【Case Brief】

In July 2005 Wang Peng executed a labor contract with ZTE to work as a salesman for a basic salary of 3,840 yuan per month. ZTE then informed Wang Peng of its rules and regulations via on-line publication. According to the Management Measures for Employee Performance, ratings for semiannual and annual performance reviews were classified as S, A, C1, C2 representing “excellent”, “good”, “not in conformity with company values” and “improvement needed”, respectively. The proportions of S, A and C (C1 and C2) employees were 20 %, 70 % and 10%. respectively. Incompetent employees were generally classified as C2. Wang Peng originally worked as a salesman in the distribution section of the sales channel management department. In January 2009 he was transferred to a sales position in the East China Region because of the dissolution of the sales channel management department and other reasons. Wang Peng’s performance was rated at C2 for the second half of 2008, the first half of 2009 and the second half of 2010. For this reason ZTE considered Wang Peng incompetent based on his substandard performance in his new position. Under this circumstance ZTE terminated the labor contract and paid severance pay. Wang Peng, however, filed for labor arbitration and the arbitration committee ruled that ZTE must pay Wang Peng 36,596.28 yuan as the remainder of its compensation for illegal termination of the labor contract. ZTE held that its termination of the labor contract complied with the law, refused to accept the arbitration ruling, and asked the court to overrule the arbitration ruling.    

Wang Peng replied that his performance rating of C2 was not due to his incompetence and that ZTE had no other direct evidence to support its claim. He claimed that the job transfer was initiated because of the dissolution of the distribution section rather his own incompetence. Wang Peng asserted that ZTE’s termination of the labor contract was illegal and therefore asked the court to uphold the arbitration ruling. 

【Issue in Dispute】

Whether an employer can terminate a labor contract based on a performance review concluding that the employee is “incompetent”. 

【Substance of the Judgment】

The court’s judgment held that the termination of a labor contract is clearly restricted by the PRC Labor Law and the PRC Labor Contract Law to protect employees’ legal rights and profits and to establish and develop harmonious and stable labor relationships. Since the plaintiff ZTE intended to terminate the labor contract, it should bear the burden of proving that the defendant was still incompetent after being transferred to the new position. According to the Management Measures for Employee Performance, Rating C (C1 and C2) accounts for 10% of all employees. Although Wang Peng was evaluated as C2, this was not sufficient to prove that he was incompetent and therefore could not serve as the legal basis for termination of the labor contract. It is true that Wang Pei was transferred from the distribution section in January 2009. However, the employer could not prove that the transfer resulted from Wang Peng’s incompetence because after transfer to the new department he still worked as a salesman, and because the fundamental reason for the transfer was dissolution of the distribution section. For this reason, ZTE’s evidence was insufficient to prove Wang Peng’s incompetence either before or after being transferred to the new position. The court ruled that the labor contract was illegally terminated and ordered the employer to pay Wang Peng double the compensation standard.


1. Whether an unsatisfactory performance review amounts to “incompetence”.

If an employer intends to terminate the labor contract on the basis of Article 40.1.1 of the Labor Contract Law, it must prove the following three facts: (i) the employee was incompetent; (ii) training was given or the employee was assigned new job duties; and (iii) the employee was found to remain incompetent despite such training or change in job duties. The employer must bear the burden of proving that the employee was incompetent both before and after being trained or transferred to a new position. Since job positions are quite different from each other, statutes and regulations list in detail the circumstances that constitute “incompetence”. We assert that whether or not the employee is incompetent should be treated as a factual issue that should be decided based on the duties of the position described in the labor contract, the company’s internal rules and regulations, and the performance review requirements.

In this case, the ZTE performance review divided review results into several levels and ascertained the employee’s level of competence. It still lost the lawsuit, however. In fact, the role that ZTE’s assessment rules played in determining whether or not the employee was competent was acknowledged by the court. Nevertheless, ZTE merely provided the court with the performance review results but neither explained the review process nor submitted independent evidence of incompetence. 

Consequently, unsatisfactory performance reviews were not enough to prove that the employee was incompetent. A performance review is a unilateral evaluation of an employee’s performance based on rules and regulations as well as the employee’s actual performance. Only when the employee’s performance is proven to constitute “incompetence” under these rules and regulations can the employer prove that its performance review results are reasonable.    

2. Proving Incompetence

To terminate a labor contract on the ground that the employee is incompetent, the employer must have evidence that the employee’s performance was incompetent. In practice, employers must prepare evidence of the following:

  1. A clear definition of “incompetence” in the labor contract or company work rules. Although as previously mentioned, job duties vary for different positions, employers can still specify the requirements for each job in the job description and provide that those who fail to meet these requirements will be deemed incompetent. Quantitative indicators are the safest way to measure employee competence.
  2. An employee’s performance review results should be supported with certain objective evidence that can be submitted to court if necessary, and the employer should retain this evidence even after the performance review. Such evidence might include sales performance data, manufacturing productivity, period of service, and complaint records.
  3. The review process should be objective and fair, and the employee’s performance should be clearly identified by certain ratings. If the rules and regulations are ambiguous, or if the level of employee competence is not clear, the assessment result will not be capable of proving employee incompetence.

In addition, a “lowest rating elimination” system is used by some employers. Under this system, the least competent employee among several employees with the same job position or within the same sector or group will be rated as incompetent regardless of his objective competence. Employers face high legal risks by using this system, because showing that the employee is the least competent member of a group of employees does not necessarily mean that he cannot perform his job duties, and therefore cannot prove that he is incompetent.