Year Of The Rat Brings A Plague Upon Employers In China

May 5, 2008 | Print | Email Email | Comments | Category: Viewpoints

By Kevin Jones and Stan Abrams
We all saw this coming. Since last year, there have been countless articles and commentaries about China's new employment law, so by now employers should have already implemented new labor regimes without further incident and employees should be quite satisfied. Right?

Not quite. Implementation has been slow, litigation has picked up markedly this year, and China's new Employment Contract Law continues to pose huge problems for employers. The new law has the potential to become a compliance nightmare, with labor costs widely anticipated to increase by 20% for manufacturers, squeezing profit margins further at a time when costs for other economic inputs are rising and preferential tax treatment is being rolled back. According to a study recently released by the American Chamber of Commerce in Shanghai and Booz Allen Hamilton, 20% is also the percentage of foreign invested companies that are planning to move at least some of their operations elsewhere.

The new law is designed to combat widespread and longstanding employment abuses in China, ranging from withholding or underpayment of wages and social insurance to improper dismissal of employees. Employees and unions have become more empowered under the new law, with employers finding themselves with less flexibility in their ability to manage employment relationships. Additionally, although many of the new law's requirements are not new, there are now stiff penalties for non-compliance.

Employers who have been non-compliant in the past will be hit the hardest by the new law. But is the outlook really that bleak for all employers? The answer is no, not necessarily – for employers who have been largely in compliance with the 1995 Labor Law (which is supplemented, not replaced by, the Employment Contract Law), and who implement proper administrative procedures to ensure continued compliance going forward, the pain will be bearable.

One of the impacts of the new law is that it effectively eliminates the use of consecutive fixed-term contracts by employers. The Employment Contract Law limits fixed term contracts to two consecutive terms, after which an open term contract is required to be offered to an employee. However, it is unclear as to whether an employer has the option to simply let the second term expire without offering a new contract to the employee. Draft implementing rules will apparently address this issue; it appears that the new rules shall stipulate that an employer is obliged to provide an open term contract if so requested by the employee. This would effectively give employers only one fixed term opportunity to evaluate employees. It is not clear when the implementing rules will be issued, although we understand that if they are not issued relatively quickly, then they are unlikely to come out until the fall of this year. Employers need to be more mindful of when employment contracts expire and need to properly evaluate the long term employability of employees during the initial term.

Extensive press coverage of the new law's employee-friendly provisions has contributed to greater employee awareness of labor rights and more active demands for redress of alleged labor violations. These factors have led to a significant increase in formal labor disputes. The number of labor arbitration cases filed in Shanghai so far this year has reportedly doubled from the same period last year. Arbitration cases will likely rise even further once the new Labor Dispute Conciliation and Arbitration Law comes into effect in May of this year. The new arbitration law eliminates arbitration fees, limits an employers right to appeal to the People's Court and extends the time in which employees are allowed to file an action from 60 days to 1 year.

One important ground available to employers to dismiss employees is when employees have materially violated an employer's internal rules. This ground existed under the 1995 Labor Law. However, the Employment Contract Law introduces a employee consultation process that employers must follow in order for company rules to be valid. It is very important for employers to have procedures in place for implementing such consultation process, and then properly documenting that they have followed such procedures whenever implementing or modifying company rules.

For company rules to be enforceable under the Employment Contract Law, the employer must (i) discuss and seek feedback on proposed company rules with all employees or an employee representative congress, (ii) conduct negotiations with the union or an employee representative; and (iii) publish the rules. This effectively empowers a union or employee representative to bargain with employers over salaries, bonuses, training and other work-related benefits and duties. However, as the law currently stands this does not mean that unions or employees have veto rights over any rules.

High level Chinese officials have recently been quite vocal in pressing unions to take a more active role, in both private Chinese and foreign-invested companies. The implications of this new rhetoric remain to be seen, but it is worth noting that formulation and implementation of company rules may face greater scrutiny.

The Employment Contract Law does have a couple of bright spots for employers. One is that employers now have two additional grounds of cause for unilateral termination by employers. Perhaps more importantly, there is a cap on severance which will greatly reduce the amount of severance otherwise payable to employees with high salaries. Severance is payable at the rate of one month's wages for each year of service. For any periods of less than 6 months, a half month is payable. For employees earning more than 3 times the local average monthly wage, their monthly severance is limited to this amount and the period is capped at 12 months.

Although it has been several months since the new law took effect, many employers are just now taking necessary steps to comply. For employers that have consistently followed local requirements over the years, compliance should not be onerous. For others, there may be significant costs associated with the new law. In any event, the challenging labor dispute environment of 2008 has already proven that non-action is no longer an option.

About the authors:
Kevin Jones is a senior associate and heads DLA Piper's employment practice in Shanghai. He has been based in Greater China for over 13 years. He advises on all aspects of employment related matters, including documentation (such as employment contracts, handbooks and non-competition, non-solicitation and confidentiality agreements), employee incentives, redundancies, dispute resolution (including mediation and negotiation with employees), employee issues in mergers, acquisitions and restructurings, audits of human resource compliance and data protection. Kevin also has extensive experience on a wide range of China and cross-border transactions, such as joint ventures, mergers and acquisitions, private equity investments, venture capital financing, project financing and corporate restructuring and reorganization.

Stan Abrams is a senior associate in DLA Piper's Beijing office. He has eight years experience in China dealing with intellectual property, technology and cross-border corporate transactions. Stan has advised technology companies, including biotech, telecom and software enterprises, on China commercial and regulatory matters, and has counseled his clients on confidentiality, protection of trade secret information, and enterprise human resources best practices with respect to intellectual property.

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