New Labour Contract Law: impact on foreign invested companies

The PRC Labour Law (the “Labour Law”), in force since 1994, has been considered for a long time to be unsuitable to China’s economic development, particularly in terms of protection of employees. As a result, the Standing Committee of the People’s National Congress (the “National Congress”) promulgated the long awaited Labour Contract Law (the “LCL”) on June 29th, 2007, after more than two years of intense debate and solicitations from the public. The LCL took effect on January 1st, 2008.

This contribution discusses and highlights some key issues of the LCL.

1. Written Employment contract

According to statistics released by the Ministry of Labour and Social Security in late 2005, only around 70% of the national labour force entered into written employment contracts with their employers . In reality, this rate could be even lower. It is noteworthy that the rate reaches 90% or more for employees working for State Owned Enterprises (“SOE”), Foreign Invested Enterprises (“FIE”) and other big companies. That rate falls to somewhere between 50% and 80% for employees working for Small and Medium Enterprises, while the lowest rate by far is found among ex-farmers working in second-tier cities where the rate can be as low as 30%.

In the absence of a written employment contract, it was often difficult for courts or arbitration committees to establish, not only the starting date of the employment contract (which is essential for the calculation of unpaid salaries and termination allowances), but also the existence of an employment relationship itself.

Although the Labour Law assumed that the employers entered into written employment contracts with employees, failure to comply with such obligation was not directly addressed nor penalized.

The LCL addresses this shortcoming by providing that the employer shall enter into a written employment contract with his employee within one month upon the date on which the employee started working and that in case the employer fails to do so within one year, an open-term employment contract shall be deemed to have been concluded between the parties.

In addition, the LCL provides that if the employer delays entering into a written employment contract for more than one month but less than one year after the employee started to work for the employer, the employee shall be entitled to receive double salary for the period during which he was working without a written employment contract.

It is also worth noting that the LCL grants a consultative right without co-decision making power to the trade union, the employee congress or the employee representative congress (as appropriate), on rules and regulations, or matters that have a direct bearing on the immediate interests of the employees. The adoption of an employee's handbook would typically be one example of such consultation.

2. Fixed Term Employment Contract

The Labour Law did not provide for any compensation to be paid to employees upon expiration of the term of an employment contract, therefore, most employers entered into short-term employment contracts with their employees. According to a survey conducted by the Beijing Labour and Social Security Bureau, less than 10% of employees in FIEs and private companies in Beijing have entered into open-term employment contracts, 30% entered into an employment contract with a duration of between one and three years, and the remaining 60% have a one year maximum term.

Although initially beneficial for the employer, who avoided paying any compensation to his employee upon expiration of the term of the employment contract, the use of short-term contracts seems to have had an overall adverse impact on employee commitment due to lack of security, which is not desirable for the long-term development of an enterprise.

To address this issue, the LCL has implemented two new rules:

• Firstly, the LCL provides that upon termination of a fixed-term employment contract, the employer shall pay a severance to the employee in proportion with the duration of the contract (usually one month salary for each year of service).

• Secondly, the LCL provides that, in the event that an employee has completed two fixed-term contracts and that the parties wish to pursue the employment, a contract with no fixed term must be concluded between them.

These new provisions aim to reverse many employers’ practice of entering into short-term employment contracts.

3. Severance in case of lawful unilateral termination

The Labour Law provided that in the event that the employer terminated an employment contract for a lawful reason, except if the employee was at fault or within other limited circumstances defined by the law, the employee had the right to obtain “appropriate compensation”. The law did not however mention the amount of such compensation.

The LCL therefore provides that in the event of unilateral termination of an employment contract for a lawful reason, including expiration of the term (cf. supra), but except in the circumstances described below, the employee shall be entitled to obtain a severance equal to one month’s salary per year of service.

However, compensation shall not be payable in the following circumstances, the two last ones being additional new grounds under the LCL:

• The termination of the employment contract is initiated by the employee;
• The employee is prosecuted for criminal liability;
• The employee is at fault and/or has committed gross negligence causing serious damage to the employer;
• The employee appears not to be competent for the job while on probation;
• There is a material conflict of interest caused by employment with another employer; and
• The employee coerced or deceived the employer into entering into the employment contract.

It should be noted that the LCL provides for two thresholds regarding the maximum amount to be paid to the employee: (1) the severance shall not exceed twelve months of salary, even if the employee has worked with the company for over twelve years, and (2) the amount to be paid shall not exceed three times the average monthly salary of a similar employee in the municipality where the employee works, even if the actual salary of the said employee is much higher.

In our opinion, this provision, which is extremely favorable to the employers, may not be fair in practice, as the discrepancies between salaries are enormous in China, even within one municipality.

4. Outsourcing Agreement

It is common practice for employers, mostly FIEs and private companies, to enter into outsourcing agreements, according to which, a sponsor shall recruit an employee and dispatch him/her to an employer. The employer pays an amount equal to the employee’s social welfare and monthly salary to the sponsor and the sponsor shall pay the above amounts directly to the employee. This practice, which circumvents direct employment, allows the employer to stay within his authorised quota of employees. It also allows the employer to save on social welfare expenses, as the sponsor is usually located in the same registration district as the employee’s domicile, leading to a lower social welfare rate than if the employer would have entered into a employment contract directly with the said employee. If the employer was to hire the employee directly, the social welfare rate would be much higher for the employer as, most of the time, the employer’s company and the employee’s domicile are not registered in the same district, which leads to a higher rate. In addition, since no contract is signed, no direct labour disputes may arise between the employer and the employee, which often leads to abuses.

To circumvent this practice, the LCL provides that:

1. The registered capital of the sponsor shall be no less than RMB 500,000;
2. The sponsor shall not be entitled to charge any expenses to the employee;
3. The sponsor agreement shall include the employee’s precise job description, term of placement, payment method and social security, and the sponsor shall fully disclose the content of the contract to the employee;
4. The outsourced employees shall be entitled to receive the same salary as the formal employees of the employer;
5. The employer shall not be entitled to place the employee with another company; and
6. Outsourcing contracts shall be allowed only for temporary, auxiliary or interim positions.

5. Non-competition

Although the Labour Law authorizes, in principle, the existence of non-competition clauses, it does not provide for any further details as to their operation, which has led to an increase in the number of disputes regarding the existence and enforcement of such clauses over the last couple of years.

The LCL therefore expressly addresses the issue by stipulating that:

1. The maximum duration of a non-competition clause shall not exceed 2 years upon termination of the employment contract (as compared to 3 years prior to the LCL); and
2. The employer shall, upon termination of the employment contract and during the entire term of the non-competition clause, pay an economic compensation to the employee on a monthly basis.

However, the LCL fails to clarify the requested minimum amount to be paid by the employer for a non-competition clause to be enforceable and how much the employee needs to pay in the case of a breach of such non-competition obligation. Local implementation rules are awaited to further address these two issues.

6. Probation Period

The Labour Law allowed a probation period of a maximum of 6 months, which granted excessive flexibility to the employer and failed to protect the interests of the employee.

To remedy this problem, the LCL regulates the probation period as follows:

• The maximum duration of a probation period shall be:

1 month for employment contracts with a duration exceeding 3 months but less than 1 year;

2 months for employment contracts with a duration exceeding 1 year but less than 3 years;

6 months for employment contracts with a duration exceeding 3 years or without a fixed term;

• An employee can only be subject to a single probation period;
• The provisions of the employment contract containing a probation period shall not be limited to the probation period only;
• The employee’s salary during the probation period shall not, cumulatively, be lower than 80% of the agreed salary under a regular employment contract and the lowest salary level for the same position in the employer’s company; and
• If the employer decides to terminate the employment contract within the probation period, the employer shall properly explain its decision [to the employee].

7. Professional Training Contract

A professional training contract is a contract where an employer volunteers, without charge, to provide an employee with specific training or professional study and where the employee, in return, undertakes to work for the employer for a minimum term. Although quite common in practice, the LCL formally addresses the legal status of such contracts for the first time.

The LCL provides that the parties may enter into a professional training contract provided that:

1. In case the employee fails to comply with the conditions of the professional training contract, he shall be liable to pay liquidated damages equivalent to the amount of the training expenses pro rata with the remaining term of the contract; and
2. The calculation of the employee’s promotion or salary raise shall not be affected by the duration and/or terms of the professional training contract.

8. Unlawful Termination

According to recent practice in China, in the event of unlawful termination of a employment contract by an employer, the employee could choose between being reinstated in the company or receiving compensation. However, the circumstances of such reinstatement as well as the amount of compensation were not defined by any text, which often led to uncertainties and disputes.

The LCL provides some guidance regarding this issue and provides that if the employee requires his reinstatement upon unlawful termination, the employer shall agree to do so. However, in case the employee does not wish to be reinstated or if the reinstatement becomes impossible, the LCL provides that the employer shall pay double economic compensation.
Regrettably, the LCL fails to define which circumstances shall render the reinstatement impossible.

Conclusion

With the swiftly swelling Chinese labour force, currently counting over 800 million people, and China’s rapid economic growth, the PRC government felt pressurised to provide workers with a fair and protective legislation in an attempt, it is claimed, to achieve social and economic stability as well as a sustainable labour market. Although the adopted LCL does not include all of the contemplated changes related to the employees’ rights which were suggested in the draft LCL, the adopted LCL is still considered a landmark piece of legislation by the government, as the new text substantially tightens the protection of the interests of the employees by imposing mandatory obligations on the employers. However, since many provisions of the LCL need to be further clarified, the central and/or local labour authorities shall soon promulgate detailed implementation rules regarding the LCL, enabling companies to better assess the impact of the new law and adjust, as the case might be, their human resource practices.

References

1 See: http://finance.sina.com.cn/g/20060421/02152517769.shtml
2 See: http://211.167.236.236/china/newzt/2006magezine/200602006823163145.htm