China's New Labor Contract Law
Asia Observatory

12 December 2007

China's New Labor Contract Law

Labor law is a relatively new phenomenon in China, with the first comprehensive law passed in 1994. The new law, adopted by the National People's Congress (NPC) on 29th June 2007, seeks to redress some of the poor working conditions found in China, particularly those of the average worker. Prior to the new law's passage, most Chinese employees in small- and medium-sized firms lacked employment contracts. Moreover, most contracts were short-term, giving employers the flexibility to frequently bring in new, often cheaper, hires whenever they saw fit. Employers also often refused to pay overtime and some even relied on forced labor.
The intention of the new Labor Contract Law (LCL) is to provide a more effective protection of employees by offering an "employer-friendly" environment which must be accepted by all Foreign Invested Enterprises (FIEs) and domestic companies in China. With the law coming into effect on 1st January 2008, many companies are now under the pressure of restructuring their human resource policies.

Major Changes
Written employment contract.
The LCL stipulates that employers are requested to enter into written labor contracts within one month of the commencement date of the employee. Where the employer fails to sign a written labor contract with the employee, the employer would be required to pay the employee twice the monthly salary until the written contract is signed by both parties. In addition companies do not have to pay this "penalty", if the employee fails to require double salary. However it is recommended to sign written contracts at all times. Oral contracts are permitted in case of part-time workers, employed less than 4 hours a day and 24 hours a month.

Duration of the Employment Contract
Starting from 1st January 2008, it is the aim of the NPC to promote longer-term employment relationships. The parties (to any newly signed) labor contract can agree to either a fixed or open-ended contract. Open-ended contracts must be signed if the employee has been working for the employer for a period of over ten years or if he has already completed two fixed-term contracts. Fixed-term contracts would then no longer be permitted.

Contract Interpretation
With the implementation of the new law, a well drafted labor contract in English and Chinese is a necessity to avoid misunderstandings and misinterpretations by future candidates. Avoiding ambiguous terms may assist in future disagreements between the employer and employee.

Probation Period
The LCL stipulates that the probation period shall be determined according to the terms of the employment contract. Where the term of the employment is equal to or less than 1 year, the probation period shall not exceed one month, where it lies between one and three years, the period shall not exceed two months; where the term is more than three years or open ended, the probation period shall not exceed six months. In addition the law requires employers to pay at least 80% of the contractual salaries during the probation period. If the probation period exceeds the time limit, the company will be required to pay compensation to the employee.

Non-Competition Clauses
As can be seen from employee turnover rates, companies do lose their employees to competitors. It is critical that non-compete clauses are added to contracts, particularly with the increasing amount of technological transfer from abroad. The new law requests the parties to define the scope, territory and term of a non-competition clause. The mandatory term cannot exceed 2 years. Mandatory compensation for non-compete provisions shall be paid by the employer in monthly installments during the non-compete period (from the termination of the contract to a maximum of 2 years) as agreed by both parties. The use of non-competition clauses is restricted to senior management, senior staff and other staff familiar with the intellectual property of the employer. With the employer-friendly emphasis in the law, employee's violation of the non-competition clause means that compensation and liquidated damages are subject to the agreement of the parties and are no longer limited to three times the compensation as was previously adopted.

Training Agreements
The LCL permits a training agreement clause stipulating a loyalty period after training is provided with special funding. In case of termination before the expiry of this period, the employee must pay the agreed liquidated damages.

The new LCL clarifies that the employer may layoff redundant employees, subject to mandatory procedures, under the following circumstances: where the company is under restructuring or falls under bankruptcy in accordance with laws and regulation, where serious difficulties have occurred with relation to the production and / or management of the company, where the company is relocating, engaging in new product lines and / or is going through major technical renovation. Further conditions include the material breach of the employer's rules, a serious dereliction of duty, incompetence or disability.

Severance Payment
Similar to the present law, severance must be paid to an employee in case of ordinary termination. New to the law is that severance payment is also required to be paid in situations where the employer does not renew the fixed term labor contract, unless the employee has rejected an extension despite being offered the same or better terms, or the employer proposes a termination and the parties agree. The severance payment shall be equal to the employee's monthly salary multiplied by the employee's years of service. The law places a cap on the amount of severance for those employees with higher salaries.

Internal Company Rules
The LCL clarifies that companies must negotiate with employees, employee representatives and / or trade union officials regarding the internal labor rules, and publishes the agreed rules for all employees. Internal labor rules should include issues such as remuneration, working hours, leave and holidays, labor security and sanitation, insurance, benefits, vocational training and labor discipline.

Trade Unions
Under the LCL the role of trade unions in safeguarding the legitimate rights and interests of employees has been strengthened; by allowing them to assist in the formulation of corporate rules, negotiate on collective contracts, provide opinions on mass layoffs and the termination of labor contracts. However, there are limitations in that trade unions will only be "informed" and "heard" on many instances, as they do not have the right to block any actions taken by the management.

Labor Service Companies
Representative offices and Limited Companies using the labor service companies must play their part in upholding worker's rights. Labor contracts between employees and labor service companies hiring on the behalf of the employer must have fixed-term contracts with a minimum length of 2 years. With this new regulation labor service companies are becoming more stringent; affirming that they will not sign labor contracts unless the employer has a legal entity in China.

Situation for Foreign Companies
Impact and Enforcement
The aim of the new LCL is to curb the deeply-rooted problem of worker exploitation in China. Nevertheless the impact of the law lies in the government's willingness and ability to enforce it. With much probability there could be misinterpretations of the law from the local government offices, who support any loopholes that are available. This could result in an advantage to FIEs who have good government relationships or it could increase their labor costs as the rules may be strictly applied to them in comparison to domestic companies.

In addition the increasing role of the All-China-Federation of Trade Unions (ACFTU), who are controlled by the Communist Party (CCP) have begun influencing foreign companies by enforcing stringent regulations on them. As an example, Wal Mart was successful at keeping its outlets in China union-free for ten years, however in August 2006 ACFTU began operating in Wal-Mart and proceeded to spread like wildfire throughout other superstores. The ACFTU has since announced its intention to unionize 70 percent of foreign companies by the end of this year.

It is expected that the impact of the law would be greatest in companies that use fixed-term contracts, as severance must be compensated for the non-renewal of a contract and there is limited flexibility. Moreover business costs and employments risks are expected to increase and collective bargaining will be reinforced for larger companies, influencing the role of the ACFTU.

Although the new law does try to improve labor conditions in China, it does contain loopholes, which would be important for the larger corporations. As an example, there is a new penalty (double the severance pay) against employers who fire workers without good cause before their contracts expire. This law may only encourage employers to lay off workers early in their contracts, when they are not yet entitled to significant severance packages.

Impact on General Management Policies
It is necessary for upper management personnel to review cost implications for current and future employees, discuss appropriate accruals with auditors and calculate outsourcing options. One of the first essential steps should be the training of the Human Resource department as well as other Senior and Executive personnel in terms of future employment and termination procedures.

Impact on Human Resource Policies
Human resource departments will have to re-structure their employment arrangements, renew all contracts whether for full or part-time positions and create new strategies for the future composition of their workforce. Companies may even begin looking for outsourcing solutions in order to lower their risks.

Companies already using labor service agencies will also have to begin to review and modify their training, compensation and communication strategies towards their employees and review their current agency contracts.
All companies should create or update their company handbooks with all internal regulations before 2008. Subject to the size of the company it may be advisable to create supplemental contracts for anti-corruption, non-competition, non-disclosure, anti-harassment and business conduct which could protect a company should the actual employment contract be terminated.

Although the impact of the labor reform will vary depending on the type and size of the company, generally foreign companies will lose their competitive advantage. However, as is common in China, the larger issue is government enforceability and making the Chinese employees and workers aware of the new working changes. As these concerns about the practical implementation are speculative, companies should still develop a feasible strategy to prepare for the execution of the new law in order to reduce negative impacts before the law comes to effect. If you require assistance with the above subject, please contact us at with your detailed questions.

Klaus Koehler, Managing Director, Klako Group