Samsung Electronics Company earlier this month joined other tech giants like Apple and Foxconn on a growing list of familiar names accused of violating Chinese labor law.[1]  The increased scrutiny of outside non-governmental watchdogs combined with demographic, statutory and economic developments within the People’s Republic of China are causing some production shifts to other Southeast Asian nations.

While the needle trade follows the lowest wages to Bangladesh or Burma, many companies will stay put on the mainland chasing the expanding domestic market or because coastal China’s comparative advantages of infrastructure, skilled workforce and relatively low wages cannot be replicated elsewhere in the region.[2]   Companies looking to do business in China increasingly must pay attention to both economic trends and growing awareness and enforcement of Chinese employment law, and this article will discuss aspects of each in turn.

Economics and Demography

While some argue that demography is destiny, China’s “fifth-generation” leaders like Xi Jinping and Li Keqiang hope this aphorism does not hold true for their country.  The explosive growth of recent years that elevated living standards across the country and China’s infamous one-child policy linked to stifle population growth.  Working age population is expected to peak sometime in the middle of this decade.  By the middle of this century, the PRC may now be turning grey faster than Japan.[3]  By 2035, China will have about 390 million people aged 60 or over compared to about 181 million now, and only two workers for every person 60 and over.  However, with this growing cohort expected to equal about 25% of the world’s population over 60, opportunities in the medical sector may be the next great wave of foreign direct investment in China.[4]

Even attorneys can grasp the economic effects a shrinking labor pool will have on future wages.

Governmental policies have joined with demographic shifts to lift Chinese wages.  Cognizant of the growing wealth-gap, two-thirds of China’s provinces announced increases in the minimum wage by an average of 22% in 2011, and Beijing and Shenzhen, home to many foreign-invested entities, announced further mandatory wage hikes earlier this year.[5]  Wages along China’s eastern coast where Deng Xiaoping inaugurated his reforms are now growing at about 20% a year.[6]  On the other end of the employment ladder, salaries for managerial professionals in China are almost equal to their American counterparts.[7]  

Introduction to Employment Law and Practice in the PRC

Regardless of whether lower manufacturing costs or access to China’s consumer market drive companies to establish China operations, statutory restrictions still limit some activities.[8]  For example, foreign companies who establish a representative office as their China beachhead are prohibited from directly employing Chinese staff.  Instead, operators of representative offices must contract with domestic staffing firms (the largest of which are government-owned), who then second employees to the representative office.  

This staffing office model dates to China’s earliest opening to foreign investment when no foreign invested entity could employ any Chinese national, but remains a viable option for many companies today, with about 60 million people employed using this triangular relationship.[9]   Those operating in China as a wholly-foreign-owned entity or a joint venture may employ either a staffing company or enter into a direct employment relationship with Chinese staff.  Alternatively, some western companies opt for dual system whereby upper level managers have a direct contractual relationship with their employer and support personnel are employed via a staffing firm.

Regardless, Chinese law requires employment contracts to be in writing.[10] While local regulations or enforcement may vary widely across provinces, the Labor Contract Law of the People’s Republic of China, which became effective on January 1, 2008 (the “Labor Law”), establishes national minimum standards for any employment agreement.  Even though the Labor Law states that the staffing company will be considered the employer for purposes of the Labor Law, a foreign employer cannot escape all of its obligations by out-sourcing its direct employment responsibilities.[11]  

Working with Staffing Companies

The Labor Law abolished licensing requirements for staffing companies, replacing it with a registered capital requirement and sparking a proliferation of employment agencies.  In choosing a staffing company, many foreign companies follow the path of least resistance and choose to work with the local branches of the two largest government-owned agencies – the Foreign Enterprise Service Corporation or China International Intellitech Corporation.  When negotiating and selecting a staffing company, a foreign company should:

  • confirm that such company has the required certificate demonstrating its mandatory registered capital contribution;
  • determine whether such company offers to share or waive any placement fees charged employees as this would run afoul of prohibition on employees being charged placement fees (such fees should be paid by the organization engaging the staffing agency); and
  • request a copy of the written agreement between the staffing company and the employees, because the Labor Law requires that such contracts be in writing and conform with  specific requirements.[12]

While a foreign company may be able to escape some (but not all) liability associated with an employer-employee relationship by reliance on a staff leasing company, reputational damages from indirect violations attributable to a disreputable third party may find their way into the U.S. press or onto China’s micro-blogs.  Established staff leasing companies should have little problem complying with the above due diligence requests and often offer payroll or other services to foreign companies employing Chinese staff directly. 

That said, an employer should not use staffing company personnel to undercut its existing pay structure for direct hires, as Article 63 of the Labor Law states “placed employees are entitled to the same pay received by workers employed by the client company for the same work.”[13]  Additionally, even though direct investment in the PRC oftentimes requires intricate corporate structuring for tax and other statutory requirements, businesses (whether they are foreign or domestic) are prohibited from establishing an employee staffing company “to place employees in its own facilities or its affiliated facilities,” thus attempting an end-around of other provisions of the Labor Law.[14]

Non-Compete Agreements

In hiring and selecting top-level Chinese managers, many organizations prefer to directly contract with their C-suite personnel.  To retain their high-echelon team, such companies rely on non-compete agreements and offer increasingly generous benefit packages. 

Like their counterparts in the US, the rising generation of Chinese white-collar employees (especially in the eastern mega-cities) no longer expects lifetime employment.  Instead opportunities to improve their skills – especially with training or temporary postings to offices outside China – or achieve a reasonable work-family balance increasingly are determinative in making career decisions.

However, most companies on either side of the Pacific do not rely solely on benefit-package carrots, and Chinese law governing non-compete provisions allows companies to wield a contractual stick as well.  Like other agreements governing employment, a non-compete agreement must be in writing, but “only senior managers, technicians or other personnel with confidentiality obligations” can be subject to binding non-compete agreements.[15]  Therefore, any contract should specify that the employee performs senior management functions and contain a recitation that such employee will know trade secrets of the employer, and include confidentiality provisions as well.

Like similar provisions in a U.S. setting, non-compete provisions in a Chinese contract should detail the “scope, territory and term” of any non-compete period, but such term is statutorily limited to two years.[16]  The Labor Law, however, does allow for blue-penciling of partially invalid employment contracts.[17]

However, in spite of the similarities between Chinese and U.S. law governing non-competes, Chinese law differs from its American counterpart in one crucial respect, as the Labor Law requires employers to pay terminated employees monthly compensation for the duration of the non-compete period.[18]  This provision can easily trip the unwary foreign investor, especially because the thought of continuing regular payments to a former employee is especially unpalatable.

Conclusion

While slowing economic growth and impending leadership changes likely will dominate the news from Beijing, the foibles associated with China’s sometimes faltering adoption of a uniform rule of law will continue to grab occasional headlines.  However, foreign companies viewing China’s employment law as mere suggestions to be creatively structured around with a nod and wink risk serious legal and reputational consequences. 

China’s citizens also are becoming more cognizant of their legal rights – especially in the commercial context, with financial cases submitted to China’s courts and arbitration settlements are up more than 20% in 2012 above 2011.  “People are more conscious of their legal rights,” a Beijing lawyer told the Financial Times last month.  “When it comes to disputes, they start to use legal remedies rather than other approaches.  That’s a good development.  Before, if there was a dispute, they sometimes just got into a physical fight.”[19]

These days ignorance of Chinese employment law may yield more than just a punch in the nose.