After four readings, the long-anticipated and hotly-debated Labor Contract Law (“LCL”) was passed by the Standing Committee of the National People’s Congress, the top legislature of China, on June 29th, 2007, and will come into effect on January 1st, 2008.

Before the passage of the LCL, China did not have one unified national law governing labor contracts, and various provisions in this regard used to be dispersed through many laws and regulations, at both national and local levels, with some inconsistencies and ambiguities. This has sometimes made it difficult for employers (in particular, those which are foreign-invested enterprises) to gauge their employment liability exposures and for employees to protect their employee rights and interests.

The LCL, hailed as a big improvement, has clarified issues such as the method of calculating severance pay, the length of probationary period, and the consequences of employers’ refusal to sign written labor contracts, just to name a few. In general, the LCL is a laudable attempt to enhance the protection of individual employees, with also some new rights to employers, such as the introduction of cap for the calculation of severance pay and expanded circumstances for economic lay-offs.

The purpose of this article is to outline the most significant provisions of the LCL.

Conclusion of Written Labor Contracts

The LCL requires that, when hiring employees, or within one month after hiring employees at the latest, employers shall sign written labor contracts with their employees. An employer, who has signed written labor contracts with its employees after one month but within one year, shall pay a double salary to its employees affected; an employer, who has failed to sign written labor contracts with its employees within one year, shall be deemed to have signed open-ended labor contracts with its employees, which can only be terminated for cause.

These provisions are pro-employees in an attempt to prevent employers from refusing to sign written labor contracts with their employees, a circumstance where the workers would encounter difficulties in proving the existence of employment relationships with their employers and their remunerations for employment as well.

Open-ended Labor Contracts

The term “open-ended labor contract” (or “labor contract without a fixed-term) refers to a labor contract with an indefinite term. By contrast, a “fixed-term labor contract” has a definite term specified by both parties.

There has been a common misconception among employers in China that an employer may terminate an open-ended labor contract with its employees at will due to the lack of a specified contract term therein. Employers must be aware that an open-ended labor contract will never expire because its term is indefinite, and an employer is not allowed to terminate an open-ended labor contract unless under very limited circumstances expressly stipulated in the Chinese law. Therefore, an open-ended labor contract provides extra protection to employees as opposed to a fixed-term one.

The LCL extends the circumstances where an employee may require the conclusion of an open-ended labor contract with his/her employer to the following:

1. the employee has already been working for the employer for 10 consecutive years;

2. When the employer initially adopts labor contract system or when a state-owned enterprise re-concludes employment contracts with its employees due to restructuring, the employee has already been working for this employer for 10 consecutive years, and will reach the statutory retirement age in less than 10 years; or

3. the employee has consecutively concluded two fixed-term labor contracts with his/her employer, and does not have any of the circumstances as set out in the LCL which can be used by the employer as legal reasons to refuse to sign a fixed-term labor contract.

Probationary Period

As an employer may terminate, virtually without cause, the labor contract with an employee who is still serving his/her probationary period, some employers have used abusively extended probationary periods to sack their employees unfairly.

To address this problem, the LCL links the length of probationary period to the term of labor contracts more clearly, and does not allow an employer to require the same employee to serve more than one probationary period. A probationary period is not allowed for a labor contract with a term of less than three months, and must not be more than one month if the term of the labor contract is between three months and one year, must not be more than two months if the term of the labor contract is between one year and three years, and must not be more than six months if the term of the labor contract is more than three years or the labor contract is open-ended.

The LCL also introduces three standards regarding salary payable to employees during the probationary period. According to Article 20 of the LCL, before the completion of his/her probationary period, the salary payable to the employee must not be lower than the minimum salary for the similar positions in the employer, or 80% of the salary as agreed in the employee’s labor contract, and must also not be lower than the minimum salary of the city where the employer is located.

Non-compete Clause

The LCL reduces the maximum length of the non-compete obligations imposed on an employee from 3 years to 2 years. In addition, the LCL also makes it clear that the non-compete obligations shall only apply to those employees who are senior management personnel, senior technical personnel, or hold other positions which shall be subject to confidentiality obligations. During the non-compete period, an employee bound by non-compete obligations shall not work for any other employer which produces or provides products or services similar to those of the employer, or start his/her own business to produce or provide such products or services.

However, the LCL does not provide for the standards relating to the amount of economic compensation which an employer shall give an employee for his/her assumption of non-compete obligations. Neither does the LCL adopt guidance on the application of non-compete obligations in terms of applicable scope and geographical territory, leaving them to the mutual consent of the employer and the employee.

Economic Lay-offs

The LCL expands the circumstances under which an employer may lay-off its employees to include the situations where the employer has changed its operations and where there have been changes to the employer’s economic conditions. The LCL also sets out certain new restrictions on economic lay-offs, and requirements for preferential retention.

Severance Pay

The LCL requires that an employer shall pay severance pay to an employee whose fixed-term labor contract expires, unless the employer offers to renew the employee’s labor contract with conditions not less favorable to him/her than those in his/her current contract, but he/she refuses the renewal. This is one of the most significant changes to the original rules on the application of severance pay, and may serve to prevent employers from intentionally using fixed-term contracts to avoid giving severance pay.

It is also worth nothing that a cap, which is triple the average salary for the last year in the city where the employer is located, is introduced for the calculation of severance pay for employees with high salaries.

Collective Labor Contracts

The LCL allows workers to negotiate collective labor contracts with their employers through the trade union, and in enterprises where the trade union has not been established workers may elect their own representatives to negotiate a collective contract with their employers under the “direction” of the higher-level branch of the All China Federation of Trade Unions.

After a collective labor contract has been concluded, it shall be submitted to the local labor administrative authority, and come into force unless the local labor administrative authority raises any objection to the collective contract within 15 days.

Labor Dispatch

Labor dispatch, not clearly regulated before the adoption of the LCL, has been found being used by some employers as a way to cut the direct employment relationships between them and employees dispatched by dispatching agencies to work for them, and thus make them escape paying statutory employment benefits or even remunerations to the dispatched employees on the ground that the dispatched employees were not hired by them.

As another significant change, the LCL sets out new nationwide rules to regulate labor dispatch. The LCL requires that a dispatching agency shall sign a fixed term contract with a term of more than two years with its dispatched employees and to pay salaries on a monthly basis. The LCL also restricts the use of labor dispatch arrangements to temporary, auxiliary or fungible positions, forbids entities to establish any labor dispatching agency to dispatch workers to work for themselves or their subsidiaries, and imposes a requirement for “equal pay for equal work”.

(This article is not designed to provide legal or other advice. If you would like to know more about the subjects covered in this article or obtain the full text of the Labor Contract Law, please contact Lehman, Lee & Xu.)