The termination of employment contract and severence pay in China employment law Saturday, 26 March :50

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1 The employment system in the People's Republic of China is quite different from that of the United States. Whereas the United States uses an employment-at-will system, where an employer may terminate a contract at anytime, China uses a contract employment system, which is heavily based on a North European legal framework. In a contract employment system, it is very difficult to terminate an employee that is still under contract. The latest labor law comes into effect in 2008 and governs regulations regarding contracts and severance. Terms of Employment Employees in China are hired on a fixed-term contract. After the expiration of the contract, it is up to the employer to decide whether to rehire the employee on a second fixed-term contract. Initial contracts typically last for 3 years that include a 6-month probationary period. After the expiration of the second contract, however, the employee is then hired on an open-term contract in which the employee may be dismissed at any notice. Termination Before terminating an employee, an employer must first give notice to any relevant labor unions that represent the employee. The approval of the labor union is, however, not required. An employee may only be terminated if he cannot work because of injury, incompetence, a major change in circumstances or by mutual agreement. Thirty days' notice is required for both the employee or any relevant labor union. Severance Termination without severance pay is only allowed if the employee is in breach of national, local or company regulations. Otherwise, severance is based on the number of years worked, in which 1 month's wage is paid for each year of service. The maximum severance available is calculated by taking 3 months' average salary and multiplying it by 12. Enforcement Local governments have the authority to routinely conduct inspections as well as question employees about their labor contracts. Because of the high level of corruption and bribery in China, however, the enforcement of labor laws varies from region to region. Severance Pay upon Termination of Employment Contract 1 / 7

2 Foreign businesses looking to hire workers on the mainland should note that employees are eligible for severance pay upon termination of employment contract. The law stipulates that an employee shall be paid severance pay based on the number of completed years of service upon contract expiration, except in cases where the employee chooses not to renew the contract despite that the same or even better terms and conditions are being offered by the employing unit. The severance pay shall be calculated at the rate of one month's salary for each completed year of service. Where the duration of service is over six months but less than one year, one month's salary shall be paid as severance pay. Where the duration is less than six months, half a month's salary shall be paid. The term "monthly salary" refers to the employee's average salary during the 12 months prior to termination or expiration of his/her employment contract, which is applicable to contracts that take effect on or after 1 January Prior to the implementation of the Employment Contract Law, no such provision existed. Therefore it should be noted that the period of service prior to 31 December 2007 should be excluded when calculating the period eligible for severance pay unless such a provision was provided for in the employment contract prior to 31 December Severance pay calculation Severance pay amounts to one month's pay per year of service. For the purpose of calculating severance pay, an employment period ranging from 6 months to 1 year is to be counted as one year. If the employee has worked for less than 6 months, he will be entitled to half a month's pay. If the monthly wage of a worker exceeds three times the average monthly wages of employees in the municipality where the employer is located, severance pay shall be paid to him at the rate of three times the local average monthly wages and and shall be for not more than 12 years of work. tenure 6 months: 1 month(s) 2 / 7

3 tenure 9 months: 1 month(s) tenure 1 year: 1 month(s) tenure 2 years: 2 month(s) tenure 4 years: 4 month(s) tenure 5 years: 5 month(s) tenure 10 years: 10 month(s) tenure 20 years: 20 month(s) Redundancy payment: tenure 6 months: 1 month(s) tenure 9 months: 1 month(s) tenure 1 year: 1 month(s) tenure 2 years: 2 month(s) tenure 4 years: 4 month(s) tenure 5 years: 5 month(s) tenure 10 years: 10 month(s) tenure 20 years: 20 month(s) More EMPLOYMENT ISSUE To Discussion With a population of 1.3 billion, a labor force of over 800 million, and more than 5 million graduates from institutions of higher learning each year, China has the potential to dominate global business in the decades to come. The country currently has the world s second largest GDP in terms of purchasing power and received more than $80 billion in foreign direct investment in 2007 five times the level in India during the same year. With its rapid economic growth, China has experienced increased sophistication of human resources practices. New laws are being passed which regulate everything from hiring practices to minimum wage. Enforcement of labor laws by government officials and courts has also increased. Among the most important HR issues for foreign invested enterprises (FIEs) in China are the legal requirements surrounding the issue of termination. It is never an easy task for HR managers to let employees go, but companies wishing to avoid costly labor disputes and penalties in China must be particularly vigilant. 3 / 7

4 Labor Contracts in China China s 1995 Labor Law requires contracts for all regular employees. All labor contracts must include the name and contact information of both the employer and employee. The employee s national identification number must also be included. The contract must also provide a specified duration as well as a description of job duties and work location. Finally, the contact must include information on working hours and rest periods, leave, compensation, social insurance, and work safety conditions. On January 1, 2008, a new Labor Contract Law came into effect in China, supplementing the 1995 Labor Law. This new piece of legislation is meant primarily to protect the interests of blue collar workers, but is technically applicable to all types of employees in China, whether Chinese citizens or foreigners. In addition to reiterating the requirement for written contracts, the new law also places limits on overtime and establishes new regulations with regard to hiring temporary workers. It also provides an automatic unlimited contract with guaranteed compensation and more stringent termination requirements for workers who have been employed at the same enterprise for ten or more years. Termination Regulations Termination of employment contracts in China is divided into two categories: termination with notice and termination without notice. The circumstances under which each is legal are specified in the 1995 Labor Law and 2008 Labor Contract Law. Termination without notice is allowed if an employee is found to be in violation of company discipline or employment rules, is convicted of a crime, or causes damage to the employer through serious dereliction of duty. It is also allowed if an employee takes employment with another company that hinders the completion of his/her duties at the primary job. 4 / 7

5 An employee can also be terminated without notice if he/she is found to not satisfy the conditions of employment during the probation period. New regulations regarding probation periods in China allow more freedom in evaluating and terminating new staff before they begin permanent employment. Probation wages must not be less than 80% of the employee s wage after probation, and can never be below minimum wage. Probation periods range from one month (for fixed-term contracts between three months and one year in duration) to six months (for fixed-term contracts over three years in duration). Probation periods are not allowed for part-time work or contracts based upon completion of a task. There are several other circumstances under which termination of a contract is allowed, but must be accompanied by 30 days notice or pay in lieu of notice. These include situations in which the employee is found to be incompetent and does not improve after training or the employee cannot work due to a non-work-related injury or illness after a set period of time. The law also allows for termination when major changes have occurred in the objective conditions of the workplace. This point remains vague in Chinese labor law and gives companies some room for interpretation. Termination is clearly prohibited by Chinese labor law under the following circumstances: Employee has a work-related illness or injury: all employees must receive a pre-departure health examination before being terminated. This is meant to keep employers from terminating employees before a suspected occupational disease or injury is diagnosed. Women during pregnancy, confinement, or nursing period. Employee has worked for the employer for at least 5 years and is less than 5 years from retirement age. Additional circumstances under which termination is allowed and prohibited in China are listed in local labor laws, varying by region. If the employee is not in the same province as the employer, the laws of the province where the employer is registered generally apply. When terminating an employee for any reason, a company must give notice to all applicable labor unions. However, union approval is not required for termination. The terminated employee must also be given proof of termination or expiration of the employment contract, including documentation of the last day of work and final payments made. This document should be signed by both parties. The company is also required to report the termination to local social insurance authorities and keep the employment contract on file for at least 2 years after termination. 5 / 7

6 Layoffs for Economic Reasons Layoffs for economic reasons are governed by a special set of regulations in China. If terminating at least 20 people or 10% of the workforce (whichever is lower), a company must adhere to the following procedures. Explain the situation clearly and consult with employees and any unions present. Give 30 days advance notice of layoff Report plans for reduction with justifications to local labor authorities Give priority to remain at the company to employees with longer-term fixed contracts, those who are the primary earners in their families, and those who are caring for elderly relatives or small children. Legitimate justifications for this type of layoff under Chinese law include restructuring after bankruptcy, serious difficulties in production or business operations, or changes to production, technology or business methods that require reduction. Severance Pay China s new Labor Contract Law requires severance pay under a variety of circumstances. It is important for multinational companies in China to become familiar with and adhere to these regulations, as they often differ from requirements in Western countries. Although still inconsistent, enforcement in China has also increased substantially in China in recent years. If a fixed-term employment contract expires and is not renewed, severance pay is required in China. Firms can avoid this by offering renewal on the same or better conditions. If the employee does not accept, severance pay will not be required. Severance pay is also required for all circumstances described above for termination with notice and layoffs for economic reasons. Severance pay is not required under circumstances in which an employee s contract is terminated with just cause without notice. The Labor Contract Law also outlines the required minimum severance amounts. In general, when severance is required, one month s salary per full year worked must be paid. For periods of six to twelve months, employers must round up to one year. For periods less than 6 months,? month s salary must be paid as severance. One month s salary is generally defined by Chinese labor law as the average monthly wage over the 12 month period before the termination. 6 / 7

7 The maximum total severance pay required in China is three times the local average monthly wage times 12 years worked. Local average monthly wage in Beijing, for example, is around $400. Therefore, maximum required severance pay whether for blue collar or white collar workers would be calculated as follows: $400 x 3 x 12 = $14,400. Labor Issues Although given substantial power legally under the Trade Union Law in 2001, labor unions had little or no real power in China until several years ago. Unions are not required, but companies may not prevent workers from forming unions. In June 2008, the All-China Federation of Trade Unions (ACFTU) launched a 3-month national unionization campaign focused on Fortune Global 500 firms operating in China. According to official government statistics, 73% of all foreign firms in China are now unionized, yet this is true of less than 50% of Fortune Global 500 firms. The ACFTU has announced plans to increase this figure to 80% by the end of Although it is unlikely that this goal will be achieved, foreign companies in China should prepare for negotiations with the ACFTU. At the end of 2007 there were more than 1.5 million grassroots trade unions in China with nearly 200 million members. The ACFTU is directly in charge of the unionization process for 10 of the Fortune Global 500 firms, including FedEx, IBM, and Sony. Wal-Mart, which was already unionized in China during the summer of 2006, has recently come under pressure from unions to increase salaries and set up terms for paid vacation, social security and overtime pay for its workers. To this point, the company has cooperated with this initiative, due to strong media attention. In China, a country with a highly regulated state media, negative publicity can be even more damaging to foreign businesses than legal action. 7 / 7