In an unpublished opinion issued earlier this week, the federal Ninth Circuit Court of Appeals held that when a California employer pays out an employee’s vested vacation upon the termination of employment pursuant to Labor Code section 227.3, the employer must pay the vacation time at a “final rate” that includes shift differentials. The court rejected the employer’s position that it could pay the vacation time at the employee’s “base rate.” This unpublished opinion is not controlling precedent, but as discussed below, we encourage California employers who provide paid vacation to consult counsel to discuss their practices and policies regarding payment for vested, unused vacation upon termination of employment.

Labor Code section 227.3 provides, in relevant part: “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 at his final rate in accordance with such contract of employment or employer policy respecting eligibility or time served.” The key question at issue is the meaning of the phrase “final rate.”

In Mills v. Target Corporation, 2023 WL 2363959 (9th Cir. Mar. 6, 2023), a former employee was paid a base rate of $13.00 per hour, but at the time of her termination, she was also paid a $2.00 per hour temporary shift differential for work during the COVID-19 pandemic. Upon termination, Target paid the employee $13.00 per hour for her unused, vested vacation, because the company would have paid only the base rate of $13.00 per hour if she had taken vacation at the time of her employment. But the employee argued she should have been paid $15.00 per hour, claiming Section 227.3 requires a payout of vested vacation at the “final rate” of “wages” she would have earned for work at the time. In a brief opinion, the Ninth Circuit agreed with the employee and held that the payout for unused vacation time must include the shift differential.

However, the court acknowledged that there is little authority on this question. (Indeed, there is no published, controlling California appellate case on this issue.) The Ninth Circuit also acknowledged that decisions in the lower court have been split, and the California Department of Labor Standards Enforcement (DLSE) had issued opinion letters supporting Target’s position. For these reasons, although the Ninth Circuit ultimately disagreed with the DLSE and some lower courts, it concluded the law was “uncertain,” and Target’s withholding of wages was based on a “misunderstanding” of the law. Therefore, the court did not impose penalties under Labor Code section 203 for willful failure to pay wages upon discharge.

Notably, the new Mills decision is unpublished, which means it is not controlling precedent. However, pursuant to the applicable rules, it may still be cited, and other courts may find it persuasive. Therefore, we encourage California employers who provide paid vacation to consult counsel to discuss the possible impact of this decision.

If you have questions about how this case will affect your business, please contact us.

• Katie M. McCray (kmccray@wilsonturnerkosmo.com)
• Emily J. Fox (efox@wilsonturnerkosmo.com)
• Marissa Lyftogt (mlyftogt@wilsonturnerkosmo.com)

Wilson Turner Kosmo’s Special Alerts are intended to update our valued clients on significant employment law developments as they occur. This should not be considered legal advice.