On June 14, 2021, the Colorado Supreme Court issued its highly anticipated decision in Nieto v. Clark’s Market, ruling that employers must pay out an employee’s earned but unused vacation pay upon separation of employment, even where an agreement or policy authorizing forfeiture of such pay exists. The impact of the ruling is significant, as so-called use-it-or-lose-it vacation policies, which have become commonplace for Colorado employers, are now prohibited as a matter of law under Colorado’s Wage Claim Act (the Act). The ruling also marks the end of an otherwise contentious legal and administrative battle involving the courts, interested parties and the Colorado Department of Labor and Employment (CDLE) regarding the propriety of use-it-or-lose-it policies, providing much-needed clarity to employers regarding their payment obligations.

Background on Colorado Wage Claim Act

As background, Section 8-4-101(14) of the Act defines “wages” and “compensation,” which must be paid out at separation from employment, to include “vacation pay earned in accordance with the terms of any agreement.” The Act further provides 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.”

Historically, this language has caused widespread confusion. On the one hand, those in favor of forfeiture argue that the Act requires only the payout of vacation time “earned in accordance with the terms of any agreement,” including, as the case may be, agreements mandating the forfeiture of earned but unused vacation time. Employee advocates, on the other hand, have taken the opposite position, relying, in part, on a separate provision of the Act – Section 8-4-121 – which prohibits the waiver or modification of any employee rights provided by the Act, including through an oral or written agreement.

Conflicting Lower Court Decisions and CDLE Regulations

In Nieto, the employer did not pay a discharged employee her accrued but unused vacation pay pursuant to its policy that employees forfeit their vacation pay, prompting the employee to file suit. Finding in favor of the employer, the appellate court initially advised that use-it-or-lose-it vacation policies were permissible under Colorado law if they did not operate to deprive employees of earned vacation time.

In response to this ruling, the CDLE, in August 2019, issued an emergency regulation opposing the decision, which later became permanent, in December 2019. In contrast to the appellate court, the CDLE’s regulation clarified that it would interpret Section 8-4-101(14) of the Act to prohibit forfeiture of any earned but unpaid vacation without restricting agreements on matters such as “whether there is vacation pay at all,” including agreements concerning the amount of vacation pay, how it accrues and potential caps. Under the regulation, then, employers could minimize payout liability at separation by capping the amount of vacation pay that accrues each year, provided that they pay out accrued but unused vacation pay at separation.

The Supreme Court’s Ruling – What’s Included and What’s Not

Through its decision last month, the Colorado Supreme Court resolved the discrepancy between the lower court’s ruling and the Colorado Department of Labor and Employment (CDLE) decision, adopting the CDLE regulations in full. As a result of that decision, all earned and determinable vacation pay must be paid at the end of the employment relationship regardless of the terms of any forfeiture policy or agreement. To limit the scope of their liability, however, employers are permitted to impose a cap on employees’ accrual of vacation time.

Notably, the Supreme Court’s decision makes clear that the Act does not entitle an employee to vacation pay or require an employer to provide for vacation pay in any employment agreement. However, if an employer provides vacation pay, any accrued and unpaid vacation must be paid out at the end of the employment relationship.

By contrast, the Supreme Court’s decision leaves open the question of whether or not similar obligations apply to paid time-off (PTO) compensation that is accrued but unpaid. PTO compensation often encompasses different types of leave, including, but not limited to, legally required leave (e.g., sick leave), personal leave and vacation. While the CDLE has previously advised that PTO is not subject to the vacation payout provision at issue in Nieto, the Supreme Court’s decision creates additional ambiguity in this area for employers, and employers are strongly advised to consult legal counsel regarding PTO-related payout questions until further guidance is available.

Practical Guidance and Takeaway

Colorado employers, including employers based in other states who have Colorado employees, should act now to ensure compliance with the Act as interpreted in Nieto. Employers should review their policies and procedures to remove use-it-or-lose-it forfeiture language applicable to vacation pay and, if necessary, replace it with caps on vacation accrual (or, alternatively, flexible vacation policies that do not involve accruals) to limit the maximum liability at separation. In addition, employers should exercise caution in applying use-it-or-lose-it policies to PTO compensation, including for personal or general leaves of absence. Finally, employers should continue to monitor the state’s regulation of leave-related payouts upon separation from employment, including in the PTO context, and ensure that their policies and procedures follow the CDLE’s and the judiciary’s latest guidance. As always, employers with specific questions concerning the scope and impact of the Act and the Supreme Court’s decision on their particular operations should consult with legal counsel to determine the best course of action.