China Adopts Landmark Labor Contract Law

China has approved a new law that will bring the largest overhaul to labor and employment law in more than a decade, and tips the balance of power from employers to unions and employees. The landmark legislation, which takes effect on January 1, 2008, is expected to have a massive impact across the entire labor law field, including contract terms, non-competition provisions in contracts, and severance arrangements.

The China Labor Contract Law ("CLCL"), which was adopted by the government on June 29, 2007, and supplements the current China Labor Law of 1994, has already sent Chinese and foreign companies scrambling to adjust their employment and labor policies. Below are several key provisions of the new law that are important for employers doing business in China to review before the new law takes effect:

I. Significant Provisions of the CLCL

A. Non-Competition and Confidentiality Provisions

The CLCL states that an employer and an employee may include in their labor contract non-competition and confidentiality provisions to protect the employer's commercial secrets and intellectual property rights. During the term of the competition restriction after a labor contract is terminated, the employer is required to pay the employee financial compensation on a monthly basis. However, the employee must pay liquidated damages to the employer if he or she breaches the non-competition provisions. The amount of financial compensation and liquidated damages are to be negotiated and stipulated in the labor contract. The non-competition provisions apply only to senior management personnel, senior technicians and other personnel with confidentiality obligations. The scope, geographic areas, and time limits of the competition restrictions shall be agreed upon by the employer and the employee. The competition restriction period may not exceed two years.

B. Mandatory Written Contract

To establish a labor relationship, the CLCL requires an employer and an employee to conclude a written labor contract. If an employee begins his or her employment with an employer before a written labor contract has been signed, the labor contract must be concluded within one month from the date on which the employee begins work. Where the employer fails to conclude a written labor contract with an employee more than one month, but less than one year from the date on which an employee begins work, the employer shall pay the employee twice his or her wages each month. Should the employer fail to conclude a written labor contract with an employee within one year from the date on which the employee begins work, the employer and employee shall be deemed to have concluded an open-ended labor contract.

C. Fixed-Term Contract and Open-Ended Contract

The CLCL imposes greater regulation on the use of fixed-term labor contracts. An employer can terminate a fixed-term labor contract only for good cause or in case of a mass lay-off. An employer must pay severance to an employee if a fixed-term contract expires and the employer fails to renew the contract, unless the employee fails to renew the contract even though the new contract terms are equal to or better than those stipulated in the current contract. The CLCL, however, encourages the use of open-ended labor contracts. An open-ended labor contract is a labor contract without a definite expiration date, and may be negotiated and concluded by the parties. In addition, an opened-ended labor contract may be concluded if an employee agrees to renew a labor contract or conclude a labor contract after the employee has been working for the employer for a consecutive period of more than ten years or after a fixed-term labor contract has been concluded on two consecutive occasions. If an employer fails to conclude an open-ended labor contract with an employee, the employer must pay the employee twice his or her wages each month, starting from the date on which an open-ended labor contract should have been concluded.

D. Mass Lay-off

The CLCL defines a mass lay-off as a lay-off involving more than 20 employees, or fewer than 20 employees, but who constitute more than 10 percent of the total number of employees. To reduce its workforce, an employer is required to explain the circumstances of the lay-off to its labor union or to all of its employees 30 days in advance, and consider the opinions of the trade union and employees prior to the lay-off. The CLCL states that a mass layoff is allowed where the workforce reduction is still needed after modifying labor contracts as a result of an employer's change of production, introduction of major technological innovations or adjustment of its operational modes or where other major changes in the objective circumstances upon which the labor contract was based render the contract non-executable.

E. Role of Labor Unions

The CLCL allows a labor union to play a more important role in representing the interests of the employees. An employer must negotiate with a labor union or employee representatives when establishing labor rules and regulations concerning wages, hours, breaks, leave, work safety and hygiene, insurance and benefits, training, work discipline or work quota management. If a labor union or an employee believes the rules, regulations or decisions on significant matters to be inappropriate in the course of performance, the labor union or the employee is entitled to raise the matter with the employer and seek to improve conditions through negotiations. A labor union has the right to negotiate and conclude a collective contract with an employer on such matters as wages, hours, breaks, leave, work safety and hygiene, insurance and benefits.

F. Severance Pay

An employer must pay an employee severance pay in certain circumstances. For a general employee, an employer must pay severance pay at the rate of one month's wage for each year of employment. For a high-income employee, if the monthly wage of the employee is greater than three times the average monthly wage of local employees for the preceding year, the rate of severance pay will be three times the average monthly wage of local employees, for each year of employment up to a maximum of 12 years.

II. Impact and Interim Suggestions

The CLCL will be effective on January 1, 2008. In the months preceding the new year, it is suggested that employers consider the following steps: (1) train executive or senior level employees and human resources personnel to better understand the new labor contract law and the best practices under the CLCL; (2) review the current labor contracts and redraft or revise these contracts; (3) organize, if necessary, a labor union or employees representative congress, and establish and perfect democratic management procedures governing the meeting and negotiations between the employer and a labor union or employees representative congress; (4) review and update the employer's internal rules and regulations or human resources policies, especially in the areas involving employees' interest for conformity with the new law; (5) assess expiration dates of the current labor law contracts and carefully make contract renewal or lay-off plans; (6) consult with knowledgeable labor counsel with respect to the conclusion of non-competition agreements and check local rules and regulations about scope and geographic area competition restrictions and permissible liquidated damages provisions. Employers who start to take such steps now can better operate successfully under the new CLCL.

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If you have any questions about the information contained in this Client Alert, please contact Jian Hang in the New York office at (212) 351-4799, [email protected]; Dean Silverberg in the New York office at (212) 351-4642, [email protected]; or Frank Morris in the Washington, D.C. office at (202) 861-1880, [email protected]. Messers. Silverberg and Morris co-head the Firm's China Initiative.

This document has been provided for informational purposes only and is not intended and should not be construed to constitute legal advice. Please consult your attorney in connection with any specific questions or issues that may impose additional obligations on you and your company under any applicable local, state or federal laws.