China’s Contract Law Something for Everyone

By Ed Frauenheim

Sep. 6, 2007

China’s new employment contract law is poised to strengthen the workers’ hand, but it deals employers a high card or two as well. And it may help both sides win.

In the run-up to the law, which was passed in June and goes into effect in January, employer groups warned that the statute could hurt China’s economy by overly protecting workers. The final, revised rule could restrict management’s authority, analysts say.

But the law includes some bright spots for employers. Mass layoffs may be easier to do. And high-wage employees—possibly including expatriates—will have severance payments capped, potentially saving firms hundreds of thousands of dollars for a single ousted executive.

What’s more, some analysts argue the new statute might prove beneficial to both employers and employees. Jill Malila, director of client management for the China operations of Mercer Human Resource Consulting, says the law provides some “much-needed clarity” on labor relations in the country.

“While the law limits the flexibility for a company in managing employment affairs, it does more clearly articulate the terms of the employee-and-employer relationship,” Malila says. “This can bring greater consistency in the market.”

Economic upheaval
China’s labor market is young by Western standards. The communist government only began experimenting with capitalism about three decades ago, and its economy has been called a kind of Wild West.

The new employment contract law is part of a broader push by government leaders to balance the country’s breakneck economic growth with the goal of a “socialist harmonious society.” The country’s market reforms have generated great wealth in China and reduced poverty, but they’ve been accompanied by a dramatic widening of inequality and many reports of worker exploitation.

China has experienced tens of thousands of protests in recent years, including many labor-related incidents. Low wages, unpaid back wages, lack of retirement insurance and inadequate layoff compensation have been cited as major causes of labor disputes.

Analysts say most of the labor abuses take place at Chinese-owned firms rather than at foreign-owned operations. In any event, the new law will apply to both sorts of employers.

Unlike the U.S. employment landscape, which is dominated by “at will” relationships between worker and employer, China’s employment system is based on contracts. The new law aims to improve that contract system as well as “to specify the rights and obligations of the parties to employment contracts, to protect the lawful rights and interests of workers and to build and develop harmonious and stable employment relationships,” according to a translation of the statute by international law firm Baker & McKenzie.

Among the law’s 98 provisions is the requirement that a written contract be created within one month of the day an employer starts using a worker. A company that fails to draw up the contract on time faces the penalty of paying the worker twice his wage.

Required elements of all employment contracts, including job description, compensation and working hours, are spelled out. The new decree also specifies limited conditions under which contracts can be terminated, such as incompetence and serious rule-breaking.

Protections for temporary agency workers are included in the statute, such as their right to earn the same pay as comparable workers at the firm to which they are assigned. When mass layoffs occur, the law directs employers to prioritize retaining sole breadwinners who need to provide for a minor or elderly person.

It also contains measures to help employees cope with job loss. Thirty days’ written notice, or one month’s wage, is required for terminations in a variety of situations. And the law identifies the circumstances requiring severance pay. In general, workers receive one month’s wage for each full year worked.

Curbing labor abuse
Simply requiring written contracts and instituting the double-wage penalty will do much to stem the abuse of China’s millions of migrant workers, says Tim Costello, co-director of Global Labor Strategies, a research and advocacy group based in the United States. Currently, he says, many workers flocking from rural areas to work in factories do not receive contracts and find themselves without much recourse if their employer fails to pay them.

He also says the rules on severance promise to help workers, given high turnover in China and the country’s limited aid to displaced employees. “Severance pay is really important in an economy where you don’t have much of a safety net,” he says.

In writing the statute, Chinese officials borrowed heavily from Germany and other European nations, says Andreas Lauffs, head of the Greater China employment law group of Baker & McKenzie. For example, he says, the law gives a good deal of responsibility to unions and employee representative congresses, which are similar to the “works councils” common in Europe.

Lauffs says that although attention to the law has focused on its rules for individual contracts, it bestows plenty of power to collective worker groups. Article 4, for example, gives employees and employee groups some authority over work rules. “The employee representative congress or all the employees, as the case may be, shall put forward a proposal and comments, whereupon the matter shall be determined through consultations with the labor union or employee representatives conducted on a basis of equality,” it reads in part, according to the Baker & McKenzie translation.

Lauffs says a recent meeting with a member of China’s National People’s Congress who worked on the law failed to clarify whether “on the basis of equality” means the union will have a veto over work rules. ” ‘Consultation’ means at least the union has to be heard,” he says.

The question of authority over work rules was among the lightning rods for controversy last year. A draft of the law more strongly indicated that employees or their representatives could block company rules. The American Chamber of Commerce in Shanghai warned of management “chaos” if all rules and policies required the approval of employees. In comments to government officials, that group also argued that a draft of the law was vague about what sorts of work rules were at issue.

Chinese officials appeared to take those points into consideration in writing up the final version, softening the language on employee power over rules and offering examples of the kinds of rules covered.

In July, the American Chamber of Commerce in Shanghai said it welcomed the new law as well as the way Chinese authorities had invited the public to make comments on it. “We support the law and the process by which it is has been developed,” the chamber said.

The chamber also made a plea for evenhanded enforcement: “As we have previously stated, consistent enforcement of the labor laws will be crucial to solving many of the labor practice problems in China.”

Stepping up enforcement
Enforcement of labor rules and other regulations in China has been uneven historically. And China’s official labor union, the All China Federation of Trade Unions, has been criticized as colluding with management more than aiding employees.

But there’s reason to believe things are changing on the labor front, Lauffs says. With the urging of top Chinese leaders, the All China Federation of Trade Unions has been aggressively organizing in foreign-owned companies, Lauffs says. These efforts include establishing unions in Wal-Mart stores in China. Union officials could play a role in ensuring enforcement of the new contract law, he argues. “Labor unions are becoming more assertive,” he says.

Then there’s the overall Chinese push for a more harmonious society. The need for greater worker protections was underscored recently by allegations of slave-like conditions in brick kilns in China. According to news reports the past few months, authorities rescued hundreds of people who had been forced to work long hours in kilns. Reports said dozens of children were found working in the kilns—a disturbing situation covered in the Chinese media.

Although the level of enforcement for the new law remains to be seen, companies operating in China would do well to study the statute and update their practices accordingly, says Mercer’s Malila. She says human resource departments will need to gear up to make sure they abide by the contract-writing and notification requirements. In addition, she foresees it becoming more difficult and expensive to terminate workers.

“Employers need to be sure they’re careful in hiring employees,” says Malila, who is based on Shanghai.

Layoffs, severance eased
The new law, though, doesn’t just look out for workers. Lauffs says one clause provides new legal grounds for a mass layoff—defined as a workforce reduction of 20 or more people or 10 percent or more of a firm’s employees. Added to layoff rationales such as bankruptcy and serious production difficulties is “another major change in the objective economic circumstances relied upon at the time of conclusion of the employment contracts, rendering them unperformable.” The catch-all phrase should give employers more flexibility when it comes to large-scale layoffs, Lauffs suggests.

The statute also sets limits on the severance pay of highly paid employees. If an employee’s monthly wage is more than three times the average monthly wage in the area, his or her severance pay rate is capped at three times that average monthly wage per year worked. And the length of service used to calculate the severance pay for that high-income worker is restricted to a maximum of 12 years.

Lauffs says this feature of the law will drastically reduce the severance payments of executives in China, including expatriates who are directly employed by a Chinese subsidiary. He gives the example of a manager earning $1.2 million annually who is employed for two years and then terminated for incompetence. “Under the old law, he would be entitled to one month’s salary for each year of service, here $200,000,” Lauffs says. Under the new rule, Lauffs says, that severance payment could shrink down to roughly $2,000.

Malila cautions, however, that firms may be asked to fill in the gap for their senior managers. “We expect employers will revisit contracts with key employees and consider other ways to make up the loss in benefits under the law,” she says.

Relaxing the rule on mass layoffs may not be much of a boon to businesses in China, says Beijing-based business consultant Teresa Woodland. She argues that companies generally are growing amid the country’s boom, and major layoffs still will require negotiations with local government leaders.

Even so, Woodland is optimistic that the new law will ultimately help, rather than hurt, companies in China. She argues it could give workers at abusive Chinese firms a means to protect themselves without turning to protests.

“Yes, it increases regulation, but I think it’s workable,” she says. “You don’t hear people screaming, ‘We can’t work with this.’ “

Costello, of Global Labor Strategies, wishes the law had gone further—to authorizing independent unions. He also is concerned that the statute’s exemptions for part-time workers could lead to abuses.

But overall he thinks it is a “good law.” Although Costello primarily worries about workers, he thinks the new rule will eventually benefit businesses as much as or more than employees. In his view, better-paid workers with greater job security will turn into good consumers. “It can really unleash a huge market in China,” he says. “This is a step in that direction.”

Workforce Management, August 20, 2007, p. 35-39Subscribe Now!

Ed Frauenheim is a former Associate Editorial Director at Human Capital Media and currently works as Senior Director of Content at Great Place to Work. He is a co-author of A Great Place to Work For All.

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