Doing Business in China: Understanding China's Newly Adopted Labor Contract Law, as appeared in International Legal News

I. Introduction

On June 29, 2007, the Standing Committee of the National People's Congress, China's top legislature, adopted the Law of the People's Republic of China on Labor Contract ("China Labor Contract Law" or "CLCL" ). The CLCL's approval followed 18 months of deliberation, intense debates, warnings about the potential damages to business including threats to withdraw foreign investment from China, and complaints from activists that foreign companies were trying to erode workers' rights. The CLCL will take effect as of January 1, 2008.

The CLCL makes significant changes to the current Labor Law of the People's Republic of China ("China Labor Law" or "CLL"), and is decided pro-workers. Under the CLCL, an employer is required to provide a written labor contract to its employee, to negotiate and consult with its labor union when establishing employment rules and regulations, making mass lay-off plans and concluding collective labor contract, and to pay severance when a fixed-term contract expires. The CLCL specifically permits the use of non-competition agreement in a labor contract but limits employees who are subject to the non-competition agreement.

This note introduces some significant provisions of the CLCL and some steps an employer may take to comply with this new law.

II. Significant Provisions of the Labor Contract Law

A. Non-competition and Confidentiality Provisions

Currently in China a non-competition agreement is generally permitted and enforceable if it is reasonable in nature. Based on different local rules and practice, however, two local people's courts may reach two completely different decisions on whether a compensation clause is needed for the non-competition agreement or what constitutes a sufficient amount of compensation. The CLCL, for the first time, clearly states by statute that an employer and an employee may include in their labor contract non-competition or confidentiality provisions to protect the employer's commercial secretes and intellectual property rights. In addition, the employer is required to pay the employee financial compensation on a monthly basis during the term of the competition restriction after labor contract is dissolved or terminated. The employee shall pay liquidated damages to the employer if he or she breaches non-competition provisions. The amount of financial compensation and liquidate damages shall be negotiated and stipulated in the labor contract by the employer and the employee.

Non-competition provisions, however, do not apply to every employee. Only senior management personnel, senior technicians and other personnel with confidentiality obligations are subject to competition restrictions. For example, the employer may not conclude a non-competition agreement with a clerk working in its mailroom. The scope, geographic areas, and time limits of the competition restrictions shall be agreed upon by the employer and the employee and the agreed-upon restrictions on competition shall not violate relevant laws and regulations. After the dissolution or termination of the labor contract, senior management personnel, senior technicians or personnel with confidentiality obligations may be prohibited by a non-competition agreement from working for a competing employer that produces the same type of products or engages in the same type of business as his or her current employer, or establishing his or her own business that produces the same type of products or engages in the same type of business. Under these circumstances, the period for which the employee is subject to competition restrictions shall not exceed two years, which is a reduction of one year from the currently required three years.

The uniform non-competition and confidentiality provisions in the CLCL allow an employer to include and enforce a non-competition agreement to protect its intellectual properties and commercial secrets. When a U.S. employer wishes to include a non-competition agreement in its labor contract, it should check the relevant local rules and regulations on the scope and geographic areas of competition restrictions so that its non-competition agreement will not be deemed invalid because of violations of these local laws. Further, the employer shall specify its business scope and operation scope in its non-competition agreement, and, if possible, list names of competing employers. The employer shall also pay the employee who has confidentiality obligations financial compensation after labor contract is terminated. Currently, in order to avoid financial compensation payment to their employees, some employers specify in their labor contacts that a portion of employees' wage is paid as financial compensation payable to employees for the conclusion of non-competition agreement, which shall be deemed invalid under the CLCL. Because there is no cap on liquidated damages payable to an employer, the employer may fairly and reasonably value its commercial secrets and intellectual property rights. In most circumstances, the amount of liquidated damages may exceed the amount of financial compensation payable to the employee; therefore, this liquidated damages provision may well serve as a deterrent to the employee who would breach a non-competition agreement.

B. Mandatory Written Contract

In the United States, the common law recognizes the doctrine of employment at will, that is, an employer may dismiss an employee at-will for good cause or no cause without being guilty of legal wrong and an employee may quit his or her job at any time and for any reason. There is no a counterpart of employment at will in China's legal system. Rather, to establish a labor relationship, the CLCL requires an employer and an employee to conclude a written labor contract. The labor contract shall specify the basic information of the employer and employee, employment period, job description and place of work, working hours, break and leave, remuneration and social insurance, labor protection, working conditions and protection against occupational hazards, and other matters required by laws and regulations. In addition to these requisite terms, the employer and employee may negotiate and stipulate other terms in the labor contract, such as probation periods, training, confidentiality, supplementary insurance and other benefits.

If an employee begins his or her employment with an employer before a written labor contract has been signed, a labor contract shall be concluded within one month from the date on which the employee starts to work. If an 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 starts to work, the employer shall pay the employee twice his or her wages each month. If an employee fails to conclude a written labor contract with an employee within one year from the date on which an employee starts to work, the employer and employee shall be deemed to have concluded an open-ended labor contract as explained further below.

To avoid double wages payment an employer should timely conclude a mandatory written labor contract with its employees for the establishment of the labor relationship. A written labor contract shall include in detail both requisite terms and stipulated terms. In reality, a labor contract whose terms are too simple or lacking in detail often creates unnecessary mistakes or misunderstandings when it is performed. In addition, the contract language shall be clear and easy to understand. It is a best practice to provide the employee a labor contract draft at least two weeks before employee begins work so that the employee has enough time to read and understand the terms of the contract and make his or her own comments. In addition, in its labor law contract, the employer may add a provision stating that "Before I sign this labor contract, I have read carefully about all terms in the contract and have agreed on all contract terms," and ask the employee to sign below the provision.

C. Fixed-term Contract and Open-ended Contract

The CLCL imposes greater regulations on the use of fixed-term labor contracts. At present, many employers often use fixed-term labor contracts of one to three years. If an employer is not satisfied with an employee's performance, the employer can simply let the fixed-term contract expire without the need to pay severance. Under the CLCL, fixed-term contracts are still allowable, but strictly regulated. For example, an employer can terminate a fixed-term labor contract only for good cause or in case of mass lay-off. An employer shall 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 new contract terms are equal or better than those stipulated in the current contract.

The CLCL, however, encourages and prefers the use of open-ended labor contracts. An open-ended labor contract is a labor contract without a definite expiration date. An employer and an employee may negotiate and conclude an open-ended labor contract by themselves. 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 shall 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.

Is an employer able to terminate an open-ended labor contract even though it is open-ended? The answer is yes. In fact, an employer and an employee may terminate their open-ended labor contract if they so agree after negotiations. An employer may terminate an open-ended contract if an employee: (1) fails to meet conditions for the employment during his or her probation period; (2) materially violates the employer's rules and regulations; (3) commits serious dereliction of duty or practices graft, causing substantial damage to the employer; (4) simultaneously works for another employer, thereby affecting the completion of his or her task with the current employer, or refuses to take corrective actions after the current employer has raised the issue; (5) deceives, coerces, or takes advantage of the employer's difficulties to cause the employer conclude or amend an labor contract; or (6) commits a crime. In addition, an employer may terminate an open-ended labor contract by giving an employee 30 days' prior written notice, or one month's wage in lieu of notice if: (1) the employee cannot engage in his or her original work or any other work assigned by the employer after a prescribed period of medical care for an illness or non-work-related injury; (2) the employee is incompetent and remains incompetent after training or adjustment of his position; or (3) a major change in the objective circumstances upon which the labor contract was based renders the contract non-executable, and after negotiations, the employer and the employee cannot reach an agreement on amending the labor contract.

An employer should begin to review their employment arrangement and consider carefully the length of the fixed-term contract in order to avoid hard costs of employees termination and inadvertent employment shortage or surplus. Generally, the length of the fixed-term contract can be one year, three years, five years, ten years or even more as long as the contract term is fixed. In determining length of the contract term, the employer shall consider whether the employment is seasonal, temporary, flexible, consecutive, or stable as well as assess whether the employee is able to perform his or her job. As for an open-ended labor contract, the employer should understand that the open-ended contract is not a life-time contract. As discussed above, the employer can terminate an open-ended contract with the employee under certain circumstances. Further, the employer and the employee may amend their open-ended contract on such matters as wage, hours, work conditions and work benefits, etc. In fact, the use of open-ended contract enables the employer to attract and retain more qualified personnel, motivate its employees, and prevent brain drain.

D. Mass lay-off

The CLCL defines a mass lay-off as lay-off involving more than 20 employees or fewer than 20 employees but by a proportion that accounts for more than 10 percent of the total number of the employees. To reduce its workface, an employer is required to explain the circumstances of lay-off to its labor union or to all of its employees 30 days in advances, and consider the opinions of the trade union and employees. During a mass lay-off, the employer is required by law to retain with priority employees who have concluded with the employer a fixed-term labor contract with a relatively long period or an open-ended labor contract, or who is the only one in his or her family to be employed and whose family has a senior citizen or a minor who needs to be provided for.

Under current labor law, mass-layoff is permitted only when an employer comes to the brink of bankruptcy or runs deep into difficulties in production and management. The CLCL follows the current labor law and added that a mass-layoff is also allowed under two more circumstances where workforce reduction is still needed after modifying labor contracts as a result of an employer's switching production, introducing major technological innovations or adjusting its operational modes or where other major changes in the objective circumstances upon which the labor contract was based renders the contract non-executable.

While it is still not quite clear what constitutes "other major changes in the objective circumstances," this provision, in some degree, enhances the employer's flexibility in its reduction in force due to economic conditions. Further, if a mass lay-off involves fewer than 20 employees and by a proportion that accounts for less than 10 percent of the total number of the employees, the employer does not need to explain the circumstances of lay-off to its labor union or all of its employees. For example, an employer can simply lay off 19 employees of its 200 employers without consulting with its labor union or employees.

E. Role of Labor Union

In addition to an involvement in a mass lay-off plan as discussed above, the CLCL allows a labor union to play a more important role in representing the interests of employees. For example, when establishing labor rules and regulations concerning wage, hour, break, leave, work safety and hygiene, insurance and benefits, training, work discipline or work quota management, the employer shall negotiate with a labor union or employee representatives. If a labor union or an employee believes the rules, regulations or decisions on significant matters inappropriate during the course of implementation, the labor union or the employee is entitled to raise the matter with the employer and seek to improve them through negotiations. In addition, a labor union has the right to negotiate and conclude a collective contract with an employer on such matters as wages, hours, break, leave, work safety and hygiene, insurance and benefits, etc. An employer without a labor union shall conclude the collective contract with a representative chosen by employees under the guidance of the labor union at the next higher level. Certain industry-wide or area-wide collective contracts may be concluded between labor union on the one hand and representatives of enterprises on the other hand in such industries as construction, mining, catering services, etc. within areas below the county level.

The CLCL has strengthened the role of labor union with respect to the establishment of employment rules and regulations, the adoption of mass lay-off plans and the conclusion of collective labor contracts. An employer can no longer determine by itself and should negotiate with a labor union or employee representatives on these matters. The employer needs to review its current employment handbook or HR policies with the labor union or employee representatives for conformity with the new law. The employer may consider appointing a person as the liaison with the labor union or employees representatives for the purposes of concluding, amending, and performing the collective labor contract.

F. Severance Pay

An employer shall pay an employee severance pay in the following circumstances: (1) the employee terminates the labor contract because the employer fails to provide labor protections or working conditions, or fails to pay social insurance premiums or full salary on time, or violates rules and regulations on concluding and enforcing labor contracts; (2) the employer proposes to terminate labor contract and contract is terminated by the employer and the employee after negotiations; (3) the employer terminates the labor contract because the employee is incompetent to perform a job or a major change in the objective circumstances upon which the labor contract was based renders the contract non-executable; (4) the employer lays off employees because it needs to restructure pursuant to the Enterprise Bankruptcy Law; (5) the employer terminates or fails to renew a fixed-term contract when the contract expires unless the employee fails to renew the contract even though new contract terms are equal or better than those stipulated in the current contract; (6) the employer goes bankrupt, has its business license revoked, or is ordered to close or is closed down; (7) other circumstances specified in laws or administrative statutes.

For a general employee, an employer shall pay severance pay at the rate of one month's wage for each year of employment. The computation formula of the severance for a general employer is: Severance Pay=monthly wage × number of years 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 for the severance pay shall be three times the average monthly wage of local employees and the maximum period of severance pay shall not exceed 12 years. The computation formula of the severance for a high-income employee is: Severance Pay=3 times average monthly wage of local employees × number of years of employment (≤ 12).

For both severance pay computations, any period of between six months and one year shall be counted as one year, and severance pay for any period of less than six months shall be one-half of an employee's monthly wage. The monthly wage is defined as the employee's average monthly wage for the 12 months prior to the termination of the labor contract.

Most employers are uncomfortable with the provisions that the employer has to pay severance pay if it terminates or fails to renew a fixed-term contract when the contract expires, which, they believe, will increase their employment costs. Employer should understand that currently the average monthly wage remains relatively low in China; therefore, the increase of employment cost of a general employees is not significant. In addition, the limitations of three times average monthly wage of local employees up to 12 years should help lower the severance pay owned to a long-tenured high-income employee and decrease employment cost of these employees.

III. Conclusion

The CLCL is about to come into effect on January 1, 2008. In the following few months before the new year, it is suggested that employer to do the followings: (1) train executive or senior level employees and human resources personnel to better understand labor contract law and its best practice; (2) review the current labor contracts and redraft or revise these contracts; (3) if necessary, organize 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 made contract renewal or lay-off plans. (6) consult with local legal counsel with respect to the conclusion of non-competition agreements and check local rules and regulations about scope and geographic areas competition restrictions and stipulation of liquidated damages.