Legal News and Views

Uncertainty With Vacation Pay

By: Fadi Rustom

Kavanaugh Scully, Sudow, White & Frederick, P.C.

Under Illinois law, an employee who resigns or is terminated without having taken all earned vacation time must be paid for the unpaid vacation time upon separation. For example, if an employee is allotted two weeks of vacation in a given year, and quits before using any of that annual allotment, he is entitled to payment of two weeks’ salary. But a question facing many employers is whether the employee is entitled, i.e. has already earned, a portion of the vacation time for the following year. The answer hinges on whether, according to the employment contract, he earns the vacation time at a certain point every year, or if he earns it on a pro rata basis. The distinction may be slight, but the consequence is measurable.

Recently, an Appellate Court was faced with this question when the Department of Labor (DOL) filed suit against General Electric (GE) on behalf of GE’s former employees in People ex rel. Illinois Department of Labor v. General Electric, 282 Ill. Dec. 555 (1^st Dist. 2004). Two former GE employees worked a portion of their final year, earning vacation time, before retiring mid-year. Upon their retirement, GE paid the employees for unused vacation owed in the year they retired, but refused to pay for any additional amount. The employees, and eventually the DOL, demanded GE pay them vacation time they earned by working a portion of their final year, i.e. a portion of the vacation time the employees would have received the following year if they had remained on the payroll.

The 1^st District Appellate Court posed the question in this manner: "The core dispute here is whether GE employees earn vacation days for prior work, i.e., vacation time was compensation for the prior year’s work, or whether vacation days were given as an incentive for future work and were not compensation for past services." Id. GE’s employment policy, which was part of the employment contract, provided that GE employees had to work for a year before earning vacation time. On the date of his/her first anniversary, the employee would be entitled to varying amounts of paid vacation. The Court ruled that GE’s vacation policy arrangement was an "earn-in-arrears" policy whereby vacation pay was compensation for the prior year’s work, and thus awarded the former GE employees vacation pay that would have been allotted for the year following their departure.

To avoid problems with departing employees over vacation pay, employers should be very conscious of creating a detailed employee policy. A vacation policy should state how much vacation time an employee receives, how vacation time is earned, when vacation begins to accrue, when employees may use vacation time, any conditions on the use of vacation time, and what happens to vacation time that is left unused at year’s end. Employers may or may not wish to inform employees that employers must pay out unused vacation pay, but, either way, a vacation policy should not state that an employee forfeits accrued but unused vacation upon termination.

When drafting a vacation policy, employers can establish accrual by one of two options: forward-looking or earn-in-arrears. The choice may depend on the type of employment. For example, a high turnover position should incorporate an earn-in-arrears policy because very few employees endure an entire anniversary term. However, a forward looking policy, which awards employees all of their vacation days on the first of the year, may be more appropriate for permanent or semi-permanent positions.