Investing In China: Proposed Labor Contract Law

If you are considering setting up a company in the People’s Republic of China (the “PRC”) you should be aware that Chinese law is more protective of employees than the laws of many western nations, particularly the United States. The current PRC Labor Law was enacted in 1994; however, a new PRC Labor Contract Law, intended to supplement the Labor Law, is expected to come into force at the end of 2006. This new law contains both bad news and good news from the point of view of the foreign investor; however, in general it further strengthens the protection of employees.

The Bad News:

Severance Pay

Because it is difficult under the PRC Labor Law to terminate open-term labor contracts, employers usually prefer fixed terms. The Labor Contract Law will address this issue by requiring employers to pay severance compensation to employees on fixed term labor contracts if these contracts are not renewed at the end of the contract term. The proposed compensation is at least one month's salary for each year of service.

Company Rules/Employee Handbooks

No provision in the employee handbook or other rules affecting the employee’s "personal interest" may be put into force absent consultation with the labor union or other employee representative body (under Chinese law, virtually all employees are required to be unionized).

A Shorter Probationary Period

Currently, the probationary period may be agreed between the employer and employee in the labor contract, but the maximum probation may not exceed 6 months. The Labor Contract Law shortens this period to one month for non-technical work and two months for most technical work (the six-month maximum is still retained for “senior technical work”, probably because these highly skilled employees are seen as less vulnerable in the employment market. This is significant because it easier to fire an employee during the probationary period than afterwards.

Non-Competition Clauses

Foreign invested companies in particular have tended to insert post-employment non-competition clauses into labor contracts in order to protect their intellectual property rights in China’s “wild west” business atmosphere. Although the Labor Contract Law allows post-employment non-competition restrictions, it will limit their enforceability to two years and restrict the geographical area of applicability to areas where actual competition is likely to occur. In this respect the reform will render Chinese law more similar to US law, since the current Labor Law does not impose any geographic restrictions at all (but does permits a maximum duration of up to three years). The Labor Contract Law goes even further, however, by requiring the employer “buy” a non-competition clause by paying a minimum compensation equal to the employee's annual salary upon termination of the labor contract. It is still unclear what, if any compensation will be due the employee if the period of restriction is less than a year.

Contract Interpretation

Any ambiguous term in a labor contract will be construed in favor of the employee. This rule does little more that codify what has long been the prevailing practice in PRC courts.

Representative Offices

The current Labor Law requires Representative Offices to go through designated agencies such as FESCO (similar to Manpower in the United States) in order to hire employees. The new Labor Contract Law offers Representative Offices greater flexibility by allowing them to directly contract with employees for their first year of employment.

In summary, the new Labor Law will restrict foreign investor’s flexibility and make it more expensive for them to operate. The only good news is that Representative Offices will find it somewhat easier to operate. Typically, the new Labor Contract Law does not bother to define terms like “technical”, “senior technical”; and “personal interest” However, foreign investors have long been used to waiting months and even years for ambiguous terms in Chinese law to be defined through the further issuance of “implementing regulations” to supplement the main law; meanwhile the government’s actual implementation of the law in particular cases will be closely watched.