Five Legal Tactics to Reduce Employee Disputes in China

- Dr. Lefan Gong, Zhonglun Law Firm

This article provides foreign companies doing business in China with advice on how they can prepare themselves to be successful when facing wrongful termination claims from former employees in China. The new Labor Contract Law in China has made the dispute resolution environment fairly pro-employee, so it is important for companies to take multiple precautions to protect themselves in labor disputes.

One of the most difficult business decisions is to let people go. China’s new Labor Contract Law that took effect on January 1, 2008 certainly makes it even more difficult. To make matters worse, another new law, Labor Dispute Mediation and Arbitration Law, has now made it easier and less expensive for aggrieved employees to assert claims against companies. Faced with the risks of increasing employment disputes, companies should change their existing strategies and approaches; and, address key issues in HR management and employment law compliance in the new environment. This article introduces five employment related pitfalls that foreign companies in China may often come across, and discusses ways to address the issues and mitigate risks of employment disputes Chinese employees.

1. Termination – Did the Union Get the Memo?

An apparently less significant provision of the Labor Contract Law has caught many companies off guard when they saw wrongful termination claims brought by employees. Article 43 of the Labor Contract Law provides, “If the employer terminates the labor contract unilaterally, it shall notify the labor union of the reason(s) for such termination. If the employer’s termination decision violates the law, regulations, or the labor contract, the labor union shall have the right to request the employer to correct [the wrongful termination].”

No one knows to which “labor union” the law refers: Whether to a labor union of the company, to a labor union of the city where the company is located, or to the labor union headquarters in Beijing. However, a company’s failure to notify the “labor union” may be deemed a procedural flaw of the employer’s termination process, and may therefore result in an arbitration commission or court ruling that the termination was unlawful.

Arbitration commissions and courts generally will not accept a defense based on the employer’s lack of knowledge of the identity of the proper labor union that should receive the notice. Arbitration commissions and courts are generally more sympathetic with the terminated employees. Pending further regulatory or judicial clarifications of this ambiguous article, companies are advised to send such notice to one of the labor unions, just to satisfy the procedural requirement.

2. The Power of Employee Manuals

The new Labor Contract Law in China has made it clear that except for a reason specified under the law, no company may unilaterally terminate an employee. One of the few statutory bases for a company’s unilateral termination of an employee is for violation of the company’s internal policies, rules and employee manual. However, if such policies, rules or employee manual are not in compliance with the law, not only are the rules voidable; but, the company could also be required to pay extra compensation for the wrongful termination of a Chinese employee.

The employer must follow the statutory procedures when creating and releasing the rules. For instance, it should consult with its employee assembly, or all employees, before it publishes the finalized version of the internal rules. There is no regulatory or judicial guidance on how such “consulting” should be conducted. But at minimum, the company should solicit comments from employees by posting the draft rules on company’s intranet or bulletin board. If the company calls a town hall meeting, it would be advisable to prepare a sign-in sheet for the employees to fill out with their names. The idea is to document the process and keep the record as future evidence. Email may not be a preferred way of communicating such important information, as some arbitration tribunals and courts do not accept emails as evidence, on the ground that emails can be easily edited or changed.

3. Background Check and Pre-Employment Screening

What if an employee turns out to have lied about his or her credentials? Do not take for granted that the company can easily terminate their employment. The employer now has a heavier burden of proof to show there was falsehood in an employee’s job application. As a best practice, the company should keep all records of the employee’s job application, and include a clause in both the employee manual and employment contract stating that an employee’s untruthful representation of his or her credentials, employment history or educational background will be deemed a fraudulent act, and may result in penalties including immediate termination. It would also be helpful to conduct background checks and obtain references, preferably prior to the commencement of the employment.

The employer should also request a new hire to provide proof that his or her prior employment relationship has been effectively terminated, as a new employer may be held liable for damages to another company if they simultaneously have existing employment relationships with the same employee.

4. The Trap of Open Term Employment Contracts

One of the harshest penalties that companies are subject to is, in case of failure to conclude employment contracts (including open-term employment contracts), a liability to pay double salaries for the period counting from the date on which they should have entered into such contracts. The Chinese contract law apparently does not address the situation in which an employee voluntarily opts out and continues to sign a fixed term contract instead of an open-term one. The risk for the company is that after several years, the employees will turn around and request double salary by arguing that the company refused to enter into an open-term contract. If the company cannot prove that it was that employee’s decision to opt out of an open-term contract, the company will face the penalty.

It is therefore advisable to document the processes and keep evidence of employees’ voluntary decisions not to enter into open-term contracts. This advice also applies to circumstances in which employees refuse to sign employment contracts.

5. The Right Costs of Professional Training

Some employers previously used the provision of training and education as grounds to lock employees into unjustifiably long service periods. In these situations, employees would be faced with hefty damages if they left their employers prior to the expiration of such “service periods.” The new Labor Contract Law in China, however, imposes new requirements on such service periods and regulates the amount of damages that a company may request or claim.

First, the employer now must show proof of actual costs associated with the training or educational programs, and the asserted damages may not exceed such costs. Second, the actual damages that the company may claim must correspond with the remaining service period of the employee.

Consequently, companies now need to be very careful when drafting and signing a training agreement with employees. Setting the right figure of liquidated damages now seems to be a challenge in light of the new law. It would certainly be necessary now for the company to carefully document all costs for those training programs. For the new restrictions on liquidated damages that companies may claim, one way of easing the rigidity of the new law is to include a confidentiality clause and/or a non-competition clause in the training agreement, so that damages no longer have to tie in with the amount of the training costs.

Faced with new challenges and risks in labor and employment matters, companies now have to be more cautious when making hiring and firing decisions in China. Prudence dictates that companies carefully address those potential issues before sending out the pink slips. To reduce future employment related disputes, it would be also advisable for companies to revisit and make necessary changes to their China HR policies, employee manuals and employee termination procedures.

Lefan Gong ( This e-mail address is being protected from spambots. You need JavaScript enabled to view it ) is a partner in the Shanghai office of Zhong Lun Law Firm (www.zhonglun.com). Previously, he practiced with a Wall Street law firm in New York, and with a large U.S. firm’s Shanghai office. Lefan specializes in corporate transactions. He has advised large multinational and U.S. Fortune 500 companies and other clients in a wide range of transactions, including cross-border mergers and acquisitions, private equity deals, venture investments, joint ventures, and China foreign direct investments. A frequent author on China law-related topics, he is admitted to practice in New York and in China. He received his Science Juris Doctor and LL.M. from the University of Michigan Law School.

Other articles by Lefan Gong (ZhongLun Law Firm):

• Effective Ways to Hedge Against the Rise of the RMB
• Choosing the Right Forum for Business Disputes in China
• How to Choose a Law Firm in China

More Information on Business in China:
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