China Adopts Its First Major Labor Contract Law

All businesses with employees in the PRC are affected

July 17, 2007

All businesses with employees in the PRC are affected.

China adopted its first major law about employee agreements on June 29.  The Standing Committee of the National People’s Congress, China’s top legislature, passed the labor contract law after almost 2 years of deliberation and public comments.  The law takes effect on January 1, 2008.  All companies with employees in China should review and conform their employment practices in light of this major change.  This includes the many US companies that have American expats or Chinese nationals working in the PRC.

The new law sets standards for mandatory labor contracts, lay-offs, severance payments, use of temporary workers, and other conditions in China’s rapidly evolving labor market.

Mandatory Labor Contracts

The law requires contracts for all workers to be in writing and signed within one month of first use of the worker.  The employee immediately becomes eligible for benefits of the law.  Foreign companies in China must award either fixed-term or open-ended employment contracts to employees after they complete a probationary period.

The law is designed to discourage short-term contracts.  In any of the following circumstances, employees will automatically secure an open-ended contract and lifetime benefits:

In addition, if an employer fails to sign a contract with an employee within the first year, the employer and the employee will be deemed to have concluded an open-ended contract. 

Foreign companies in China will find new restrictions for laying off workers.  The law does not stipulate any time limits, minimum or maximum, for a fixed-term contract period.  This will probably lead to longer fixed-term contracts that will give employers and employees plenty of time to work together before lifetime benefits apply as a matter of law.

The choices of how to configure fixed-term agreements will vary depending on a company’s objectives for each employee.  Existing agreements should be reviewed and changed before January 1, 2008, or the law will apply by default to a current work force, and the consequences may not be pleasant for employers.

Collective Bargaining

The law empowers company-based labor union or employee representative committees to bargain with employers over salaries, bonuses and other benefits for workers.  A company that (a) plans to lay off 20 workers or more or (b) has fewer than 20 employees and intends to fire 10 percent or more of the total number of the company’s employees has to inform its union and consider its opinion.  This was a subject that received extensive comment from foreign owners in China, and where the Government had taken the unprecedented step of specifically asking for foreign company input before settling on final language.

Industry-wide or area-wide collective bargaining agreements may also be concluded between a labor union and representatives from companies in industries such as construction, mining, catering services, etc. 

Non-compete Agreements

Employers may agree with workers on competition restrictions in their employment contracts and may use confidentiality agreements.  These should stipulate that the employer pay financial compensation to the worker on a monthly basis during the term of the competition restriction after the end of the contract.  If the worker breaches the competition restriction provisions, he must pay liquidated damages to the employer.  The competition restriction period cannot exceed two years.  The law does not specify the amount of either compensation or liquidated damages. 

All non-compete and confidentiality agreements should be reviewed to conform provisions to the specifics of the new Chinese law.  Agreements that predate the law are not likely to be enforced by the Chinese courts, and will be readily open to defensive challenges after employees leave a company.

Severance Pay

The law stipulates severance pay.  An employee shall be paid severance pay based on the number of years worked with the employer at the rate of one month’s wage for each full year worked.  If an employee’s monthly wage is greater than 3 times the average monthly wage of employees in the employer’s area, the severance pay shall be 3 times the average monthly wage of employees and shall not extend for more than 12 years of work.  This means that for long-term employees, a full year’s severance pay will become a normative condition in China.  This obviously affects budgeting for Chinese work forces and calls for evaluation of related matters in managing employees.

Forced Labor

Employers are not to force employees to work overtime, and employees can terminate a contract without early notice to the employers if they are forced to work by violence, threat or restriction of personal freedom.  This is a departure from US norms that require extra compensation for overtime rather than banning it completely.

Foreign Nationals Working in China

The law governs all employers and employees in China.  It has no separate provision about foreign nationals employed in China.  This leaves obvious questions for companies who send employees to China for part of a year or for a limited assignment.  Are they Chinese employees for purposes of the labor law, US employees or both?  How can a non-Chinese business plan for such persons?

According to Rules for the Administration of Employment of Foreigners in China and relevant circulars, a foreign national who has a labor contract and income from a foreign employer outside China is considered employed in China if the person works in China for more than 3 months.  In this case, the foreign national must conclude a labor contract with the person’s employer in China.  This could mean such persons having two agreements – one with the non-Chinese employer and another with the Chinese employer.  Careful planning is required to address this group of persons, and refinements to the law can be expected in the future.

For further information, please contact a member of the International Services Group.  

Frost Brown Todd's China Consulting Group serves both US and Chinese companies.  Through an Alliance with the Hubei Sunshine Firm in Wuhan, offices in Shanghai and Beijing through the firm's affiliated FK MidAmerican Consultants LLC and strong established connections with Chinese law firms, Frost Brown Todd is committed to China's further integration into a globalized economy.

For those with serious interest in Chinese legal and business developments, you may bookmark (free of charge) to www.fbtchina.com, where a China Blog appears.  The China Blog regularly reports on developments of interest to businesspeople involved with China.

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