A Minnesota Court of Appeals decision — requiring an employer to pay a terminated employee nearly 200 hours of accrued vacation — is the latest reminder to employers to be cautious in denying employees their earned and accrued paid vacation, according to Irrigator Technical Training School.

The recent decision, Lee v. Fresenius Medical Care, might be appealed and overturned. And it applies only in Minnesota. But the conclusion is a reminder to employers in all states that it can be risky to adopt policies that put restrictions on the payment of earned and accrued vacation. Some states forbid the practice. And in other states, courts have defined earned and accrued vacation pay as earned wages due to employees.

Facts of the case: The employer, Fresenius Medical Care, had a policy in its handbook telling employees, “…if your employment is terminated for misconduct, you will not be eligible for…payment of earned but unused [paid time off] unless required by state law.”  Fresenius terminated Susan Lee’s employment for misconduct and refused to pay her nearly 182 hours of earned, but unused, vacation time.

Lee contested the employer’s denial. The District Court ruled in favor of the employer, determining the handbook policy was part of the employment contract between Fresenius and Lee. Since Lee was discharged for misconduct, the District Court concluded she was not entitled to be paid for unused vacation time under terms of her employment contract.

However, Minnesota law states an employer must pay a discharged employee “wages or commissions actually earned and unpaid at the time of the discharge…” But the state law does not define "wages."

The Appeals Court ruled in August of 2006:

The term "wages" includes pay for accrued vacation time.
Under Minnesota law, an employer “cannot provide by contract what is prohibited by statute.”
Thus, under Minnesota law the Appeals Court stated: “When an employer discharges an employee, any compensation for accrued vacation time that the employee has earned but has not been paid at the time of the discharge is immediately due and payable upon demand of the employee.”

A “use it or lose it” policy: The Minnesota case raises another question common for many employers: Can an employer adopt a "use it or lose it” vacation policy, telling employees any accrued vacation time not used after a certain date is lost?

The general rule followed under “wage and hour” laws and court decisions is:

Employers don’t have to give their employees a paid vacation benefit.
But if employees earn paid vacation under an employer’s established policy, the employer owes the employee the paid vacation — or paid wages in lieu of the vacation.
So a “use it or lose it” policy can be risky and in some states it is not legal. (Note: To determine what the law in your state may be on this and related questions, review your vacation policy with an attorney familiar with state employment law.)

For example, some years ago, in California, a terminated employee sued his employer for $24,200 because of a "use it or lose" vacation policy. The employee claimed he had 22 weeks of unused vacation accumulated over 13 years in two separate stints at the company.

The California Court of Appeals declared the policy a violation of state laws. (When an employer promises a vacation, that becomes part of the employee’s compensation for time put in. Even if vacation is deferred — earned now, taken later — it is compensation due the employee.) The court said an employer can’t promise vacation and then take it away...even if the employer has a policy in it’s employee handbook stating that’s what will be done.