China issued its first nationwide labor contract law on June 29, 2007, which will take effect on January 1, 2008 (the “Labor Contract Law”). The Labor Contract Law will not replace the existing Labor Law of China but supplement it. However, any local regulations that conflict with it will be superseded. The Labor Contract Law will not affect existing employment contracts that are executed before January 1, 2008, except for calculation of severance pay to employees upon expiration or termination of existing employment contracts.

The legislative intention of the Labor Contract Law, which came out after a series of incidents of severe abuse of workers in China, is to better protect the lawful rights of workers and form more stabilized employment relationship. As a result, the Labor Contract Law emphasizes the execution of written employment contracts, execution of contracts with an open term when certain conditions are met, termination by employers only for causes set forth by law after probation, and economic compensation upon contract termination or expiration. The following is a summary of major points in the Labor Contract Law that employers should be aware of. Please note that there are many provisions in the Labor Contract Law that are too general and require further detailed implementing rules to properly interpret and implement, such as the reasonable compensation amount for non-competition. We are aware that the first draft implementing rules of the Labor Contract Law are in place and being circulated among certain organizations, but not yet publicly available. With the effective date of the Labor Contract Law approaching, we envision that the passing of the official implementing rules will not be far away.

Contract Formation:

  • Open Term Contract

An employer must enter into an open-term employment contract with an employee if one of the following conditions is met: a) the employee continuously works for the employer for 10 years; or b) the employer has signed two fixed-term employment contracts with the employee during which the employee has not committed certain violations set forth in the Labor Contract Law. Failure to enter into an open-term contract pursuant to the above will subject the employer to payment of a double monthly salary per month to the employee within the failure-to-enter-into period.

  • Written Contract

The employer must enter into a written employment contract within one month upon the employer using the employee’s service. If, within one year, a written contract is not signed, then an open-term employment contract is deemed to be entered into. In addition, the employer must pay a double monthly salary per month to the employee within that one year (less the first month) period.

  • Probation Period

The Labor Contract Law has a clear provision setting forth the length of a probation period in relation to the length of the contract term. The Labor Contract Law generally shortens the length of a probation period in comparison with the old labor regulations. For example, if the contract term is less than three years, the probation period cannot be longer than two months. The same employer can only agree to one probation period with the same employee, which means that if the employer changes the employee’s position down the road it cannot obtain another probation period by law. If during the probation period the employer terminates the employment contract, it must explain to the employee reasons for the termination.

  • Confidentiality and Non-compete

The employer and the employee may agree on confidentiality of commercial secrets and intellectual property. Employees with a confidentiality obligation can be bound by a non-compete obligation. To validate such provision, the employer must pay a consideration on a monthly basis during the non-compete period. Violation of such provision will subject the employee to a pre-set penalty for breach of contract. The employer and the employee may agree upon the scope, area and period for non-competition. The maximum period shall not be more than two years, which replaces the three-year period in the previous relevant regulations.

  • Training

If the employer pays special training fees for an employee to receive professional technical training, the employer and the employee may agree to a service period. If the employee violates their agreements for the service period, the employee shall be required to pay a liquidated damage based on the agreements. The maximum liquidated damage is capped at the total training fees and allocated on a pro-rata basis in the service period.

Contract Termination:

  • Termination by Employees

The Labor Contract Law gives employees broader causes to unilaterally terminate an employment contract. Three significant additions are failure of the employer to timely pay the full amount of labor compensation, failure of the employer to pay social security charges in accordance with law, and violation of law by the employer’s rules and regulations that are harmful to the employee’s interests. Other causes include termination by agreement with the employer, 30-day prior notice, contract voidance, and failure of the employer to provide working conditions set forth in the contract.

  • Termination by Employers

The Labor Contract Law gives employers numerated causes to unilaterally terminate an employment contract without paying any severance pay. Article 39 lists all such causes including termination during the probation period, or by serious violation of the employer rules, serious dereliction of duties causing material damage to the employer, contract voidance or criminal liability. One significant addition is termination by the employer due to the employee concurrently having another employment relationship with another employer. The employer may also terminate an employment contract by serving a 30-day prior written notice if the employee is incapable of undertaking the job assigned after training and adjustment or the objective circumstances in which the contract was formed have changed while the parties cannot reach agreement for amendment. Severance pay must be made in these situations. Mass layoffs are also possible provided certain required procedures are followed. In a mass layoff due to a restructuring under the bankruptcy law, severance pay must be made.

  • Termination not Allowed by Law

The employer is not allowed to terminate an employment contract if the employee was engaged in operations that exposed him/her to an occupational disease hazard and has not undergone a pre-departure occupational health examination; or is being diagnosed or under medical observation; contracted an occupational disease or was injured on the job that result in losing all or part of his/her capacity to work; or contracted an illness or non-work-related injury while the set medical treatment period has not expired. The employer may not terminate an employment contract with a female employee in her pregnancy, confinement or nursing period. One interesting addition that reflects the legislative intention of protecting elderly workers is that the employer may not terminate an employment contract with an employee if he/she has been working for the employer for at least 15 years continuously and is less than five years from the statutory retirement age.

  • Termination by Employers in Violation of Law

Wrongful termination in violation of the Labor Contract Law will subject the employer to payment of double severance pay based on the scale set forth in the law.

  • Severance Pay upon Termination

The interesting part of this provision is that it offers legal protection to compensated employees with lower relative incomes but caps the total compensation to employees with higher relative incomes. If an employee makes an income of no more than three times the average salary of the relevant locality, the severance pay will be calculated based on his/her monthly salary times his/her years of service. One month salary is for one year of service. No maximum is capped. If, however, an employee makes an income of more than three times the average salary of the relevant locality, the severance pay will be calculated based on the three times the average salary of the locality times his/her years of service. One month salary is for one year of service. The maximum years of service are 12 years.

Other Concerns:

  • Company Rules and Employee Manuals

Rules and employee manuals must be passed in accordance with the legal procedures set forth in Article 4 and made known to the employees. Otherwise, the employer may run the risk that such rules and employee manuals may not be binding on the employee as part of his/her employment.

  • Labor Unions

The Labor Contract Law gives labor unions bigger roles to play in relation to employment issues in areas of review of company policies and rules, collective contracts, mass layoffs and unilateral termination of labor contracts by employers. These provisions are the result of All China Federation of Trade Unions’ efforts in promoting itself and encouraging more companies to establish a labor/trade union within the companies.

  • Part-time Employees

The legislative intention of the Labor Contract Law is to encourage the employer to hire part-time employees. As a result, hiring part-time employees is relatively easy and flexible. No written contract is necessary and an oral agreement will serve the purpose. Part-time employees may work for more than two employers. No severance pay is made. The parties may terminate their employment relationships at anytime. However, no probation period is allowed, the maximum working time for a week is no more than 24 hours, and certain social security charges must be paid by the employer.