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Major Labor Law Changes Will Impact Employers in China

November 28, 2006

The labor contract law took effect on January 1, 1995. At its inception, this law was meant to outline and establish the basic standards for labor related matters in China. Over 33% of the labor contract law relates to the labor contract itself, including: probationary periods, term of the contract, protection of employees, remuneration, termination of employment, leave, and social insurance.

After 11 years, the Chinese government and people felt that the current labor contract law did not provide the necessary protections and stability for its employees and employers, especially under China’s reformed economic system. The central government also wanted the opportunity to revise the law to address specific issues and clarify ambiguities. Some provinces and cities enacted their own local rules and standards for employment contracts where the labor contract law was silent.

The goal of the Chinese government and the people is a draft labor contract law that strengthens the protection of Chinese employees’ rights and interests. It is not difficult to understand this posture, in light of the government’s end goal in reforming the labor contract law to address the following stated concerns:

  1. Political and economic stability.
  2. Premier Wen Jiabao’s policy on protecting the common persons, referred to as “laobaixing.” These individuals previously worked in the agriculture arena and huge numbers have recently migrated to the cities to work in the manufacturing and construction industries. Due to the labor surplus, these individuals have very little bargaining power with employers (both Chinese and foreign).
  3. A surplus of written, but unsigned and unsecured labor contracts.
  4. The vast majority of the labor contracts that are signed are poorly drafted and rarely enforced, resulting in a plethora of complaints by Chinese employees that they are not paid in a timely manner or are not paid at all.
  5. Lack of health care and/or health care allowance for local employees.

With these concerns in mind, the stated purpose of the draft labor contract law is three-fold: to provide greater protections for Chinese employees, promote a good working relationship between the employer and its Chinese employees, and create a harmonious society.

After receiving more than 190,000 comments questioning the effectiveness of the draft to advance the goal, the draft labor contract law remains virtually unaltered and contains monumental changes to the manner in which a business employs individuals in China.

Major Changes in the Draft Labor Contract Law

The most significant changes reflected in the draft labor contract law are highlighted below.

1) Non-Compete Agreements and Provisions
Current Law - The permitted restricted period of time is a maximum three years.

There is no geographic restriction.

Monetary consideration paid to an employee for entering into the non-compete varies geographically. Industry practice has been somewhere between 30%-50% of the employee’s annual salary, paid over a period of time upon termination of the employment contract.

In the event of a breach, there is no mention of a cap on damages payable to the employer.

Draft Law - The permitted restricted period of time is a maximum two years.

A geographic restriction must be included and it must be limited to geographic areas where real competition is or may arise.

Although the draft law clarifies that monetary consideration must be paid to an employee, in order to enforce the non-compete, there are a few ambiguities. First, monetary consideration is defined as no less than the employee’s “annual salary.” The problem is that “salary” is not defined and employers are left with the question of whether “salary” includes bonuses and employer paid benefits to the employee. Second, the draft law currently does not have exceptions for payment of the noncompete consideration should the employee (1) violate the terms of his/her employment agreement, (2) resign his/her employment or (3) is employed for a very short period of time. Third, the draft law is silent as to whether full payment must be made immediately upon termination of the employment contract or whether payment can be made over a period of time. Although we remain hopeful that these issues will be addressed prior to final enactment, we do not have any assurances at this time that this will occur.

In the event of a breach of the noncompete by the employee, there is now a provision addressing liquidated damages. The provision caps damages at three times the amount paid to the employee by the employer. This cap causes concern in the intellectual property arena, where the value of the intellectual property could be much higher. Thus, this amount is not enough of a deterrent to the employee and Foreign Invested Enterprises (FIEs) may continue to be hesitant to bring their intellectual property to the PRC.

The new draft law is silent as to the employee’s confidentiality provisions.

2) Probationary Periods
Current Law - Probationary periods can last up to six months based on the term of the employment contract. There are no specific job classifications of employees. In other words, employers can determine the probationary period based on the skills required for the job.

Draft Law - Probationary periods can last one to six months, depending on job classification. The following are the delineated job classifications, with attendant time periods:

  • Non-Technical - Maximum one month.
  • Technical - Maximum two months.
  • High/senior technical - Maximum six months.

Employers should note that the draft law does not define which job positions fall within each job classification. It is unknown at this point whether this will be clarified in the final enactment or whether employers will be left to their own devices to define which job positions fall within each job classification. If the latter, compliance will be an issue.

3) Training
Current Law - There is no formal definition of what constitutes employee training. Employers and employees sign separate agreements that apply only to training. The training agreements govern each party’s rights and responsibilities and are specifically tailored to reflect the needs and desires of each party. Any repayment of training expenses by the employee is set out in the training agreement.

Draft Law - Employee training is narrowly defined as technical full-time training. This definition presents particular challenges for employers. It may cause some employers to hesitate to provide training because they are unable to provide full-time training. In turn, this will affect the employee’s ability to develop and expand much needed employee skill sets, as was intended by the Chinese government. In addition, the training definition fails to recognize many informal means of training that are valuable to employees, such as on-the-job training.

Repayment of training expenses is allowed only if the employer provided training satisfies all of the following: (1) the training is full-time; (2) it is off-the-job technical training; and (3) such training lasts for a period of six months or more. Additionally, the way the draft law is written, it appears that such full-time, off-the-job technical training must be conducted for the employer by a professional training company. Thus, according to this criterion, training at an employer’s home office is not subject to reimbursement. Further, the draft law does not define expenses, so it is unclear if the cost of meals, lodging, transportation and similar costs are also subject to repayment.

4) Trade Unions
Under the draft law, trade unions have a much greater role in monitoring and approving employment changes in the following areas.

Mass Layoffs
Current Law - Mass layoffs and seasonal hiring practices are permitted with little explanation required by an employer for such action. Employers must only inform both the trade unions and employees and present a proposal for such layoffs. After providing such proposal, employers must report back to the labor administration department. Currently, there is no real negotiation with or approval by a trade union that is required. The practice has been to lay off long-term employees due to performance reasons, as well as to prevent employers’ employee benefit obligations from accruing (e.g. social benefits, welfare benefits, etc.).

Draft Law - Under the new draft law, when an employer plans to terminate more than 50 employees, it must establish a change in the company’s objective circumstances and negotiate the terms of the lay-off with the trade union or, if no union, the entire staff of the employer. If an employer fails to satisfy both of these criteria, the layoffs/terminations are void. In addition, employers are now required to retain employees with longer service histories.

Company Rules
Current Law - With no guidance or requirements in the current law, employers often draft their own employee handbooks, manuals and work rules. Enforcement is very similar to that in the United States, with fairness and degree of conduct weighed.

Draft Law - Essentially, every employer policy, rule and procedure that governs its employees must be discussed and approved by the union or employee representative. Rules unilaterally imposed by the employer will be void. The term “employee representative” is new and remains undefined in the draft law. There are also unique challenges for employers posed by this new provision. This provision fails to recognize the fluid nature of employer policies and rules. As stated, every change must be approved by the trade union or employee representative, which will inevitably lead to delay in timely implementation. And, despite the trade union’s power to effect employee policies and rules, an employer is ultimately on the hook for what is implemented. Finally, it is worth noting that this provision does not contain any incentive for the trade unions and/or employee representative to negotiate with employers.

Termination of Labor Contract
Current Law - Although the current law is silent on this issue, the PRC trade union law, as well as some local labor regulations (e.g., Shanghai labor contract regulation), state that an employer must notify trade unions of its intent to unilaterally terminate any labor contract. The employee can seek redress through arbitration or the court system if he/she feels his/her termination is illegal or improper.

Draft Law - Employers must seek permission of the trade union prior to termination of any labor contract, even if for cause. Although the PRC has always recognized termination for cause, now it will be more difficult to do so because of this additional approval step. This timing issue could create obstacles for employers who are faced with the need to immediately terminate an employee for criminal or other conduct against an employer’s interest.

5) Severance Pay
Current Law - The PRC does not recognize at-will employment. The current practice is to enter into short-term employment contracts. These labor contracts may include renewal provisions that may or may not affect severance pay. The labor contract usually contains a severance payment provision, with standard severance set at one month annual salary for each year of service. Similar to the United States, severance provisions often contain exceptions for termination with cause. If the employee is not working out, the employer would merely let the labor contract expire and no severance would be due. If an employee believes that his/her termination is unlawful, the employee often will go to court. However, this action often proves too costly for some employees.

Draft Law. Severance is payable in the event a fixed term contract expires and the contract is not renewed. Fixed term contracts cannot be terminated early, except for cause or mass layoffs (e.g., termination of more than 50 employees). In both instances, employers must seek permission of the trade union.

If an employee succeeds in establishing unlawful termination, the employee is entitled to severance pay that is equivalent to two months salary for every year
of service.

This could present a problem for employers if an employee chooses not to renew his/her fixed term contract. The current language of the draft law seems to imply severance would be due.

6) Labor Dispatch Service/Employment Agency
Current Law - There is no provision governing labor dispatch services, commonly known as employment agencies. Representative offices (one form of investment vehicle for foreign companies) are prohibited from hiring employees directly. Representative offices are required to use these employment agencies to hire all of their local employees. These employment agencies are state-owned and take a percentage of the employees’ salaries in return for providing the employee insurance and other human resource services. These individuals are employees of the employment agencies, not the representative offices.

Draft Law - Representative offices cannot use these state-owned employment agencies to avoid coverage of the new draft labor law. State-owned employment agencies can only outsource an individual for one fixed term contract. Upon expiration of the term, the representative office (or any business using such an agency) must directly hire the local employee. If the employee is not hired by the representative office after expiration of the fixed term employment contract, the employer cannot fill such position through any employment agency.

This poses particular challenges for employers who need only seasonal, temporary or project based workers. In addition, what happens when the individual is not a good fit? The draft law places a heavy burden on employers who hire through these agencies to find the prime candidate for a position the first time because there is no second chance.

7) Provisions Interpreted In Favor of Employee
Current Law - There is no specific provision in the current law that deals with the interpretation of the law should inconsistencies or ambiguities exist.

New Law - Despite the power of the trade unions to negotiate terms of the labor contract on behalf of and in the best interest of the employee, the new law specifically provides that ambiguous terms are to be construed against the employer.

Likewise, there are specific provisions mandating that all employees must have an employment contract. The mere existence of an employment contract will be construed in favor of the employee.

What You Should Do As An Employer In China
It is no surprise that the draft labor contract law has drawn criticism from both employees and employers alike. The reality is that the draft labor contract law will probably be enacted in large part as the draft remains today. To prepare for the new labor contract law, we suggest the following:

  1. Know when the final labor contract law becomes enacted and takes effect;
  2. Know if any current employment contracts and/or non-compete provisions will need to be adjusted once the final labor contract law takes effect;
  3. Familiarize yourself with the important provisions that will impact your daily hiring and firing needs;
  4. Refine your internal human resource function to account for the new administrative steps that all employers will need to follow when employing and managing employees in China;
  5. Create a checklist of all employer obligations under the new law by category and designate someone to monitor compliance when business changes are made that will or could affect the workforce;
  6. Adjust your business schedule and budget to account for the added time and expense it will take to consider and negotiate labor contracts, change and implement employee policies and work rules, and terminate unskilled labor;
  7. Educate your executive team, front line managers and human resources staff of the new employer obligations and penalties associated with failing to comply with the new employer obligations; and
  8. Examine your bottom line: human capital costs. It may just become more expensive to employ individuals in China with noncompete assurances and severance obligations.

With these first steps, employers in China should be in good shape to face the new labor contract law and all the changes it is expected to bring to the Chinese workforce.

If you have any questions or would like additional information, please contact Christine Liu McLaughlin of our Employment Law Practice Group (414-287-9232 or cmclaughlin@gklaw.com).

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