Terminating employment contracts in China

Welcome to the latest episode of Gowling WLG's Employment Essentials podcast.

Jonathan Chamberlain: Hello and welcome to the last of our series on employment law in China. My name is Jonathan Chamberlain and I head up the Employment, Labour and Equality team in the UK. To talk about the termination of employment in China I am joined today once again by my friend and partner, Annette Knoth.

Annette Knoth: Thank you very much Jonathan. It is a pleasure to be with the two of you and as Jonathan said, I am heading the German Labour and Employment team, and quite curious to learn what Chinese law thinks about employees.

Jonathan: Which is very good because to tell us all about that we have my colleague Le Rong, who is a Director in our Guangzhou office. Hello, Le Rong.

Le Rong: Hello everyone. Thank you, Jonathan. Thank you, Annette. Happy to share whatever you want to know about Chinese law or terminating employment contracts.

Annette: The first sentence we learn at university is that employment law is all about protecting employees so that applies especially when we talk about terminations. So, a termination is only valid if we have a reason to do so and I can never answer the question, 'how much will it cost?' So, very interested to hear how China sees that point.

Jonathan: So, there you are Le Rong, there's the spectrum; easy and expensive for the English, difficult for the Germans, where is China relative to us two would you say?

Le Rong: Although I'm not an English law or a German lawyer, based on what you have just explained to me I think China is somewhere in the middle and we are closer to the German system. Generally, Chinese employment law is protective of employees and employers and we do need to prove we have legitimate reason to terminate an employee's contract so based on that, I think we are more continental law/system country therefore. It's not that easy to terminate an employment contract in China. It is not impossible though.

Jonathan: Well good, as we shall be finding out later. But Annette, I think you had a really important question as to whom Chinese employment law applies.

Annette: Le Rong, would Chinese law also apply to employees transferred to China, so ex-pat employees or does it only apply to Chinese nationals?

Le Rong: The Chinese employment contract law will apply to anyone who signs an employment contract which is governed by Chinese law. So, whether this is an ex-pat working in China or local Chinese people. As long as they have a Chinese law contract the Chinese employment contract law will apply.

Jonathan: Wow. OK that is really interesting, because that makes the contract even more important in some ways than it is in the UK, but as we are talking about contracts, I mean we have different types of employment contract, we have a fixed-term employment contract, an open-ended contract, perhaps a probationary contract. How important are the differences when it comes termination in China?

Le Rong: The major types of employment contracts in China is the fixed-term employment contract and open-ended employment contract and both contracts will have a probationary period. So, the difference between when it comes to termination, the difference between the three stages; the fixed-term employment contract, open-ended employment contract or a contract during the probationary period is the pre-conditions of terminating these contracts. There is not too much difference between terminating a fixed-term employment contract and an open-ended employment contract, but when it comes to an employment contract during the probationary period, it is generally easier to terminate a contract during the probationary period because the only condition that an employer needs to prove is the employee is not compliant with the job offer. When we are looking for a job and the employer will tell the employee what the major responsibility in a job is so, if the employer can prove that the employee is not compliant with the description in the job offer, then the employer will be able to terminate this employee.

Whereas, after the expiration of the probationary period it goes into the formal period of an employment contract, then the employer will need to provide proof in accordance with the Chinese employment law whether this contract can be terminated based on legitimate reasons. So, there are various legislative reasons, there are reasons of the employee has violated the internal rules or employee handbook, or the employee has committed a fraud and caused huge damages to the company, or just simply the employee is not qualified for his/her job. So, there are various reasons, but the burden of proof after expiration of the probationary period becomes bigger. So, the big difference is, it is easier to terminate a contract during the probationary period then in the formal term of the employment contract, whether it is a fixed-term contract or open-ended contract.

Jonathan: That is really interesting, thank you, because of course in the UK we are at the time of recording about to move to having full employment protection rights from Day 1 of employment without any qualifying period, but there are going to be probationary periods - and we have no idea at the moment how that is going to work and maybe it is going to work something like in China, where the burden of proof shifts after the end of the probationary period to the employer. That might be quite a neat way of doing it.

Le Rong: Sorry, just to add, the burden of proof is always on the employer's side never on the employee's side…

Jonathan: Oh OK.

Le Rong: During the probationary period it's less strict, but when it comes to the formal term of the contract, it becomes more rigorous. You have to really provide proof.

Jonathan: OK.

Annette: I was just curious to add that it seems like that when you are on your probationary period, which is six months in Germany, I don't know how long it is in China, but you don't need any reason to terminate the contract. But after the six months, it is exactly like in China - the burden of proof is always on the employer's side, so it looks like Chinese law is pretty close to what we know in Germany, maybe also in other countries on the continent.

Le Rong: The probationary period depends on the length of the employment contract. So, the longest probationary period is six months, it can be less then six months but at the same time the length the contract needs to be right. The six-month probation period is for contracts of more than three years, including three years, and you can have a one-month probationary period contract and sometimes if the employer prefers, they can start the employment contract right away without a probationary period, but most of the time the employer would prefer having at least one-month probationary period. And of course, as I said, there is a condition, you have to prove that the employee is not compliant with the job offer description. But generally, in practice, if an employer approached an employee during a probationary period, so telling him or her that it is not going to work out between us, we will just terminate, it is generally for an employee to accept that so he will be less contentious if that employer quickly decides not to move forward with the employee during the probationary period. But once a probationary period expires, it will become contentious, because employees will ask for more compensation etc.

Annette: Just if I may I add one other question. You said that Chinese law requires a legitimate reason to terminate a contract after the probationary period, what happens if the court decides that there was no legitimate interest? Does that mean the employer has to pay more? The reason why I asked the question is that in Germany the consequence would be that the employee has the right to return so is that something you know in China as well?

Le Rong: So, if there is no legitimate reason to terminate a contract, then the court can move in two ways: (1) is to pay more, so if the employer terminates an employment contract for no legitimate reason they will need to pay double compensation. So, based on a legal legitimate reason to terminate the contract, you have to pay 10,000 and if there is no legitimate reason then its 20,000. And in the extreme case the court can rule that the employer cannot terminate an employment contract, which means the contract shall go on. This is really rare, because both the judge, employer, employee they all know that if we go to the court things are going very bad and it is really awkward if this employee after suing the company to go back to that company and sit in office working every day. So, generally, the judge and arbitrators, by the way we have labour arbitration that goes before the litigation process, so the arbitrators or the judges tend not to rule in that way. So, in most cases the result of such a dispute will be the employer paying more compensation to the employee.

Annette: Thank you very much. Well, that sounds like China is much more modern and realistic than we are in Germany. Le Rong, are there any other pre-conditions to terminate an employment contact in China?

Le Rong: Yes, the pre-conditions to terminate an employment contract, we have touched on a little bit just now. You have the legitimate reason for example the employee's committed a fraud or the employee has violated the internal rules or handbook, the employer is able to terminate the employment contract without paying any severance, so this is a one of the situations where the employment contract can be terminated. And there are other situations where employers can still terminate a contract, but they need to pay severance. We generally say it qualifies as a termination with legitimate reasons which is the employee is not qualified for his or her post, or the company is going into a difficult situation, they have to terminate because they don't have a need to keep the employees anymore, or the company just goes bankrupt, and all these are legitimate reasons of an employer to terminate employment contract paying severance.

Other than that, all the other terminations will be qualified as a termination without legitimate reasons which means the employer shall pay double severance comparing to termination with legitimate reasons. And, in China, and I believe this is the same in the UK or in Germany, if a female employee is pregnant, they cannot be terminated, they have to be capped by the employer until the maternity leave expires. And for employees approaching to retirement age, they cannot be terminated as well. Or if employees are in hospital or under medical treatment and the medical treatment period is not finished the employer cannot terminate the employment contract of these people, so that generally describes all kinds of situations where employers terminate employees.

Annette: You have mentioned several times the severance would be doubled, how do we calculate severance payments in China?

Jonathan: Yes, I mean that's…

Annette: Wouldn't that be interesting, Jonathan?

Jonathan: …that's of particular interest to the English employer all this stuff on procedures is all very interesting and reasons and things but look how much is that going to cost us?

Annette: Yes.

Le Rong: Yes, the severance can be calculated in China generally is on the years of the service of this employee with the particular employer say he has been working for an employer for six years then if the contract is terminated for legitimate reasons then the severance is six months of his average salary. The average salary is the month, the average monthly salary preceding the termination month up to 12 months preceding the termination month and the calculation based does not only need to include the actual salary which also includes any bonuses, any monetary payments paid during this 12 month-period so everything shall be calculated in the same sum and then divided by 12 the multiplied by the years of service of this employee working with the employer, and sometimes the employee is working not for a full year, so for example some employees have been working for five years and seven months. So, if it is more than six months then he will calculate it as a full year, so it will be five years seven months will become six years. But if it less than six months we will just calculate half of it. For example, if this employee has been working for the employer for five years and three months then the years of service is 5.5. So, generally, this is the basic calculation rules when it comes to salaries.

Jonathan: OK, and I suppose the key question for me is, is it possible to short circuit all the process and simply say to the employee; "you are terminated but here is the amount that we would have to pay you for severance"?

Le Rong: Of course you can, but employees will always question how did you come with that number then in our previous cases when we advise our clients what should be the amount to be paid to the employees, we will always use rules as set out by the law as a benchmark for them to decide OK this is the law, statutory minimum I need to pay, but I am willing to pay them more because I want them to leave peacefully. So just explain to the employee that this is the statutory amount but we are happy with your service, we want to terminate the contract in a peaceful way, so this is what we will give to you. It is not like the law does not say… the law only gives you the statutory minimum, but it does not prevent you to give more, it could be ten times or 20 times more.

Jonathan: Yes.

Le Rong: That is employers right to do so.

Jonathan: You can do it but why would you? What pressure can an employee bring to bear if you offer the maximum statutory amount?

Le Rong: Yes, sometimes because when the employee is leaving, being told that they are going to be terminated, they will always find a way to say that I want more compensation, so they will find all kinds of excuses. For example, they will say that "oh I am working overtime but you did not give me overtime payment, so if you don't pay me more then I'm going to sue you". Or they can say that "oh for the reasons that you have given to me, I think you don't have legitimate reasons to terminate my contract so I require you to pay me double severance. All the employers when they consultant us, they will always ask us what is the statutory minimum, so we will give them the general calculation when the contract is terminated for legitimate reasons. And then we give them the other choice, which is if the employee says they don't agree with your termination, they believe that the termination is an illegal one, then if you go to the court you may end up paying '2N', 'N' being the general severance we pay.

So, sometimes an employer will find somewhere between the 'N' and the '2N' - in the middle to just give a little bit more to the employee but less than the double severance amount. And talking about those figures, there is one think that I want to flag as well - in China, we have a severance calculation cap. So, for employees having quite high pay there is this rule of three times and 12 months cap. What does it mean? It means that if an employee's salary is three times more than the average municipal salary of the specific city that he or she works then this employee's severance is going to be capped at three times of the average municipal salary multiplied by 12 months, even if this employee has been working for the company for 20 years, their severance will be capped at 12 years.

Jonathan: Right.

Le Rong: But this not very, how do you say, logical for some employers, for some cases. Because you may have an employee that has been working for the company for 20 years, but the salary does not reach the three times threshold but very close to it. In that case, that employee may end up having a lot more compensation than an employee who has a high pay, which we don't think it is reasonable because of this rule of three times the average salary in 12 months, this is a rule that has been questioned by lots of lawyers because this is really disadvantageous for people earning high salaries, and sometimes these people earning high salaries will have huge needs of monetary compensation because their needs are far higher than the general employees.

Jonthan: Yes. Yes.

Le Rong: That's a bug in our system.

Jonathan: Yes, I see that because of course if you are earning just below the threshold then you are going to get much more compensation than someone who is earning a lot more. OK, but the interesting thing for me in all of that is that you can ultimately work out a formula which says this is the most that you can get so the negotiation is going to be somewhere between the statutory minimum and that maximum?  

Le Rong: Yes.

Jonathan: Right. OK.

Annette: Which makes the company a lot of uncertainty. If they can pay out on this situation in Germany where I cannot answer a question how to calculate a severance, it looks like you have pretty clear rules in China and again I think that makes it easier for companies to handle these termination situation, so could be a model for us as well.

Jonathan: Yes. What about notice periods in all of this, Le Rong are they calculated in addition to the severance payment, are they part of the severance payment, how do notice periods work?

Le Rong: A notice period is another bug in the employment law system because so many clients are complaining about these rules. So, the general rule in Chinese employment contract law is that when an employer wants to terminate an employee's contract, they shall give 30 days' notice. So, this 30 days' notice does not mean that you have to wait for 30 days, so you can give them payment in lieu so that they can leave right away but they will still get one month extra pay. But when I talk about this a bug is for employers it is disadvantageous because at the same time employees when they want to leave the company, they can also give 30 days' notice only, which is really problematic for people in management role leaving the company and only give 30 days' notice, which is really insufficient for them to hand over etc. So, that is another bug we can overcome, this is the law. As an employer you can give the employee longer notice period but not shorter. And from the employee's side the statutory longest time you can require from the employee is just 30 days. Therefore, we had to discuss with our client to think of mechanisms to be able to have enough time for people taking important role in a company to have longer notice period by way of, for example, we have non-compete obligations we can use for a non-compete mechanisms or we can postpone the payment of the severance until they finished the handover process etc. But for the time being there is no work around solutions because the law is the law, the employer cannot ask or force the employee to give longer notice periods when they want to resign.

Jonathan: How interesting.   

Annette: Very interesting. Even if you know there is a longer notice period in the employment agreement that would not be valid if I understood…

Le Rong: That would not be valid in the law.

Annettee: OK and the longest notice period an employer can have is also 30 days, so even if an employee worked ten years or 20 years for the same employer the notice period is still 30 days?

Le Rong: Yes. It is 30 days for all kinds of level. If the employer wants to give the employee more time, they can tell them like three or four months or even six months ahead but cannot be shorter. It can only be longer because this is favourable to the employee, so the law is not preventing the employer to give favourable treatment to the employee. But on the other hand, it cannot force the employee to give longer notice period when they want to resign.

Jonathan: Wow, you have discombobulated both the German and the English employer with that Le Ron. Let's look at non-compete obligations because again Germany and the UK take a very different approach so I would be really interested, what does China do about non-competes?

Le Rong: Non-compete is actually a right of the employer. They can choose to have it or not have it. And non-compete obligation works only for management role people or people holding company secrets etc., so you have to prove that there is a rationale to impose non-compete obligations on those employees, that's the basic. And, non-compete obligations cannot go beyond two years, so the longest term you can impose a non-compete obligation is 24 months in China under Chinese employment law. And also, during the non-compete period the employer has to pay the employee, they do not need to pay full salary so it depends on different cities – China is too big – regions have different practice. So, generally speaking, it is half or one third of the original salary of that employee, so we would recommend half because if you are preventing someone working for so long, they will need to have some kind of income to be able to respect this non-compete obligation, so those are the general rules of non-compete obligations under Chinese employment contract.

Annette: Usually, the questions clients ask me is 'can I waive my rights of this non-compete clause?' because sometimes companies find out the non-complete was not really necessary and I don't want to pay the compensation for it.

Le Rong: You can. For example, the employment contracts that we prepare for our clients we also have this non-compete clause as an optional clause, so if they want it they can have it, or even if they have it when they sign the contract the employee we will still add another phrase in the clause saying 'the employer can waive the right to ask their employee to respect a non-compete obligations' – so definitely yes you can.

Annette: So, it’s safe to say that at this point, China is much closer to UK law than it is to German law because just very briefly in Germany - and that was the reason why I asked this question - is you can only waive for the period of 12 months, so that means the non-compete clause still is valid for another 12 months so it is really inflexible and I guess it is much easier in the UK, right?

Jonthan: Well, I'm still reeling from the idea of the non-compete as being a right of the employer.

Annette: Yeah.

Jonathan: Whereas the starting point of English law of course is that these things are not valid unless the employer can clear certain hurdles and the debating is all about whether you can clear those hurdles so this is just a really, really different approach.

Well, I think what I'm learning from this podcast is that we could carry it on for a lot longer, but I think we probably have to let our listeners finish their coffee and get on with their days. Could I just thank you both, particularly Le Rong. We are obviously recording this what is a very unsociable hour for you in China, so we really appreciate you being on the podcast. If any of you would like to carry on the conversation, please do contact any of us and we should be delighted to hear from you. Thank you all very much indeed.

Le Rong: Thank you

Annette: Thank you also from my side.