Conducting a layoff in China is difficult due to the country’s highly restrictive labor laws. Worse yet, the courts aggressively enforce statutory requirements and employers tend lose disputes more frequently than winning. The secret to a successful layoff in China lies not only in legal compliance with the letter of the law, but also in a strategic approach that looks at judges’ decision making processes and establishes a layoff plan that will survive judicial review. In this article, we will look at the several legal risks associated with layoffs and at statistical data from legal analytics platforms to see what the legal landscape is like. Based on this data, we will provide strategic recommendations for conducting layoffs that can survive review by the legal system.
Contents
Substantive Basis for the Layoff.
Compliance with the Layoff Process
Contract Liability
A company that discharges an employee could be held to have unlawfully terminated the Employment Contract under §§47 and 87 of the Employment Contracts Act, in which case the employer has two main options. The employer can continue to perform the employment contract and pay salary in lieu of the time the employee is not at work. Alternatively, they can pay severance compensation for unlawful termination of the employment contract, which is double the financial compensation amount. The employee is the sole party entitled to make this decision, and the repercussions are not severe.
Much more dire consequences could occur for an employer that fails to comply with Chinese law, which could set off a domino effect that can cripple the company or cause major financial losses, brand damage, or collective action from workers. Layoff plans should focus on ensuring these problems don’t occur, with the most common being:
- Failing to follow Employment Contracts Act §41(a).
- Using an unlawful reason for mass layoffs.
- Failing to explain the situation to the labor union or all of the employees (Layoff Rules § 9).
- Failing to report the layoff to the appropriate government agency.
- No evidence that the service of process to the employees was made.
- Using the wrong termination process for the type of termination.
[activecampaign form=6]
Additional financial liability is frequently imposed on employers for failing to pay financial compensation to terminated employees. Chinese law provides that severance packages for layoffs be comprised of statutory financial compensation and additional compensation offered at the discretion of the employer. Mistakes when applying the statutory formula to calculate financial compensation usually result in underpayments made to employees. Penalties for this non-compliance are provided by Employment Contracts Act §85, which empowers the appropriate agency to issue an order to pay any remaining amounts, and impose an additional 50%-100% financial compensation for payments not made within the time limit.
Unemployment Insurance
Local governments in China set mandatory unemployment insurance contributions based on a figure between minimum wage and a living wage. Under the Unemployment Insurance Administrative Regulations, an employee who is laid off is eligible for coverage, assuming they have made contributions for at least one year (Layoff Rules § 6). The Administrative Regulations also mandate that the employer promptly issues a termination certificate and informs the employee of their right to unemployment benefits, meaning that employer must also take steps to help the employee collect benefits from the government. Moreover, under the Layoff Rules § 6, the employer must also send a list of terminated employees to the social security agency within seven days of the layoff.
Liability for non-compliance under Chinese social security law is severe, but nonetheless local management is usually quite negligent in following the process. The result of non-compliance under the Administrative Regulations is the employee will lose their right to collect their unemployment benefits from the government and you, as the employer, will be liable to pay damages to indemnify them against that loss. In other words, you have to pay the employee everything they would otherwise have collected from the government.
Non-Competes
When employers in China need to downsize for economic reasons, they will typically waive their rights to enforce non-compete agreements and instead allow workers to freely take up employment at another company. What makes China law different enough to warrant such an approach is the statutory requirement to pay compensation to the worker throughout their non-compete term (see China Non-Competes Explained).
In this context, you need to know that China Employment Act §§ 23-24 require explicit notice to the employee when waiving a non-compete or otherwise be liable to pay financial compensation. However, managers in China tend to neglect the written notice requirement during layoffs, exposing the company to liability. Additionally, under the Supreme Court Labor Law Interpretations #4-§9, even if the employee is lawfully notified that the non-compete is waived, a business entity must still pay three months of the non-compete financial compensation.
Layoff Legal Dispute Statistics from Legal Analytics Platforms in China
Several broad statistical trends about layoff disputes in China can be seen on legal analytic and case search platforms. Below, we’ll introduce some general statistical data about legal disputes involving layoffs. “Major operational difficulties” was cited as the main basis for conducting a mass layoff in China, accounting for 50% of cases, with “material change in macroeconomic conditions since the employment contract was executed” accounting for 40% of cases. Infrequently claimed bases for a layoff include:
- Major business transformation due to technological revolution.
- Global/National economic downturns resulting in industry-wide sales declines.
- Downsizing due to financial losses.
- Partial production shutdown.
Prior to the trade war, employers lost about 15% of layoff cases. Chinese courts upheld an employer’s decision to terminate an employee due to layoffs 85% of the time, whereas courts held against employers 15% of the time, a little less than 1 in 6. Since the trade war, pandemic, and recession, however, the number has surged to about 70%.
A bit under half of layoffs were rejected due to procedural defects in pursuing the layoff. Another half were rejected due to inadequacy in the reason for layoffs: 18% for layoff basis not supported by law, 12% for not explaining the basis, and 18% for not factually proving the layoff basis. In 5% of cases, the layoff was rejected because the employer failed to respect statutory retention preferences, such as by not retaining employees nearing retirement age or who have certain dependencies (Layoff Rules § 5).
In terms of employee rewards, the courts granted severance pay 65% of the time, and employees were reinstated in 35% of the cases.
Chinese courts are highly responsive to political pressure and have been raising the bar as the general public’s fear of losing their job rises. To be successful with layoffs in this climate, a business needs to have a robust compliance strategy for establishing layoff reasons based on the facts and ensuring that the statutory procedural requirements are followed. The main law to be aware of is the Business Employee Layoff Rules, which implement the more general statutory requirements, but note that the regulations are outdated in that they were intended for an era in which layoffs were rare.
Courts are expected to fill the gaps with their own judicial precedent, which can create risks in China because there is no rule saying that prior precedents must be followed. Thus, the courts could suddenly raise the bar for a successful layoff if economic conditions and public pressure change. Nonetheless, the legislative intent and general patterns in judicial precedents provide sufficient information for making strategic decisions in managing legal risk, and are covered in more detail below.
You must Establish Both that the Layoff is Collective and Done for a Legitimate Reason
Collective Redundancy
Under the Employment Contracts Act, a layoff qualifies as the termination of at least 20 persons or a reduction in force of 10% or more. A common place for non-compliance occurs when management does a layoff while the headcount is lower than the statutory threshold. For example, terminating 9% of the workforce may be perceived as a layoff internally, and thus management will try to claim rights offered under the Act’s economic layoff provisions.
However, from the perspective of Chinese law, a collective redundancy means that there will be a significant reduction in force. Therefore, the economic layoff rules of the Employment Contracts Act do not apply if the layoff does not reach the minimum 20 employee of 10% force reduction threshold, and the company must proceed under an individual terminations process.
Even if the business meets the economic conditions for an economic layoff, the economic layoff provisions cannot be used unless the requisite headcount reduction is made. The other major non-compliance issue arises when a reduction in force does not occur all at once and is not announced as a layoff. Instead, management characterizes it as a series of individual terminations and does not follow the proper layoff procedures.
A common motivation with this strategy is to achieve something like a “silent layoff” that does not attract much attention. Nonetheless, management substantively treats each termination as a layoff and claims a valid basis when notifying employees.
Courts in China typically reject this approach as unlawful because terminations conducted gradually in this manner are substantively part of a collective redundancy. Courts consistently reach this conclusion even when management explains the situation to the labor union or all employees at least 30 days in advance of the layoff and provides notice to the appropriate government agency, as required by the Layoff Rules § 4(a).
Basis for the Layoffs
When laying off employees in China, you must factually establish one of the following bases under Employment Contract Act § 41:
- Business bankruptcy proceeding as a reorganization.
- Major operational difficulties.
- Production transformation due to technological revolution or business model transformation that requires layoffs even after changes to employment contracts.
- Any other events due to material changes in economic conditions since the employment contract was executed that make continued performance impracticable
Aside from bankruptcy (Layoff Rules § 2), there are no settled criteria for determining whether a particular situation qualifies under these provisions. The lack of detail in the law means that arbitrators and judges have vast discretion in determining whether a particular layoff plan is legally compliant. Thus, business managers whose layoff plans are not rock solid face substantial risk in court. Minimizing the legal risks associated with a layoff can nonetheless be achieved by performing a strategic analysis of the layoff plan to reduce uncertainty about how it will be treated by a judge.
Internally, establish the grounds for the layoff (Layoff Rules § 2) and ensure those grounds are legal. Carefully study the material changes or economic conditions that necessitate the layoff, and ensure they are objective and can be backed by data and evidence. Useful documentation includes financial statements, tax filings, industry reports, government documents, corporate board minutes, and sales contracts.
Judges will tend to reject subjective grounds for a layoff. The change that occurred must have a substantive causal connection with the termination. Seen from another angle, it should be impracticable for the business to continue performing its employment contracts without the layoff (Layoff Rules § 2). To establish that these conditions and causes were not present at the time the employment contract was signed, you need to be able to show that they were unforeseeable. For instance, if management knows that a certain job role will only be needed temporarily, then those economic conditions existed when the contract was signed. Finally, the grounds for the layoff must have been beyond your control. Ensure that the material change or condition didn’t occur due to the fault of the business itself.
Compliance with Layoff Process Including Contract Paperwork, Labor Union Negotiation, and Government Agency Intervention
Earlier in this article, we learned about how about half of losses in court—about a third of all disputed layoff terminations overall—result from a failure to comply with the set of procedures required under the Employment Contracts Act and Layoff Rules.
In particular, management in China often try to avoid the provision in the Layoff Rules that requires the employer to explain the situation to the labor union or the entirety of the employees and notify the appropriate government agency at least 30 days in advance of the layoffs. The employer must negotiate with the employee about terminating the employment contract, and then serve a termination notice on the affected employee (Layoff Rules § 4(a)). Additionally, the full range of other typical employment contract termination procedures must also be followed.
Employers will need to complete several steps when doing layoffs (Layoff Rules § 4). A primary concern for human resource departments is processing the handoff of remaining work and settling final salary payments, most of which would be defined by company policy. To comply with the Layoff Rules, you must issue a written certification of the employee’s termination on their last day (Layoff Rules § 4(e)). Failure to do so will render you liable to pay the balance of the unemployment benefits the employee would have otherwise been entitled to collect. The timeline for paying financial compensation is determined by local law, typically ranging from payment on the last day or as long as seven days from the last day.
There is also a 15-day deadline for processing a transfer of administrative registrations, such as social security and labor registration. Lastly, there is a 7-day deadline to provide the local government’s social security department with a list of the now unemployed individuals and to separately notify each terminated employee of their right to immediately file for unemployment benefits. The Unemployment Insurance Administrative regulations require individuals to request unemployment benefits within 60 days of their termination. If the employer is at fault and causes the individual to miss the deadline because they failed to provide notice, they will be liable to pay damages in the full amount of the unemployment benefit entitlement.
Since most unlawful layoffs occur due to procedural reasons, be sure to invest time and effort to ensure that the legal process is followed to the letter and that everything on the statutory timeline is completed on time. You need to ensure that the employees are alerted to the upcoming layoff at least 30 days before it happens. The statute is ambiguous as to what is defined as the “layoff date” for calculating the latest permissible time for the warning. So, being conservative in this respect is advisable, and using the date on which the government agency is notified of a layoff is ongoing as the basis, rather than the date employees are terminated, will protect you from the legal risk of providing an inadequate warning.
Labor Unions
Labor unions have the right to participate in equal negotiations with management. Chinese labor policy sees economic layoffs as balancing the interests of workers and businesses; allowing the sacrifice of some employees’ interests to ensure the survival of the business. The law ensures this balance by giving the labor union—or if none exists, all employees collectively—the right to negotiate with management as equals in preparing a layoff plan (Layoff Rules § 4). Specific procedural requirements include fully explaining the situation and listening to the opinion of the labor union(Layoff Rules § 9). Recall that if there is no labor union at the company, the entirety of the employees assume this role.
Chinese labor law does not provide specific criteria for what constitutes an adequate explanation to the labor union. However, given that judges may reject your layoff plan as procedurally defective under notions of fairness or equity, a sufficiently thorough and transparent explanation can mitigate that risk. In particular, effective layoff plans typically detail the reasons for the layoffs, their extent, and the number of affected personnel. Management should explain the specific steps to implement the layoff and how much financial compensation is provided. Provide a timeline for these events, especially if the terminations are staggered (Layoff Rules § 4).
The explanation required by the Layoff Rules to the employees or labor union should follow the best practices for procedural justice. Managers often take an overbearing tone with employees or are deceptive in their communications, both of which can cause big trouble with regulators. Instead, be as transparent as commercially reasonable, be truthful, and take steps to ensure local management treats employees with respect.
In Chinese culture, being transparent may include making best efforts to make financial data and statements available if requested by employees. Ensure that the managers doing the layoff do not hide any information or act in a way that could be construed as misleading. Paying special attention to the Chinese social value of harmony is also important during layoffs; which means you need to make good-faith efforts to coordinate with your union members to help terminated employees secure employment elsewhere.
Labor Regulators
You must cooperate fully with labor regulators. Chinese labor theory considers a layoff to strongly resemble a game theory scenario, where some participants can emerge as winners and others as losers. From the perspective of government, they want everyone to be treated fairly, regardless of their ability to play the game. Thus, China’s labor regulators vigorously intervene in layoffs to maintain fairness and social stability (Layoff Rules § 8). The Layoff Rules and employment statutes require that an employer conducting a layoff provide notification to the local government labor department and cooperate fully with their interventions (Layoff Rules § 4). Notification to the appropriate agency must include, at a minimum, the reason for the layoffs, the affected employees, the layoff plan (including financial compensation amounts), and the nature of equal negotiations held with staff.
The law does not provide for whether a layoff done at a regional division of a company requires notification to the appropriate agency in that region. However, notification is still advisable because the company’s regional division would be the entity under which social security fund accounts are opened in the region. The risks associated with local officials receiving late notice outweigh any potential benefit. Have managers meet with the local government’s labor department, write a meeting memorandum, and have it professionally translated into English. This will ensure you are aware of how officials intend to enforce the law in their jurisdiction.
Social Stability
Social stability policy requires offering preferential policies to certain workers. As mentioned earlier, conducting a layoff disrupts a core cultural value in China—social harmony. In the governance context, this is measured as the impact of the layoff on social stability. This collectivist regulatory mentality rejects the Western individualist perspective, where a corporation need only consider the interests of its investors.
The Layoff Rules and Employment Contracts Act §42 prohibits terminating workers who:
- Have encountered an occupational hazard and have not received a diagnosis or are under medical observation.
- Have been injured or sustained an occupational injury resulting in disability.
- Are currently on medical leave.
- Are women undergoing pregnancy, maternity, or breastfeeding.
- Are nearing retirement age with five or more years of service.
Additionally, there are protected classes of workers who must be preferentially retained, including employees with very long employment contracts, those with permanent contracts, or those who are the sole source of income for their family and have elderly or minor dependents (Layoff Rules § 5).
Employment Contracts Act §41(c) requires that during the first six months following a layoff, the terminated employees must be given a right of first refusal on offers for their previous job (Layoff Rules § 7). Employers can also pursue strategies to mitigate layoffs, such as changing job roles, helping employees find other jobs, or sending them to skills training programs to help them find a different type of job.
To comply with these requirements during a layoff, start by organizing an internal review of the company’s human resources to determine who cannot legally be laid off and who should be given preference for retention. Then, determine the nature of the employment relationship with employees who can be laid off, and assess the remaining employment terms and salaries. Verify contact information for all employees in advance to ensure effective service of notice on each of them.
FURTHER READING
Get authoritative insights about this topic from a official government guidance translated by CBL:
For a general overview of this topic, see also CBL’s China Employment Law FAQ.