For more than a year now, the Standing Committee of the National People’s Congress ("SCNPC") has been reviewing the draft Labor Contract Law. On June 29, 2007, the SCNPC passed the PRC Labor Contract, which will take effect on January 1, 2008.

Although existing labor contracts will be grandfathered, and employers do not need to execute new contracts for existing employees at the beginning of next year, the new law changes how foreign employers will do business in China. All employees who commence work on or after January 1, 2008, will have the benefit of the new law, and their labor contracts must be in accordance with it. The law requires a written contract for each employee and sets certain penalties for failing to timely execute a written contract. The emphasis on the written contract will mean a need for skillfully-drafted contracts, and probably greater involvement of lawyers in the process. There are new provisions about invalidity of labor contracts that will certainly warrant closer attention by the contract draftsman. The law increases the role of the labor union but in some ways does not clearly define the levels of authority between the union and the employer. Ultimately, concerned foreign employers should take comfort from the fact that it appears that final decision-making still rests with the employer.

The Labor Relationship and Contract Establishment

The law provides for three types of labor contracts: fixed duration, non-fixed duration, and project duration contracts. Each must be in written form.

Written Labor Contracts. The Law requires that an employment relationship be based on a written labor contract, and the relationship commences on the employee’s first day on the job. If the employee starts to work before a written labor contract has been executed, a labor contract must be executed within one month of the employee’s first day on the job. If the employer fails to secure a written labor contract with the employee for more than one month but less than one year following the employee’s first day on the job, the employer shall be obligated to pay double the employee’s monthly salary for each month of employment during which no labor contract was in place. (Where the employer fails to give the employee a written contract within the first year of employment, the employee will automatically be deemed to have a non-fixed labor contract.) This strict provision demonstrates the intent of the Chinese government to change the current practices of many Chinese companies, who often have no labor contracts with their employees.

In the event an employee signs a labor contract prior to the start of his or her employment, the employee’s start date shall be the actual date the employee begins work, as opposed to the date the labor contract was executed. This date will be important for purposes of calculating such time periods as the probationary period and the period for calculation of severance.

As we stated in our earlier articles, one consequence of the Law continues to be the effective abolition of fixed-term contracts. Under the Law, a fixed-term contract that expires creates a severance obligation, where none currently exists. An employer cannot deal with problem employees by simply waiting for them to leave at the end of the contract term (without paying severance). Accordingly, the Law’s downside is the increased cost of terminating employees, and less flexibility for businesses in labor contracting.

Non-fixed-duration labor contracts will be more common, and under certain circumstances employees have the right to insist on a non-fixed contract. Termination of the non-fixed labor contract may be more difficult, and the maximum probationary period under non-fixed labor contract is limited to six months.

Non Competes. Only senior management, senior technical personnel and those bound to keep confidential information of the employer may be subjected to non-competition requirements. But when non—competes are permitted, the Law provides that the terms of the non-compete, its geographic limits, and the cap on the liquidated damages paid by employee to the employer in the event of breach are subject to mutual agreement between the employer and the employees. However, the maximum term of a non-competition clause is set at two years.

During the period of a non-compete, the Law provides that the employer should pay consideration to the employee on a monthly basis. However, the Law leaves the consideration amount up to negotiation between the employer and the employee. If the employee breaches the non-compete agreement, the employee shall pay liquidated damages to the employer according to the terms set forth in the labor contract.

Liquidated Damages. The Law restricts liquidated damages provisions in labor contracts to two circumstances:

  1. The employee breaches the non-compete agreement; or

  2. The employee breaches the labor agreement after receiving special training from the employer and committing to the serve the employer for a specified service term. In this instance, the liquidated damages cannot exceed the cost of training to the employer, allocated pro rata to the remainder of the service term.

Under this provision of the Law, the employer will not be able to claim liquidated damages against an employee for early termination of a labor contract, for breach of the non-disclosure agreement (except in the case of the non-compete), or for any other reason. This provision does not bar the employer for suing in labor arbitration for such activities, but the employer would be forced to prove actual damage or loss, which may be particularly difficult in the case of a breach of confidentiality.

Probationary Periods. Traditionally, probationary periods have been based on contract term. The Law restructures the following probationary periods:

  • No probationary period for labor contracts of less than a three-month duration, or the contracts for completing a defined project;
  • A probationary period of no more than one month for a labor contract of a three-month to one-year fixed duration;

  • A probationary period of no more than two months for a labor contract of one- to three-years fixed duration; and
  • A probationary period of no more than six months for a labor contract of more than three-years fixed duration, or a non-fixed duration labor contract.

Invalid Labor Contracts. The Law provides that a labor contract shall be invalid in any of the following circumstance:

  • Securing an employee’s consent to enter into or alter a labor contract through threats or other forms of duress;

  • Containing terms contrary to the statutory provisions of the Law and the administrative regulations; and

  • Eliminating the employee's rights through negotiation, namely waiver of an employee statutory right.

The last circumstance is a new provision under the PRC Labor Law. Under the law, the employer must be mindful when seeking waiver from an employee for any statutory right, such as overtime work payment or severance payment for early termination of a labor contract. Despite the employee’s written agreement to waiver, the employer is at risk that such waiver will be deemed invalid by a labor arbitration commission or court.

Terminating a Labor Contract

Severance Pay. The Law requires severance payments in seven circumstances:

  1. An employer terminates the labor contract for cause, because the employee is not competent to perform the job, or the objective circumstances at the time of concluding the labor contract have materially changed such that the labor contract can not be performed;

  2. An employee terminates the labor contract for legal reasons, for example where the employer fails to pay salary to the employee on time or for the correct amount, or fails to contribute social benefits for the employee, or the internal rules of the employer violate laws and regulations contrary to the interests of the employee;

  3. The employer will restructure according to the PRC Enterprise Bankruptcy Law, and must lay off employees;

  4. The employer terminates the labor contract and reaches mutual agreement with the employee for the termination;

  5. The employer terminates the fixed-term labor contract when the contract expires (this does not apply if the employer agrees to raise or maintain the benefits for the employee and the employee refuses to renew the labor contract);

  6. The employer will dissolve, cease its business, go bankrupt, lose its business license or be ordered to close; or

  7. Other situations as may be stipulated by laws and regulations.

The amount of severance is set at one month’s salary for each year of employment, up to 12 years. Employment lasting less than one year but more than six months shall be rounded up to one year. For employment lasting less than six months, severance shall be paid in the amount of one-half of the employee’s monthly salary.

If an employee’s salary is three times greater than the average salary in the preceding twelve months of the municipality where the office is located (or municipalities in the event of multiple locations) ("municipality average"), then the employee may be paid three times the municipality average.

One month of salary for every year of service is the current standard under the PRC Labor Contract Law. As the average wage remains relatively low in China, this provision presents limited risk to most foreign companies doing business in China. In fact, the municipal average may help lower the amount owed to long-tenured, high-paid employees. However, the circumstances for severance payments have been expanded, meaning that more employees are entitled to severance under the new law than under the current law. Accordingly, companies will face increased employment costs.

Lay-offs. The Law, identifies the following four grounds for economic lay-offs:

  1. Bankruptcy-related reorganization;

  2. Serious difficulties in operation of the business;

  3. Change in the business, such as a major technical innovation or change in operational models; and

  4. Change in the objective circumstances of the company.

Lay-offs in these circumstances can only take place if an enterprise needs to lay-off either 20 or more employees, or fewer than 20 employees, if the number of laid-off workers accounts for ten percent of the total number of employees. In addition, the employer must consult with the labor union, listen to the opinions of the employees or the Union, and report the intent to lay-off employees to the labor authorities.

While the broader range of lay-off bases improves the position of the employer, some of the ambiguities in the law may still be problematic, particularly if the local labor bureau does not agree that the claimed basis for the lay-off is within the Law. Deciding when there has been a change in objective circumstances, or what constitutes "significant difficulties" may not be clear.

In addition, the law provides that when laying off employees, the employer should give priority consideration to retaining the following employees:

  • Those with long-term, fixed-duration labor contracts with the employer;

  • Those with non-fixed duration labor contracts with the employer; and

  • Sole income providers or those with elderly relatives or children.

The Role of Unions

The Law foresees a tri-partite relationship between the employer, the labor union, and the employee. It dictates that these three will consult with one another regarding the key features of the labor relationship, such as salaries, benefits, vacations, and worker safety. However, the Law does not specify who has the final authority in the event of an unresolved issue. That authority appears to still rest with the employer. If the acts of the employer are harmful to the worker’s interests, then the labor union can seek recourse through the local labor arbitration commission. The Law provides that the draft of the collective labor contract between the employer and the employee should be approved by all employees or at a meeting of the representatives of the employees. The union now has the power to sign a collective labor contract on behalf of the employees. Similarly, the union can bring any dispute relating to the collective labor contracts against the employer to arbitration or litigation. The union cannot bring suit on behalf of an individual worker, but may lend assistance and support in the event of suit.

A Few Final Thoughts

The Law is really aimed at changing unfair labor practices in China, which most foreign companies do not employ. For example, the new law precludes the employer from taking the employee’s identification card or a guarantee payment. In the past, employers would take such security from the employee to preclude their mobility. The inadvertent consequence of the new law will be an increase in the cost of doing business in China, particularly for companies with large staff requirements or skilled workers with high salaries. Companies currently transitioning their workers from labor agents to direct hires should be cognizant of the new law, and should draft their labor contracts in anticipation of complying in the New Year. Companies also need to reassess their in-country human resources capability and decide if the department needs greater staff or, in the absence of an established department, someone needs to be designated to handle labor issues. Companies need to decide who will be the liaison with the labor union and how that relationship will be managed. Finally, foreign companies need to review their current labor contracts and collective bargaining agreements for conformity with the new Law.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.