On January 24, 2014, the PRC Ministry of Human Resources and Social Security issued the Interim Regulations on Labor Dispatch (Regulations). The Regulations are the final piece of the puzzle for a new regime which will significantly restrict the ability of companies to engage their staff through staffing agencies. The Regulations become effective on March 1, 2014.

Background

It has been common practice for companies in China (PRC) to engage their staff through staffing agencies such as FESCO and CIIC, instead of giving direct employment contracts to their staff. This arrangement is referred to as “labor dispatch” and involves the staffing agency employing staff in its name and then “dispatching” them to work for a company.

Many companies have used this structure thinking that it shields them from liability, in a legal environment which is heavily protective of employees, because legally they are not the employer. In practice, this has rarely been the case because the service contract between the staffing agency and the company normally passes on any liability incurred by the staffing agency, to the company. This structure was also used, especially after the 2008 financial crisis, as a means of reducing (or appearing to reduce) employee headcount because the costs could be categorized as payments to service providers.

The PRC authorities have discouraged this practice for some years, but without issuing legislation to force a change. The PRC government has a constant concern to maintain social stability in China and labor dispatch arrangements are seen as blurring actual (if not legal) responsibility for employees. In particular, it seems that changes may have been driven by the practice of State- owned companies to engage staff through agencies with lower salaries and fewer benefits.

Finally, the new regime is in place. The basic restrictions were set out in the Amendment to the Labor Contract Law (LCL Amendment) that became effective on July 1, 2013, but without sufficient detail to allow the restrictions to be followed by companies or enforced by the authorities.  The  new  Regulations  provide  this  additional clarity  and  certainty.  Accordingly,  companies  need  to be aware of the new requirements and to assess how these requirements will impact business operations and what changes may be needed.

What is Changing

Staff Category

The new regime provides that companies can only engage specific categories of staff through staffing agencies:

  • Temporary staff—staff engaged for six months or less
  • Substitute staff—interimstaffcoveringfor permanentemployeeswhoareonleave
  • Auxiliary staff—staff engaged in non-core business of the company

There is still no definition of “non-core business.” The Regulations instead provide that companies must undertake an internal procedure to decide on what positions may be considered non-core. The key component is a consultation process with staff (or staff representatives) and labor union representatives (if the company has a union). There is no further guidance on the form of the consultation process, but it is likely to be treated in a similar way to the consultation process required for companies to implement handbooks and policies.

The consultation process falls short of obtaining the approval of employees, but in practice companies should ensure that they make reasonable efforts to consult, and to consider and accommodate the feedback they receive before making a final decision. It is recommended that companies think carefully about the nature of their business and the employees that they presently have before deciding on what to treat as non-core and on the form of the consultation process. Companies that fail to follow the procedures may be forced to make changes, and to pay compensation for any damage suffered as a result.

Threshold by Total Staff

The restriction on categories of staff is underpinned by a new and clear threshold. The Regulations specify that the number of staff engaged through staffing agencies must not exceed 10 percent of the total staff of the company (including direct hires and dispatched staff). This threshold is significantly lower than the informal predictions of 20 percent to - 30 percent that circulated following the issue of the LCL Amendment.

Grace Period for Compliance

The new regime does show some recognition of the fact that the new restrictions will present a logistical and timing challenge to some companies to restructure their existing arrangements. The Regulations expressly allow companies a two-year grace period up to and including February 28, 2016, to achieve compliance with the new threshold. That said, until companies comply with the threshold, they will not be able to engage any new staff through staffing agencies, even if such staff fall within a permitted category.

The Regulations also provide that companies currently exceeding the threshold must file a proposal with the local labor bureau setting out their proposed plan for restructuring to meet the deadline. At present, it is unclear whether this requirement will be enforced by local labor bureaus or what might be the required form and level of detail for such proposals.

Representative  Offices

The Regulations clarify that representative offices (which do not have legal person status) will not be subject to the restrictions on staff category and the threshold. This is important and logical, because representative offices are not permitted to hire any staff directly. Accordingly, representative offices can (and must) continue to use staffing agencies to engage their staff or, in the case of foreign nationals, hire them through an entity outside China and second them to work at the representative office in China.

Employment Contracts and Returning Staff to Agency

An apparent anomaly of the new regime is that it does not amend the requirement for staffing agencies to give an employment contract with a term of at least two- years to employees. This seems illogical for temporary staff and substitute staff, who by nature, will probably  be required for periods of less than two years. This is significant because, unless the staffing agency agrees, companies are not permitted to simply return staff to the agency “at will.” The company normally can only return staff when a legal ground for termination of employment exists. Under PRC law these grounds are limited.

The Regulations do provide expressly, however, that a company can return a dispatched employee to the agency if the following legal grounds for termination exist:

  • Major change in the objective circumstances relied on to conclude the contract
  • Mass lay-off (i.e., minimum 20 employees or 10 percent of total staff) due to serious financial, technological or operational difficulties

This is a favorable new development because, in the past, some agencies had refused to allow the return  of dispatched employees as part of a mass lay-off on the basis that while the company may be experiencing financial or other difficulties, the agency, as the legal employer, was not. In addition, the express recognition of the “major change” ground may be helpful for companies to justify the return of temporary or substitute staff at the end of the period for which they are required by the company.

As a practical matter, companies should try to have staffing agencies agree contractually to dispatch employees for a period of less than two years, even if the agency is required by law to give a two-year employment contract. It is unlikely that staffing agencies will be significantly prejudiced by this practice, because they are permitted to re-dispatch an employee or, if unable to do so, to pay only minimum wage to the employee. In such circumstances, employees tend to resign from the staffing agency and seek better paid employment  elsewhere.

Equal Pay for Equal Work

The Regulations reinforce the existing legal principle of equal pay for equal work regardless of how staff are hired—whether on a direct contract or through a staffing agency. There is still no definition of “equal work,”  which means that labor authorities and labor arbitration commissions will have a relatively free hand to interpret the term as they see appropriate.

Stricter Qualifications for Staffing Agencies

The LCL Amendment has already established that staffing agencies must be duly qualified and must have registered capital of at least RMB 2 million (approximately USD 330,000), which is a significant increase on previous requirements. Foreign companies should check that the approved business scope of the staffing agency allows it to provide services to foreign- invested companies in China. Many staffing agencies are only authorized to serve domestic companies.

Penalties for Non-Compliance

Penalties may be imposed for failure to comply with the new regime, including fines of RMB 5,000 – RMB 10,000 (USD 825 – USD 1,650) per agency employee. These penalties may be imposed on both the staffing agency and /or the “accepting entity” (i.e., the company).

Key Points and What To Do Next

The Regulations give clarity and a sense of intent to the new regime. It is important for companies to assess whether they will need (or want) to restructure their existing staffing arrangements as a result of the changes and if so, devise the best strategy to achieve the restructuring.

Does the company need to use a staffing agency at all?

The use of staffing agencies to engage staff does not normally shield a company from liability, and staffing agencies can still provide HR payroll and administration services to companies if the employees are hired on contracts with the company directly. That said, if staffing agencies will agree to flexible conditions for the return of staff, there will still be value in using the dispatch structure for the permitted categories of staff. Companies should look at the terms different agencies are willing to offer and negotiate hard on their service contracts with agencies.

Headcount issues

The greatest challenge will probably be for companies that have headcount issues and how these companies should handle the transition internally. The Regulations emphasize that staffing arrangements must not be disguised as outsourcing or service provider relationships. The grace period for compliance allows companies time to structure and effect changes, potentially in stages.

Non-core business

Consider how to define non-core business, which employees can and will be engaged through staffing agencies, and what form the consultation process should take.

Timing for Transition

Consider whether to restructure all dispatch arrangements to direct employment contracts with the company immediately, or whether to adopt a more structured approach over time within the grace period. The advantage of a “one shot” restructuring is that the required changes will then be complete and not an ongoing process to manage.

By contrast, companies could transition dispatch staff to direct employment contracts in batches, as the existing employment contracts with staffing agencies expire. Given the severe limits on an employer’s right to terminate, this would give companies the opportunity to consider whether to continue to employ an individual.

If the company chooses, it can simply let the old arrangement expire with no obligation to give a new direct contract to the employee. For larger companies, however, this strategy would require considerable and careful administration.

Process for Transition

The transition process will involve close coordination with existing staffing agencies and communication with affected employees. These employees will need to legally terminate their employment relationship with the agency, as well as sign a new contract with the company. Many agencies have a standard three party agreement to document the transition, although these tend to be basic and companies should carefully review the sections on apportionment of liability.

Companies should also ensure that their existing forms of employment contracts and other employment documentation are adequate before having dispatch employees sign up to these forms.

Communication and Employee Expectations

Clear communication with employees is important. The agency should be a part of the communication process, but the company should ensure that the messaging is consistent. Employee uncertainty tends to lead to unrest, and can be disruptive to a business, or result in negative media coverage.

Employees in China increasingly seem to view situations such as this as an opportunity to obtain some kind of windfall or benefit, regardless of whether this is legally required. Companies need to be prepared for questions regarding recognition of previous years of service under the new direct contract, and requests for the new contracts to be open term rather than for a fixed duration.

Final Thoughts

Despite the fact that the new regime applies to all companies in China and may be aimed primarily at pushing State-owned companies to change their practices, foreign-invested companies are sometimes held to a higher standard in practice and may be used by the authorities as examples to incentivize domestic companies to comply.

Be prepared and have a strategy!