It is clear that economic growth in China is in a downtrend as dismal manufacturing data has consistently shown. By some measures, the manufacturing sector has shrunk at the fastest rate since 2009. With pro-growth policies yet to take effect and few prospects for near-term improvement, many firms are considering workforce reductions and cutting labor costs.
US and certain other foreign firms which may enjoy at-will employment in their home countries have found it challenging to dismiss employees in China. Even with for-cause dismissal clauses in labor contracts, employers are unable to terminate employees unless the cause for termination is itself statutorily articulated. In other words, grounds for an employer to unilaterally terminate employees can be based only upon reasons expressly provided for under PRC law, and nothing else.
Legal grounds exist but are limited
In general, an employee may be unilaterally terminated if he or she:
- commits serious wrongdoing;
- is unable to work due to non-work related injuries upon the conclusion of the statutory medical period; or
- is proven to be incompetent after training or a change in work duties.
An employee can be terminated only in very limited instances if he or she is not at fault and is able and in good health. Fortunately for foreign investors, group layoffs are recognized under PRC law. The Labor Contract Law (promulgated in 2008 and later amended in 2012) has offered broader and more practical applications than the Labor Law (promulgated in 1994). Whereas the old law permitted group layoffs only during bankruptcy-related restructuring and in cases of serious production or operational difficulties, the Labor Contract Law now recognizes other circumstances. Such circumstances include “changes in business direction, major technological innovation or changes in business model,” and “other material changes in objective economic circumstances which . . . make continued employment no longer possible.”
Bankruptcy is an end-game scenario which most employers will not encounter. Other legal grounds, however, are both reasonable and provable. As is often the case with PRC legislation, however, the layoff provisions are worded too general without detailed provisions and thus implementation by each competent authority tends to vary significantly. Therefore, before initiating a group layoff, employers are well-advised to thoroughly research local labor tribunal cases in order to better evaluate how to proceed. While legal precedent is not binding in China, case law nevertheless serves as a useful guide when pursuing similar cases.
Procedurally, a group layoff of more than 20 people or 10% of the workforce requires notice, consultation and reporting. A 30-day notice to the labor union of the employer (or all employees in the absence of a labor union) shall be delivered. After details of the layoff plan have been determined, it shall be consulted with the labor union (or all employees) to solicit comments. In theory, no approval is required from the labor union or another employee representative. In reality, however, the support of the union or the employee representative should be sought because its or the representative’s signature or official chop is generally required in documents to be submitted to the labor bureau, and because employers may need help in supporting employee morale. After consultation, an employer will report the plan to the labor bureau. Reporting a planned layoff is generally handled at the district or county level, although local rules may require a sizable group layoff be reported to higher level authorities.
After fulfilling consultation and reporting obligations, an employer is then able to formally announce and execute the layoff. Time is usually of the essence for a successful layoff, but the involvement of the labor bureau, labor union, and possibly the entire workforce, will often prolong the process, which often concerns employers. Some employers therefore prefer to initiate successive rounds of smaller group layoffs, because layoffs of fewer than 20 people or 10% of the workforce are exempt from the procedural requirements discussed above. In the case of such a layoff, the employer is only required to give notice to the labor union prior to termination, with no minimum period of notice or approval by the labor union is required.
Alternatives – Unilateral Termination, Mutual Agreements, and other Cost-Saving Measures
Employers often seek to avoid formal layoffs because of the legal constraints, worries over capricious local tribunals, and fears of labor unrest and negative publicity. Therefore, what else can employers do to reduce their workforce or cut labor costs?
Multiple individual terminations
First, an employer can terminate an employee upon 30 days’ notice if there has been a “material change in objective circumstances” that existed at the time the contract was concluded which results in the contract no longer being able to be performed. Same as a formal group layoff, “material change in objective circumstances” is a vague and ambiguous concept. Employers can pursue this approach if the factual circumstances warrant. Before termination, employers must consult with employees in an attempt to amend employment contracts. Usually, employers will offer a substitute position and reduced wages, or, in other cases, explain that other suitable positions are unavailable. Proposed terms shall be reasonable to show the employer is engaging in good faith negotiations. If the parties cannot reach an agreement, the employer may then terminate the labor contract. While the termination and negotiation are usually conducted on a case-by-case basis, if the “material change” relates to a corporate restructure or change in business model affecting multiple employees, a “de facto” layoff may take place. Such de facto layoffs are not subject to the same procedural difficulties as formal layoffs, but prior notice to the labor union is required. The labor union has the right to raise objections though it cannot directly overturn a termination.
Mutually agreed terminations
Another alternative to group layoffs is termination by mutual agreement. This is a preferable means of terminating employees if the terms of such an agreement are not too costly to the employer. The potential for employee legal claims can be greatly reduced by using mutual agreements. Negotiations will usually take rounds and the final agreed upon severance payments are usually higher than the statutorily required minimum. In practice, employers often choose to offer “N+2” or “N+3” deals, where “N” stands for the number of employee service years, plus an additional two or three months of pay. Sometimes, a month’s wage in lieu of notice is also provided, although notice is not required for mutual terminations. Individual discussions for mutual terminations are
appropriate for management level employees or for those upon whom employers wish to impose non-competition obligations. If the employees are mostly blue-collar workers, or employers have no general preference with respect to which employees are terminated, a voluntary departure plan (or a voluntary resignation incentive program) may be more economical and effective. Such plans are essentially the equivalent of a group mutual termination. Voluntary departure plans can be appealing if the terms make economic sense to both the employer and employees. However, these plans also present certain pitfalls, such as if more employees are interested in leaving than expected, if there is any negative impact on the morale of employees who seek and are denied termination, or, even worse, if unwanted employees remain. Sometimes, such a plan may cause business disruption if it is too well received by employees. Care must be taken when formulating eligibility and terms of the plan.
Other cost-saving measures
Other than directly reducing headcounts, employers may also utilize cost-saving measures. Undertaking cost-saving measures may provide the added benefit of showing that the employer has exhausted all other remedies if it later becomes necessary to pursue layoffs. Such measures may also be good transition steps if shareholders cannot yet reach an agreement on strategic changes for the company’s repositioning or downsizing.
Employers may negotiate compensation reductions with employees, with or without reducing job responsibilities. Employees who are aware of operational difficulties will often comply with reductions for fear of being laid off. As employment contracts are to be in writing, any amendment to them should also be in writing. Note that the Supreme People’s Court, in its judicial interpretation relating to labor contract disputes, has relaxed documentation requirements -- orally agreed amendments are effective if the amended contract has been performed for more than one month, unless the amendment conflicts with statutory provisions or is against public policy. Therefore, the reduced compensation or change in work duties can be effective if the employee has performed under the amended contract for a period longer than one month, and cannot otherwise prove that he or she has objected the amended terms.
Alternatively, employees can be placed on temporary leave. Uncompensated leave is illegal, but if the leave is due to a facility shutdown which lasts for more than one wage period (typically one month), employers are required only to pay the local minimum wage. In this scenario, the leave would be accompanied by the shutdown of all or part of the employer’s business operations. Under certain local rules, payments to employees may be further reduced. In Beijing, for example, an employer is required to pay only 70% of the local minimum wage; in Shenzhen the amount is 80%.
When considering workforce reductions in China, employers should consider both the legal and practical business elements involved. A well-planned and thoughtful strategy usually requires an understanding of the local practices, skilled communication with employees and labor authorities, and effective management of employee expectations. Whether or not a direct layoff is feasible, employers should also be flexible with other alternatives in order to achieve the best possible results under PRC law.