On July 21, 2005, in Conley v. Pac. Gas & Elec. (2005) __ Cal.App.4th __, 2005 WL 1693801, the First District Court of Appeal decided an issue of first impression in California wage and hour law: whether an employer’s policy of charging its exempt employees’ vacation leave banks for partial-day absences (4 hours or more) from work renders all of those employees non-exempt as a matter of law under the salary basis test. The good news for employers is that the answer is no. In affirming the trial court’s denial of class certification for a proposed salary basis class of exempt PG&E employees, the Court of Appeal held that, consistent with federal policy, PG&E’s practice of deducting partial-day absences from vacation leave does not violate California law. 2005 WL 1693801, *1.

Under federal regulations implementing the Fair Labor Standards Act (“FLSA”), employers may not dock the pay of an exempt employee for an absence of less than a day (a partial-day absence). See 29 C.F.R. §§ 541.602(a), 541.602(b)(1). If the employer does so, the affected employees will not meet the salary basis test, and are non-exempt for purposes of overtime pay. 2005 WL 1693801, *3.

In Conley, there was no evidence that PG&E deducted exempt employees’ pay for partial-day absences. Instead, plaintiffs challenged PG&E’s express policy of making deductions from exempt employees’ vacation leave banks for partial-day absences. Plaintiffs contended that PG&E’s vacation leave policy constituted a reduction in the amount of compensation they received based on the quantity of work they performed. Thus, plaintiffs claimed that none of PG&E’s employees met the salary basis test, and therefore none of them were exempt. Based on this argument, plaintiffs sought to certify a salary basis class consisting of all PG&E employees classified as exempt. Id.

The trial court denied certification of this proposed class based on the lack of a viable cause of action. 2005 WL 1693801, *4. On appeal, plaintiffs relied primarily on Suastez v. Plastic Dress-Up Co. (1982) 31 Cal.3d 774. Suastez involved the interpretation of Labor Code section 227.3, which provides that “whenever a contract of employment or employer policy provides for paid vacations, and an employee is terminated without having taken off his vested vacation time, all vested vacation shall be paid to him as wages . . .” and that “an employment contract or employer policy shall not provide for forfeiture of vested vacation time upon termination.”

In rejecting an argument that the employer could avoid paying vacation pay to any employee terminated prior to his first anniversary date based on a one-year vacation “vesting” policy, the Suastez court analogized vacation pay to pension benefits, and held that “[t]he right to some share of vacation pay vests, like pension rights, on acceptance of employment,” and that a forfeiture of the right to vacation upon an employee’s termination was barred by the clear mandate of section 227.3. Suastez, 31 Cal.3d at 781-782.

The court in Conley held that plaintiffs’ challenge to PG&E’s vacation leave bank practices would expand the holding of Suastez too far, as “PG&E’s exempt employees do in fact receive all of the paid time off they have earned–they must simply use that accrued vacation time to make up for partial-day absences.” 2005 WL 1693801, *5. More specifically, the Court found that:

[B]ecause the deductions made from vacation leave banks of exempt employees represent days on which those employees have, in fact, taken at least four hours off work, PG&E’s vacation leave policy neither imposes a forfeiture nor operates to prevent vacation pay from vesting as it is earned. All it does do is regulate the timing of exempt employees’ use of their vacation time, by requiring them to use it when they want or need to be absent from work for four or more hours in a single day.

Id. (emphasis in original). The Court concluded by holding that nothing in California law precludes employers from following the federal rule that permits them to require the use of vacation leave for partial-day absences without causing otherwise exempt employees to become non-exempt under the salary basis test. Id., *6.

This is a significant development in California wage and hour law. In August 2002, California’s former Labor Commissioner Art Lujan announced that an exempt employee could not use vacation or paid-time-off (PTO) benefits in partial day increments without jeopardizing the exemption. Recently Labor Commissioner Donna Dell withdrew the August 2002 letter, but left unclear whether an employer may require employees to use vacation or PTO in partial day increments, as opposed to allowing exempt employees to voluntarily do so. (See “DLSE Rescinds Controversial Opinion Regarding The Ability Of Exempt Employees To Use Vacation In Partial-Day Increments” by Richard J. Simmons, Esq., posted on the Sheppard Mullin Labor & Employment Law Blog on June 27, 2005.)

The court of appeal’s decision in Conley now resolves this question and brings this portion of California’s salary basis requirements in line with federal authority. Of course, California’s wage and hour law still differs from federal law in many ways and California employers should ensure compliance with all relevant laws.