Sublett v. Henry's Turk and Taylor Lunch (1942) 21 Cal.2d 273.

C. Employers Retaining the Right to “Recover” Bonuses Violate Labor Code §300

As indicated above, Labor Code §300 provides that no assignment by an employee, of his/her present or future wages, is valid unless certain stringent requirements are met.

A written agreement, i.e., a promissory note, providing that an employee will assign the earning of certain future wages, including sign-on and retention bonuses, constitutes an assignment subject to Labor Code §300. Fitch v. Pacific Fidelity Life Ins. Co. (1975) 54 Cal.App.3d 140. Again, as indicated above, the purpose of Labor Code §300 was to protect wage earners from sacrificing future income through such imprudent decisions.