China: China Watch: China´s Draft Labor Contract Law

The spotlight has been turned on China’s labor practices. A recent report by an international alliance of trade unions and nongovernmental organizations has accused four manufacturers of Beijing Olympics products of engaging in unfair labor practices, namely, using underage workers and underpaid workers, and providing poor working conditions. The report was followed by news coverage of the rescue of slave workers in brick kilns and mines in Henan and Shanxi provinces. The Standing Committee of the National People’s Congress (SCNPC) is slated to review the nation’s most recent version of the PRC Labor Contract Law from June 24—29. The increased media attention may be sufficient to push the hand of lawmakers in Beijing.

One year ago, Thelen published its analysis of the then-new draft labor contract law. In this article we revisit the key features of the law, and update you on the proposed changes to the law and how they may affect business in China.

On April 27, 2007, the third draft of the proposed law was submitted to the SCNPCfor review. In general,proposed legislation is presented in draft form to the public for comment three times before a final version is adopted by the NPCor its Standing Committee. The third draft has not been made available for public comment. Our comments below are based on SCNPC Web site information and our review of the second draft of the law. After review of the proposed law, the SCNPC proposed five main changes to the draft:

1. Clarify the amount of severance to be paid to terminated employees;
2. Require the use of written labor contracts;
3. Add language concerning contractual rights of female employees;
4. Limit the labor union input into company policy; and
5. Expand the circumstances permitting an employer to lay-off employees.

The SCNPC also emphasized the issue of occupational disease, specifically, the need to alert workers of the risk of occupational disease and to take preventive measures. We expect more comments or approval after June 29, 2007.

The second draft of the law identified five situations requiring an employer to make severance payments, but made no recommendation concerning the method of calculating the amount to be paid. The five scenarios requiring severance are:

1. An employer terminates the labor contract for cause, such as the employee is not competent to perform the job;
2. An employee terminates the labor contract for legal reasons, such as the employer fails to pay the employee’s salary or benefits;
3. The employer will restructure according to the PRC Enterprise Bankruptcy Law, or the employer will dissolve, cease to do business, declare bankruptcy, lose its business license, or be forced to close for other reasons;
4. An employer terminates the labor contract and reaches mutual agreement with the employee regarding the termination; or
5. The employer allows a fixed-term labor contract and declines to renew.

The SCNPC has suggested the following additions:

• The amount of severance should be tied to length of service: one month’s salary for each year of employment with a 12-year maximum. (Employment durations of less than one year shall be rounded up to one year.)

• If an employee’s salary is three times greater than the average salary in the preceding 12 months of the municipality where the office is located (or municipalities in the even t of multiple locations) ("municipality average"), then the employee shall 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. The average wage remains relatively low in China, so 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 may be entitled to severance under the proposed law than under the current law. Accordingly, companies are likely to face increased employment costs.

The second draft of the law identified three principles concerning the establishment of an employment relationship:

1. A written labor contract is required for establishment of an employment relationship;
2. The commencement date of an employment relationship is established from the employee’s first day on the job; and
3. If an employment relationship has already been established, but a written labor contract has not yet been executed, then alabor contract must be executed within one month of the employee’s first day on the job.

The SCNPC clarified one additional point in this regard. It suggested that—in the event an employee signs a labor contract prior to the start date of his 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 is 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 article, the main concern under the new draft continues to be the effective abolition of fixed-term contracts. Under the draft, a fixed-term contract that expires creates a severance obligation, where none currently exists. Thus, an employer’s ability to allow a problem employee to leave at the end of the contract term without paying severance will no longer be an option. The down-side for business is increased costs in terminating employees and less flexibility in labor contracting.

The SCNPC proposed a special, and rather obscure, provision concerning the rights of female workers:

The employee and the employer may establish a special collective labor contract to protect female employees’ interests.

This statement appears in the collective bargaining section of the draft law, but does not elaborate the specific interests at stake. We assume that the SCNPC intended to protect women’s rights relating to pregnancy and maternity leave, but no further details have been provided.

The proposal regarding female employees’ interests is in line with the increased role of labor unions under the draft law. Commentators on the draft had voiced the concern that allowing the unions to "approve" company rules, including handbooks, would give the unions too much control over company policy. The SCNPC seems to have listened to those comments and removed the approval requirement in favor of a requirement that management and the union discuss policies that may directly affect the rights of the workers. However, the second draft granted more power to the unions to protect the interest of the employees. The SCNPC provided in the second draft that the Union can bring the disputes to arbitration or litigation if the union and the employer have disputes under the collective labor contracts.

In the second draft of the law, four grounds for lay-offs were identified:

1. Bankruptcy-related reorganization;
2. Serious difficulties in the operation;
3. Relocation to minimize pollution; and
4. Changes to 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.

In the third draft of the law, the SCNPC has proposed that additional circumstances justifying a lay-off be added:

• When the enterprise transfers production to another location;

• When a technical innovation results in the need for fewer workers; or

• When operational methods are adjusted, reducing the needed number of employees.

While the broader range of lay-off bases improves the position of the employer, some of the ambiguities in the draft 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. Also, the transfer of production to another location may not be appealing to the local authorities, whose cooperation must be sought to limit exposure in the event of a lay-off.

The second draft deleted the consideration amount requirement, geographic limitation, and the cap on liquidated damages paid by the employee to the employer in the event of breach of contract. The second draft leaves these issues to the mutual decision of the employer and the employee in the labor contract. At the same time, the second draft continues to set a maximum period of non-competition post-employment at two years. In addition, the second draft provided that only senior management, senior technical personnel, and other employees with access to the business secrets of the employer may be subjected to a non-compete provision.

Traditionally, probationary periods have been based on contract term. Given the change in the prevalence of fixed contracts, restructuring of the probationary periods is to be expected. However, the SCNPC has not asked for any clarification of the probationary periods proposed in the draft law, namely,

• No more than one month for a labor contract of less than one-year;

• No more than two months for a labor contract of more than one-year, but less than three-years; and

• No more than six months for more than three-year fixed-term or unfixed-term labor contracts.

If the SCNPC acts on the draft this month, it will likely be effective in early 2008. In its current form the law is likely to increase the cost of doing business in China. Larger companies will feel the need to have human resources capability in-country. Severance payments, non-compete payments, and the decrease in probationary period length will all increase the employer’s labor costs. The undefined role of the labor union may complicate the relationship with management. The ambiguities for justifying a lay-off may also result in increased costs to the employer. If Beijing decides that this is an appropriate time to send the message internationally that the PRC takes labor conditions seriously, we may have a new law approved within the month. For now, we are still waiting for the other shoe to drop.

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.