Practice and Procedures for Termination of Employees in China Due to Financial Difficulties

By Wang Jun and Stephen Lou

 

In light of the financial downturn, many foreign invested and domestic companies in China have been laying off their employees in masses.  Although much of the focus has been in the manufacturing sector with stories of massive lay-offs and factory shutdowns, very few industries will be completely immune to the downturn – forcing many employers to consider downsizing as an option to weather the storm.  This, coupled with the new Labor Disputes Mediation and Arbitration Law (effective May 1, 2008), allowing employees to file labor arbitration cases free of charge, China has since reported a significant increase in applications for labor dispute arbitration filed.  Consequently, employers should be especially aware of proper procedures when considering the termination of employees during these times.

 Under current Chinese law, there are two options available for the employer to reduce its financial obligations to employees based on financial difficulties.  With respect to the first option, in lieu of dismissing the employee, the employer may negotiate with the employees to adjust the current employment agreement by significantly decreasing the employee’s work assignment and salary; in effect placing the employee on “holiday status”.  The second option would be to simply terminate the current employment contract with the employee.

 

 RENEGOTIATION DUE TO FINANCIAL DIFFICULTIES

 Under the first financial difficulties-based option, Article 35 of the PRC Employment Law (PEL) provides that the employer may negotiate with the employees to significantly decrease their work assignment and salary up to the minimum standard allowable by law.  In such severe cases, the employees could potentially be paid the minimum salary standard allowable by law (approximately USD120/per month in Beijing), and in essence, the employees would be placed on “holiday”.

 Note however that this arrangement may only be temporary and the employer would be required to specify the duration term of this arrangement.  However, in the “holiday arrangement” scenario the employment contract would remain in full force and effect, entitling the employer to end the “holiday” at anytime and ask the employees to return to work.

 The employer should be aware that the employees are not obligated to agree to the “holiday arrangement”, thus the minimum salary may not be feasible.  As such, if the employer wishes to utilize the “holiday arrangement”, the employer should consider providing a reasonable payment and duration of term that the employees are likely to accept.

 Once the employees agree to the “holiday arrangement” it is imperative that an agreement be signed between the employer and employee effectively modifying the employment agreement to reflect that such an arrangement was made with the consent of the employee.  Failure to do so may subject the employer to employees claiming the illegal termination of the employment agreement.  If successful, this could lead to certain damages and additional penalties.

 In any event, the “holiday arrangement”, if accepted by the employees, may be preferable to the employer, allowing more flexibility to the terms while maintaining goodwill with the employees.  This option would allow the employer to recall the employees once the financial difficulties period has ended.

 

 TERMINATION DUE TO FINANCIAL DIFFICULTIES

 Under the second financial difficulties option, Article 41 of the PEL provides that employer may terminate employees without their consent.  Under this option, employment may be terminated and, but for a one time severance compensation to be paid at the time of termination, the employer will no longer be required to continue to pay employee salaries.

 

Legal Requirements

 In order for the employer to utilize this termination option, the employer must satisfy two legal requirements.  First, the employer must show that it is in fact suffering financial difficulties.  Second the termination must apply to more than either 20 employees or 10% of the employees at one time.

 In regard to the first requirement, the law merely provides a broad provision with no strict and specific requirement to determine how the financial difficulties requirement is met.  However, in light of the present economic downturn, financial difficulties of the employer company may be presumed by the visible lack of work.  Nonetheless keeping financial reports and other necessary documents readily available as evidence to show financial difficulties to employees and relevant government departments is highly advisable.

 

Procedural Requirements Limitations

 Under the PEL, the employer would be required to prepare in writing a termination plan that would include, (1) a list of the employees to be terminated; (2) the dates and procedures of the implementation, and; (3) compensation of the employees.  Employer shall present the plan to all employees, 30 days in advance to solicit their opinions.  Based on employee opinions, the employer would make the necessary changes before filing the plan with the local government administration department.  Upon receipt of the plan from the local government department, the employer may make the necessary changes and improvements proposed by the government department (if any) and proceed to implement the plan.

 The employer should keep in mind that in compiling the termination plan, certain employees may not be terminated.  These include, (1) those confirmed to have totally or partially lost their labor ability due to occupational diseases or work-related injuries; (2) those who are in the process of receiving treatment for the said diseases; (3) women employees during pregnancy, perinatal, and nursing periods and; (4) other cases stipulated by laws and administrative decrees.

 

One-Time Severance Compensation

 Under Article 47 of the PEL, terminated employees are entitled to a “one time” compensation (severance) based on the number of years the employee has worked for the employer.  A month’s salary is available for each full year the employee has worked for the employer. If the period worked amounts to less than a full year but more than half a year, the period will be calculated as a full year; if the period worked amounts to less than half a year the employee is entitled to a half month’s salary.

 Based on the PEL, if the employee’s average salary in the previous year was three times or more than the median salary of the city for which the entity is registered (Beijing median salary: RMB3322), the employee’s compensation salary shall be limited to no more than three times that median salary.  In other words, even if the employee’s salary greatly exceeds the median salary by three times, the employee would only be entitled to the maximum three times the median salary limit.  This is a significant change in the PEL which allows for the significantly scaled down calculation of compensation, compared to the old law allowing for the compensation to be based on the employee’s full salary without regard to the median salary based calculation.

 

Additional Obligation of the Employer

 According to Article 41, the employer is obligated to give notice and priority to the terminated employee with the same terms, if the employer decides to employ new employees.  However, unlike the first option, where the employment contract specifies the time in which the employee will return to work, a terminated employee will have more difficulty in requiring the employer to reinstate the employee. To overcome the obligation, the employer would simply need to declare that the job description and skill set of the former employee do not match the job description and skill set of the new position.  Although this requirement can be easily handled, employers need to keep in mind of such an obligation when deciding to hire new employees.  

 In conclusion, employers seeking to terminate employees due to financial difficulties should be aware of the procedures involved in properly doing so.  Failure to follow the procedures can likely lead to costly and time-consuming labor disputes.  In light of the changes in the law which currently allow for free filing of labor arbitration, employers are further subject to labor disputes.  As such, employers should be especially aware of their options regarding dismissal procedures.  Regardless of whether the employer is preparing to downsize its operations it is wise for the employer to ensure that the current employment policies are properly protected and incompliance of the current labor laws.  In light of the financial downturn, if employers do plan to terminate or place employees on “holiday”, employers should take immediate action to resolve such issues to minimize loss during periods of financial difficulties.