Study on Employment Termination by Employer in China - Part. 2

by Giovanni Pisacane (Lawyer) - Greatway Advisory (Shanghai) Co., Ltd.

Categories: Employment Law
Typology: Case Law


1. The systematic deficiencies of employment termination by the employer in China related to the reasons for termination, termination notice and responsibilities for wrongful termination.
(Article published on Tuesday 16.04.2013)

2. The reasons underlying the employment termination by employer system deficiencies in China.

3. Suggestions on reforming and improving the current employment termination structure.
(This article will be published on Tuesday 30.04.2013)


2. The reasons underlying the employment termination by employer system deficiencies in China

Labor force allocation in China has been transformed from planned to market oriented. The main employers in the labor market have turned from the state into enterprises. Within the current employment contract system in China, employers and employees are free to negotiate on the duration of the employment term except for some statutory situations where employers have to sign non-fixed employment contract. Under the new Labor Contract Law it is more difficult for employers to avoid terminating an employee by making them sign short term contracts, since employers are allowed to enter into a maximum of only two fixed term contracts with employees. If an employee remains with an employer after the expiration of his or her second term contract, the subsequent employment contract is deemed an “open term” or non-fixed term contract, which protects the employee from dismissal without cause and allows the employee to remain with the employer until the age of retirement (see Garner, Yang). Nevertheless, employers try to execute short term employment contracts to lower the cost of employment termination, since through such contracts employers can avoid the payment of compensation upon termination (see Li Jing). Short term employment contracts are favorable to employers, leading employees to feel insecure in their employment and preventing them from making a reasonable career plan in the enterprise, which is ultimately unfavorable to the enterprise, economic development, and social stability.

Nevertheless, an employer may try to avoid termination rules under term contracts by failing to secure from the onset a written term contract with the employee. If an employer fails to enter into an employment agreement with the employee for more than one month but less than one year, the employer is required to pay double the employee’s monthly salary for each month of employment without a contract. This, however, can create a loophole for employers to terminate an employee (see Pagnattaro). In addition, termination is possible if the employee refuses to sign a written contract (see Harper). 

Findings from the Shenzhen Survey (“The Shenzhen Labor Survey”, the Ministry of Labor and Social Insurance) confirm that the new Labor Contract Law has prompted employers to execute written contracts. Seventy-three percent of employees surveyed had signed written contracts, with noncompliance substantially higher among locally-owned private enterprises and small and medium-sized enterprises. 

However, employers' responses represent more of an attempt to mitigate the cost of the new Labor Contract Law rather than a substantial change from the past practices. On the one hand, only around 10% of employers in the HR Survey planned to cut staff due to the Law's enactment, and 20% are expected to terminate contracts less frequently due to the higher severance costs imposed by the Law. In spite of this, nearly 30% planned to increase the use of labor services and secondary workers. The Shenzhen Survey also found evidence of greater reliance on external or temporary hires and the use of extended probation periods prohibited by the new law (although 80% reported standard probationary period terms in compliance with the new law. See Li Jing). An employer may not terminate an employment contract during the probation period, unless certain criteria are met (Pagnattaro). Nevertheless, employers may take advantage of these probation period practices and attempt to arbitrarily terminate employees’ probation employment. Prior to the new Labor Contract Law, probationary periods were highly discretionary, and were highly exploited by the employers. Employers controlled the length of the probationary period, terminated without cause, and paid less than the amount to be paid after the probation period or even less than the local minimum wage.  Now, the Labor Contract Law calculates the probationary period based on the term of the employment contract (Monique Garcia). The intent of the new law is to prevent employers from misusing probationary periods, and allows an employer to stipulate only one probation period for any individual worker. For instance, the maximum length of probationary period for a three month employment contract term under the Labor Contract Law is zero months and for a term greater than three months but less than a year it is less than or equal to one month (Pagnattaro). 

These practices give employers more flexibility and create lower costs, since temporary and probationary hires can be paid less than permanent workers and in some cases can be more easily terminated. These practices have become more widespread due to the financial crisis. The surveys confirm media reports that employers are hesitant to enter into long-term or open-ended contracts, which require higher severance payments and give employees more protections against early termination. Thirty percent of employers responding to the HR Survey planned to use term contracts of one year or less in 2008, and an additional 50% planned to use two to three year contracts. Similarly, 60% of employees in the Shenzhen Survey had contracts for one year or less, and 33% had two or three year contracts. Less than 7% of these employees had open-ended contracts, and fewer than 30% of employers in the HR Survey planned to use them in part due to the obligations they impose. These results are particularly interesting because employers in the HR Survey are presumed to be in a better position to comply with the law (Harper).

Within a few months of the Labor Contract Law enactment in 2007, there were reports of employer tactics used to evade some of the burdensome effects of the law, including mass dismissals and using “labor services” (independent contractor) agreements rather than employment contracts. Huawei, a Chinese global telecommunications giant, came under investigation for forcing the “voluntary” resignations of 7,000 workers in December 2007, with the intent to rehire in January and reset the employees' tenures. Since employers have fewer obligations toward part-time and secondary workers under the Labor Contract Law, some have attempted to avoid hiring full-time workers by implementing two half-time shifts or simultaneously hiring through two separate legal entities. Others created “new” companies to hire the same employees on different terms.  In addition, employers are forcing employees to sign written contracts without full disclosure of the contract terms or under terms that do not protect their legal rights. Despite evidence of formal compliance with the written contract requirements, interviews conducted for the Shenzhen Survey and with labor lawyers indicate the continuation of many common abusive workplace practices and many employers' disregard for the new labor contract rules. The speed and ingenuity of these efforts to evade the new law indicate some of the challenges confronting the implementation of the new Labor Contract Law. Six percent of employees in the Shenzhen Survey were forced to sign blank form contracts, while another 13% signed contracts missing key terms, such as the employer's name or the place of employment. Sixty three percent of employees reported that the contract terms did not accurately reflect the employer's name and address, the worker' position, or other key terms of employment. One employer in the Shenzen survey put workers on leave and threatened to terminate them without compensation if they refused to sign a contract with the corporate seal of two different companies (Harper).

Despite the widespread use of these practices, the Labor Contract Law imposes some severe consequences on employers that refuse to comply (Harper). The Labor Contract Law prohibits most of these evasive and coercive practices, and such practices are grounds for damages or invalidation of the contract itself. Others, like Huawei's attempt to reset workers' tenures, are prohibited in new local regulations. However, these kinds of violations can ultimately only be challenged if workers file and prove their claims in a labor arbitration. In addition, labor inspectors do not have the capacity to review the content of contracts and will not interfere with the contract formation process unless a complaint is filed. They generally do not intervene, even if the local form contracts are inconsistent with the law. In addition, defects in the content or formalization of a contract may make legal challenges even more difficult or allow an employer to evade responsibility altogether. For example, if a worker challenged a contract that provided for the “wrong” wage amount, the worker would have to show that the contract was coerced. The employer could argue that the parties negotiated lower compensation in exchange for the security of a written agreement. If instead the employee refused to sign the contract and the employer terminated him or her as a result, the Labor Contract Law would uphold this termination due to the employee's refusal to sign. To avoid this the employee would again have to show there had been coercion. Although some local courts have demonstrated a willingness to sanction employers who engage in such practices, these cases raise difficult evidentiary issues and will generally be harder to resolve. In addition, since all contract modifications must now be in writing, employees cannot rely on separate commitments to “repair” deficiencies in the written contract once a legal dispute arises. This problem is evidenced in surveys showing that many employees are still not provided with a copy of their contract as required by the Labor Contract Law. As a result, identifying and challenging illegal contract terms or other workplace practices becomes even more difficult (Harper).

During the course of labor reforms in China, creating new legislation has been easier than implementing and enforcing it. It is widely recognized that weak enforcement of labor laws in China is the result of decentralized administrative structures, limited administrative capacity, and local government competition to attract investment. For example, in 2008, districts in Guangzhou that oversee 30,000 to 100,000 registered enterprises only had six full-time labor supervision officials. In addition, the penalties for violators are not high. Although administrative penalties are potentially severe, high sanctions are rarely imposed in practice. Labor supervision in practice is intended to reform rather than punish violators. If sanctions are imposed, violators have a due process right to challenge them through internal administrative review or administrative litigation, and inspectors who seek to enforce penalties must rely on the courts, which only have a 50% success rate. Thus, since violators are likely to ignore or appeal high fines and defending or enforcing sanctions drains time and resources, officials tend to impose lesser legal sanctions. Moreover, depending on the size of the employer and the employer's perceived ability and willingness to pay, officials may reduce the amount of sanctions or not impose them at all. Finally, administrative fines are really the only mechanism labor inspectors can rely on to punish violators. It is more difficult for labor inspectors to suspend a violator's business license or increase sanctions for most violations. The only punishment for resisting administrative investigations or orders is an additional fine of up to RMB 20,000. As a result, labor inspectors can be victims of intentional obstruction, delays, and evasion. Labor inspectors interviewed in Guangzhou complained that they are simply not taken seriously, whereas employers are more afraid of occupational safety inspectors, since they can shut down or suspend businesses (Harper).

In addition, government officials lack economic and political incentives to scrutinize local businesses' employment practices. Performance evaluations of local officials largely depend on economic growth in the local area. Forcing compliance with labor laws would add costs to local businesses and thus slow down the area's economic growth. These considerations easily outweigh the interest of protecting workers' rights. Also, uncovering poor labor practices may cause bad publicity that negatively affects the evaluations of local officials. Consequently, local labor officials are generally unwilling to burden employers by vigorously enforcing the law (Yin Lily Zheng).

Second, the sanctions that labor authorities may impose are not sufficient to overcome employers' incentives for noncompliance. Incentives for engaging in illegal employment practices and adopting low labor standards are very strong among Chinese businesses due to cost reducing strategies. Moreover, the labor administrations' sanctioning power is limited to imposing fines. That power is further weakened by the fact that judicial enforcement has to be constantly invoked to force employers to comply with labor standards (Yin Lily Zheng).

Third, there is a shortage of labor inspectors. Thus, businesses have sufficient time to “prepare” for administrative inspections by, for example, fabricating records or coaching employees to deceive inspectors, in case bribery does not work. The new Labor Contract Law is also silent on increasing the power of labor administrative authorities to compel employers' compliance with the law (Yin Lily Zheng).

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