Recently, Colorado’s Department of Labor and Employment (CDLE) proposed certain amendments to the rules promulgated under Colorado’s Wage Protection Act (WPA) and the Colorado Wage Claim Act (CWCA) related to the payout of vacation time when an employee is discharged from employment. The proposed amendments, if permanently adopted, will prohibit employers from establishing agreements requiring employees to forfeit unused vacation pay at the end of the employment relationship.

‘Use it or lose it’ as interpreted in Nieto

As recently interpreted by the Colorado Court of Appeals, Colorado law currently allows employers to include a “forfeiture” clause, also known as a “use-it-or-lose-it” clause, in their employment contracts. Such clauses allow employers to refuse to pay out unused vacation time upon employees’ separation or termination from employment. In Nieto v. Clark’s Market, Inc., the court of appeals upheld an employer’s enforcement of its use-it-or-lose-it policy upon the termination of its employment relationship with a worker.

In Nieto, the district court found in favor of the employer when a former employee sued under the CWCA after the employer refused to pay out her accrued but unused vacation time when she left its employ. The district court held that the employer’s handbook clearly states that an employee “forfeits all earned vacation pay benefits” if she is discharged, with or without cause, or if she voluntarily leaves the company but fails to give two weeks’ notice. The court of appeals affirmed the lower court’s determination that the policy didn’t violate the CWCA because the payout of vacation time is dependent on the employment agreement signed by the parties.

Under the CWCA, “wages” or “compensation” includes “vacation pay earned in accordance with the terms of any agreement” (emphasis added), and any “wages or compensation . . . unpaid at the time of such discharge is due and payable immediately” when an employee is involuntarily separated from employment. The court concluded that because the terms of the employment agreement are controlling in determining which wages or compensation are due at the time of discharge, an employer that refuses to pay out unused vacation at the time of discharge pursuant to its use-it-or-lose-it policy would not be in violation of the CWCA.

Changes proposed after Nieto

After the release of the Nieto decision, the CDLE adopted proposed rules interpreting the WPA. The rules became effective on August 20, 2019, albeit temporarily, but they may become permanent in December. A public hearing on the proposed rules will be held by the CDLE on October 15. If they’re made permanent, the rules would effectively mandate that use-it-or-lose-it policies that apply to vacation payout at the time of discharge violate the CWCA.

The proposed rules state that “vacation pay,” which is included in the definition of “wages” or “compensation,” is “earned in accordance with the terms of any agreement.” However, they further unambiguously state that “if an employer provides paid vacation for an employee, the employer shall pay upon separation from employment all vacation pay earned and determinable in accordance with the terms of any agreement between the employer and the employee.” The proposed rules also interpret the CWCA’s language pertaining to vacation time “earned and determinable in accordance with the terms of any agreement” to prohibit employers from requiring the forfeiture of any earned vacation pay upon the separation of employment.

Employers may continue to establish agreements addressing whether they offer any vacation pay for employees, as well as the amount and frequency of accruable vacation pay during specific employment periods. Employers may also continue to have use-it-or-lose-it policies that limit the rollover of unused vacation from one year to the next, but such policies may limit rolled-over vacation time only when an employee has already accrued one year’s worth of vacation time (or more). The proposed rules include the following example:

[For] an agreement for ten vacation days per year . . . [the employer] may provide that employees can accrue more than ten days, by allowing carryover of accrued vacation from year to year; (b) may provide that employees cannot accrue more than ten days, by disallowing carryover of unused vacation from year to year; but (c) may not provide that after an employee accrues ten days, that amount diminishes below ten days for any reason.

The CDLE supported its proposed rules against use-it-or-lose-it provisions by stating:

Recent interpretations that unused vacation pay is forfeited upon employment separation [are] contrary to the text and legislative intent of the vacation pay statute, which states that the “wages” or “compensation” that cannot be forfeited include “vacation pay earned in accordance with the terms of any agreement.”
. . .

The legislature expressly rejected a prior version of that provision that would have allowed an “agreement between the employer and the employee that requires or results in loss or forfeiture of accrued vacation pay.”

Judicial action and executive reaction

Assuming they stand, the proposed rules will provide further clarity on the prohibition against forfeiture of vacation pay upon separation from employment under Colorado law. In any event, the CDLE’s rulemaking response to the Colorado Court of Appeals’ holding in Nieto presents an interesting example of the interplay between the state’s executive and judicial branches. We will continue to monitor the status of the CDLE’s rules, including whether they are permanently adopted, and track this area of the law as it develops.