California and federal law contain overtime pay exemptions for executive, administrative and professional employees. In order to qualify as exempt, employees must meet requirements regarding their duties and salary. For example, they ordinarily must spend over half their time on exempt duties and receive a minimum amount that is paid on a “salary basis.” Currently, the minimum is $28,080 a year under state law.

In 2002, former Labor Commissioner Art Lujan issued a letter that narrowly construed state law to prevent exempt employees from using vacation and paid time off (“PTO”) benefits when they miss a partial day of work. The letter also addressed the amount of notice employers must provide before requiring employees to use vacation or PTO. Because the letter appeared flawed and eliminated flexibility that exempt employees desired, Richard J. Simmons of Sheppard, Mullin, Richter & Hampton LLP and others asked the Division of Labor Standards Enforcement (“DLSE”) to reverse its position. We are pleased to report that these efforts have been partially successful. Labor Commissioner Donna Dell has now reevaluated the 2002 opinion and depublished it. The development affects exempt employees and, to a lesser extent, nonexempt employees too. It is generally quite favorable.

1. The 2002 Opinion That Created The Controversy

On August 30, 2002, Labor Commissioner Lujan issued a controversial opinion regarding the salary requirements of state law applicable to exempt employees. The opinion examined four separate questions.

It first addressed whether an employer may shut down operations for a full seven-day workweek without paying the exempt employees’ salaries for the workweek. Based on an earlier letter dated March 1, 2002, the DLSE concluded “that a weekly salary test may be used to meet the California requirements for a monthly salary.” Accordingly, an employer may deduct a full week of salary as a consequence of a full week shutdown without jeopardizing the exemption.

The second question inquired whether an employer must allow exempt employees to use accrued vacation or PTO in order to be paid for a full week shutdown. The DLSE opined that the right of employees to take vacation or PTO would depend on the employment agreement or policy on the use of such benefits since it is not mandated by state law.

The third question raised a more controversial issue. It addressed whether employers may require exempt employees to use their accrued vacation or PTO if no work is available for a full week. The DLSE explained that its “historic enforcement policy” regarding employer-mandated usage of vacation or PTO provides that employers “must give the employee a minimum of nine months notice” prior to the week in which the time must be taken. The nine-month advance notice rule appeared highly arbitrary and unrealistic.

The fourth question involved the most controversial issue. It focused on (a) whether an exempt employee who takes a partial day off may use accrued vacation or PTO for the partial day and (b) whether the employee’s salary can be deducted for the hours missed if no accrued vacation or PTO is available. The DLSE first agreed with the federal standards that prohibit deductions from the actual salary for partial days missed by exempt employees. However, it then deviated from the federal standards regarding the use of vacation and PTO benefits. Specifically, the DLSE refused to allow employees to use vacation or PTO in partial day increments, even when they wished to do so. Further, it stated that the outcome did not differ whether the partial day off “is the result of the employee freely choosing to leave work early for personal reasons, or the result of the employer sending the employee home.”

In a statement that appeared inherently flawed and illogical, the August 30, 2002 letter stated that “state law does not permit the deduction of accrued vacation or PTO when the employer already has an independent obligation to pay the exempt employee’s salary.” This flawed reasoning constituted the foundation for the DLSE’s conclusion that, in contrast to federal law, exempt employees could not be allowed or required to use vacation or PTO benefits in partial day increments. While the state and federal enforcement policies regarding the inability to take deductions from an employee’s salary for a partial day missed were compatible, the DLSE’s departure from the federal standards regarding the use of vacation and PTO benefits for partial days missed was troublesome to put it charitably.

2. New DLSE Development

In asking the DLSE to review the 2002 letter, Richard J. Simmons of Sheppard Mullin Richter & Hampton LLP and others argued that it was illogical and unjustifiably eliminated flexibility that exempt employees often desire. After examining the applicable authorities, Labor Commissioner Donna Dell agreed. She determined that the reasoning and conclusions in the 2002 letter were flawed. In fact, an internal memorandum issued by Labor Commissioner Dell on May 31, 2005 expressly disagreed with her predecessor’s conclusions.

The reevaluation of the issue occurred in the context of a review of prior opinion letters under the Administrative Procedure Act. Based on that review, Labor Commissioner Dell has “removed” the highly controversial opinion letter from the DLSE Enforcement Manual and website. While certain concerns still exist regarding the advance notice that employers must provide before mandating the use of vacation and PTO, the development is generally quite positive.

In her memorandum, Labor Commissioner Dell reached two significant conclusions. First, she addressed the feature in the 2002 letter which stated that employers must provide at least nine months notice before requiring employees to use their vacation or PTO. She determined that no legal authority supported the position taken in the 2002 letter regarding the nine-month notice standard. Second, she addressed the interpretation in the 2002 letter that prevented exempt employees from using vacation or PTO in partial day increments. The memorandum states that the 2002 letter was “clearly flawed because taking fully-paid vacation time off without any reduction in salary cannot be distinguished as a forfeiture of wages solely on the basis that it is taken in a partial day rather than a full day.”

Unfortunately, the memorandum does not eliminate the problems with advance notice where employees are asked to use their vacation or PTO. It states that “reasonable notice” of employer-mandated usage of vacation or PTO is necessary. Such notice apparently must be at least “one full fiscal quarter or 90 days, whichever is greater.” That policy apparently is not limited to exempt employees and may often be difficult to satisfy, e.g., where reductions in staffing needs are not foreseeable far in advance. Nevertheless, while requiring employees to use benefits may raise significant concerns, it appears that employees can be allowed to use their vacation or PTO without regard to the “reasonable notice” standard. For example, it is likely that nonexempt employees will often prefer to use such benefits in many instances to avoid taking the time off without pay.

Several issues in this area remain confusing and debatable.
Employers are therefore advised to consult their legal counsel before modifying any compensation or vacation policies.