It’s All Good in China, Until It Isn’t: Tips and Flags for PRC Employers

Due to factors such as China’s rapid economic development, a disconnect between legislation and enforcement, the country’s historic reliance on personal connections (or guanxi) to do business, and idiosyncratic local regulations available only in Chinese, many Western-headquartered companies with operations in the People’s Republic of China (PRC) remain blissfully unaware of some unique risks. For example, local regulations imposed certain obligations on employers to provide small bonuses and accommodations to employees who presented a certificate of compliance with the one-child policy (now that the policy is being phased out as of 2015, the status of such perks is up in the air). Even where the employer’s foreign headquarters identifies potential exposure, local PRC managers and partners often downplay the risk with the quip that “this is how it’s always done in China.”

 

On an enforcement level, these folks aren’t wrong—for the moment—but that can change in an instant and employers should manage risks appropriately.

 

Here is our top 10 list of issues to stay on top of with respect to your China workforce this summer:

 

1. The usual alternatives to direct local employment (such as FESCOs) are increasingly risky.

 

Historically, foreign employers (both those with and without PRC entities) have relied on partially government-owned entities known as foreign enterprise service companies, or “FESCOs,” to serve as their employees’ employer of record. But since the 2012 amendments to the PRC’s Labor Contract Law and the 2014 implementing regulations, this practice of “labor dispatch” has been allowed only for temporary or ancillary work and only for 10 percent of a company’s workforce. In the spring of 2016, the deadline passed for companies to comply with the 10 percent requirement, meaning that increased widespread enforcement (and consequent penalties equivalent to over US$1,500 per worker above the threshold) could be forthcoming.

 

This leaves employers (and especially those without PRC entities) in a particularly vulnerable position: Opening such an entity is extremely time consuming; staffing agencies can be expensive, unavailable, or questionable; partnering with a Chinese company to outsource often requires ceding too much control; and individual independent contracting is not a legitimate, recognized concept in China.

 

2. Beware the M visa.

 

Many expatriate executives hold a 10-year, multientry M visa, and a common misperception exists that this visa is sufficient to work in China. To the contrary, the M visa is only valid for conferences, business meetings, and other such networking events. (Still, recently implemented rules actually do allow limited categories of work for very short periods, subject to various restrictions—further confusing the issue). To do productive work in China, expatriates need work permits, which can be time-consuming to obtain and require a local visa sponsor employer. But many executives have worked successfully under the radar on the M visa for years without incident—and may resist getting a work permit, perhaps citing personal-income-tax reasons.

 

Chinese authorities may detain or deport anyone they deem to be violating the M visa rules, and may scrutinize a business’s future visa applications. To allay your executives’ tax concerns, you may wish to offer tax equalization or similar benefits.

 

3. Track travel for cross-border employees.

 

Employees who spend any significant amount of time in China may be subject to income- and payroll-tax withholding in China, and it is the local Chinese employer’s obligation to make such withholdings. Employers that violate this requirement may incur a predetermined daily penalty as well as discretionary penalties. To avoid these penalties, employers should track their employees’ travel to and from China and work with their tax advisers to ensure that they make the proper tax payments, as well as to minimize any potential immigration red flags.

 

4. Know where the chops are.

 

Businesses that have local PRC entities must have an original company seal, or “chop,” to take virtually any action in China. There are multiple types of chops. The main ones in use are: (1) the “company” chop, which is the general chop used for all contracts and official documents and applications; (2) the “financial” chop for checks, change of account information, and other financial transactions, and (3) the “statutory representative” chop serving as the designated statutory representative’s signature (the statutory representative is an individual designated as such with the corporate authorities, often an executive within the parent company based outside China). Under Chinese law, the holder of a business’s chops has substantial power to bind the company—a power that should be circumscribed clearly by contract or policy. Businesses will want to keep tabs on their chops holders to ensure discovery of any self-serving transactions, and also need to secure possession of the chops before, for example, disciplining or terminating someone who holds them. Because Chinese corporate law is so formalistic, the statutory representative’s signature is required for virtually any change to public corporate records (and authorities vary as to whether they will accept the signature chop in place of it), and it can take a long time to effect a legal change to the statutory representative. So employers will want to select a reliable individual to serve as a statutory representative and establish a plan prior to taking any employment actions to resolve any issue related to a change of statutory representative.

 

5. Execute written employment contracts, and utilize probationary periods and fixed terms carefully.

 

With few exceptions, PRC employees must have a local Chinese employer and an employment contract in written form. If an employer fails to enter into a contract containing the required elements in writing for over one year, the employee is entitled to double his or her salary as damages. Because a unilateral termination after an employee’s probationary period is nearly impossible, employers should pay close attention to the employee’s performance during the probationary period and terminate before the probationary period expires. Many employers also utilize fixed-term contracts that expire at the end of the term to give themselves the opportunity to terminate by simply declining to renew—avoiding potentially high costs of negotiating an exit (more on terminations below). But, after two fixed-term contracts, the employer must accept an employee’s request for an indefinite contract. Note that employees over the statutory retirement age are generally ineligible to enter into labor contracts, but in certain regions (e.g., in Beijing and Guangzhou) may instead be engaged under service contracts. However, courts in some regions, such as Shenzhen and Shanghai, have taken the position that employees who are over the statutory retirement age but not yet eligible to receive a basic public pension should still be engaged under a labor contract and will be considered employees for overtime and benefits purposes.

 

6. Implement carefully drafted employment policies, but consult—and document—before enforcing them.

 

Chinese law requires employers to consult with employees, their representatives, or unions before introducing or amending any employment policies. What constitutes a proper consultation varies from region to region, but employees need to be on notice of the substance of what will be implemented or changed. The documentation of such a notice and consultation process often becomes important evidence if an employee challenges his or her termination based on a policy violation. Following the process is key because in practice, any discipline an employer imposes needs to be tied to an employee’s breach of a properly executed contract or a violation of a properly implemented policy or the discipline or discharge will not withstand challenge after the fact. Because the concept of at-will employment is nonexistent under Chinese law, it is essential to make clear what constitutes just cause to terminate an employee and what misconduct could justify termination.

 

This is why some Chinese disciplinary policies contain seemingly ridiculous levels of detail—for instance, prohibitions on employees splashing boiling water from a teakettle or playing too much chess (overkill in the usual handbook, but useful as an example). Similarly, a strict policy requiring employees to produce medical certificates can help minimize rampant abuse of China’s generous statutory sick leave. Note that for a policy or an amendment to the policy to be enforceable, you must follow the proper procedure to consult with employees or the union before implementing such policy or amendment and must publish them.

 

7. Consider applying for overtime exemptions.

 

Chinese employees are entitled to overtime premium pay unless their employers have obtained government approval for an exemption. While scrutiny of these applications varies by jurisdiction, they are often accepted—and this approval is critical to defending wage-and-hour claims from employees seeking overtime.

 

8. Make your employees take vacations.

 

If business reasons prevent Chinese employees from taking their allotted vacations for the year, they can be entitled to up to three times their salaries as payout of accrued leave. For each year’s accrued but unused annual leave for business reasons, the employer must make such payments by the end of that calendar year. In practice, many employers neglect this requirement, and employees look the other way until a dispute arises, such as upon termination.

 

9. Pay-to-play for noncompetes.

 

A post-termination noncompetition agreement is unenforceable unless the employer pays the employee a percentage of his or her compensation (which varies by locality, but on average 30 percent is generally considered the minimum) during the restricted period. If a company decides it does not mind if the employee competes and therefore wishes to waive a noncompete to avoid paying the noncompete compensation, it will usually need to give the employee three months’ notice or pay the noncompete compensation for that length of time.

 

10. Negotiate terminations—and do it face-to-face.

 

Other than in situations involving grave misconduct, all employer-initiated terminations in China after the probationary period require a 30-day notice period and a payment of statutory severance at the rate of one month’s pay per year of service up to a cap (which varies based on location and increases every year. Currently some major cities’ caps are around US$2,500-$3,000 per year of service for up to 12 years of service). But unilateral termination of employees is often unworkable in China because the laws, in essence, require employers to do everything possible to avoid termination or face a potential reinstatement order. (Employees can choose to seek damages instead of reinstatement, but rarely do so because the damages are capped at two times statutory severance—which as described above, is itself capped.) A dismissal for performance issues or misconduct requires a fair process based on properly implemented policies, and the standard to justify a termination can be very high. Economic terminations (layoffs) are not easier, as employers must show that alternative measures such as transfers or reductions in pay are insufficient to address the economic circumstance. Laying off 20 employees or over 10 percent of an employer’s workforce triggers additional government-notification requirements (in some localities, even government-approval requirements) imposed on employers as well as the employer’s obligation to observe certain selection criteria. Finally, the law is commonly interpreted such that companies must notify local trade unions before unilaterally discharging employees—even where the company is not unionized. The consequences of an inartfully-executed termination can result in employees unionizing, which is essentially as simple as an application and not a process the company can contest.

 

Thereafter, most employers—in addition to paying close attention to probationary periods— begin any termination process by seeking employees’ agreements to a mutual termination in exchange for a severance package. In a typical case, employees readily agree to a reasonably-priced package, but increasing labor unrest in China in the midst of a recent economic downturn has resulted in a more volatile climate lately. Planning negotiations carefully and doing them face-to-face often helps them to go more smoothly. In finalizing any severance agreement, employers will want to explicitly reaffirm (or agree to waive) any post-termination restrictive covenants and secure the employee’s cooperation with any handover procedures.

 

For expatriate employees, it is important to get the employee’s cooperation with deregistering his or her work permit (which the employer is required to do quickly after termination). Deregistering work permits without an employee’s signature and the original work permit itself has become increasingly difficult and in some localities may involve steps such as newspaper publication. Finally, if an employer of record is a FESCO, it is important to check the services agreement with the FESCO before taking any action with regard to an employee. If possible it is often best to seek the FESCO’s cooperation in advance.

 

The law on the books is often just a starting point for companies doing business in China. Awareness of these and other local quirks can help you navigate your PRC-based personnel issues with as little pain as possible.