Retrenchment in China: Labor-Reduction Measures in Trying Economic Times

From a ¥4 trillion ($586 billion) stimulus package focused on infrastructure development to tax incentives for companies that hire laid off workers, the Chinese government is effecting robust measures to boost its economy. If, despite China's continued—albeit slowed—growth, an employer finds it necessary to downsize its China operations, there are procedures that must be followed and issues that need to be considered when conducting a layoff.

Under Chinese law, termination of employment by an employer without cause is prohibited. China's Labor Contract Law (LCL) permits what it terms a massive layoff when an enterprise undergoes “significant transformation.”¹ Some local governments prescribe a standard with respect to “serious difficulty in production or operation,” and only enterprises that meet such conditions are allowed to lay off employees.

Procedure for conducting a massive layoff

Pursuant to the LCL and China's Regulations for an Enterprise's Layoff, if an enterprise proposes to layoff 20 or more employees, or if the number of employees to be laid off is less than 20 but comprises 10 percent or more of the total employees of the enterprise, the layoff is categorized as a massive layoff.

When conducting a massive layoff, an employer must adhere to the following procedure:

• Announce the layoff to all employees or the labor union, providing information regarding the enterprise's operational status;
  
  
• Provide all employees or the union with the layoff proposal, including a list of the employees to be laid off, the time when employment will be terminated, and the laid-off employees' severance package;
  
  
• Seek opinions from all employees or the union for the layoff proposal , and adjust the proposal according to reasonable suggestions from employees or the union;
  
  
• Report the layoff proposal to the local labor bureau;² and
  
  
• Formally announce the layoff proposal, process the layoff formalities, and pay severance compensation to the laid-off employees.

The LCL provides that certain employees be given priority for retention during a massive layoff. Such employees include those: (i) who have entered fixed-term labor contracts for a long period with the employer; (ii) who have entered open-term contracts with the employer; and (iii) who have unemployed family members or who must support elderly or underage relatives. Further, an enterprise that is rehiring within six months after a massive layoff is required to notify laid-off employees and offer them priority for employment under the same conditions.

Timetable for a massive layoff

Provisions in the LCL concerning a time limit for a massive layoff are vague, and implementation of such provisions depends on interpretation by the local labor authority. The timetable for a layoff also greatly depends on the result of negotiations with employees (or the labor union) and communication with the local labor authority.

General layoff timetable³

Local regulations

Many local governments prescribe their own rules for implementing a layoff. Employers should check with an employment law specialist or the local labor bureau before proceeding. In Shanghai, the Circular of the Municipal Human Resources and Social Security Bureau Concerning the Report of Employers on Legal Layoff and Pay Decrease mandates that the following documents for a layoff plan be submitted to the local labor authority:

1. Copies of the enterprise's business license and the trade union's certificate of legal person qualification. (If no union is established at the enterprise, the certification document concerning the election of their employee representative, bearing the signatures and seals of all employees, should be submitted);
   
   
2. Personal information of the union representative or employee representative, including name, identification number, position and title, and employment term;
   
   
3. The written layoff plan prepared by the enterprise, including the number of layoffs, proportion of the laid-off and total employees, a name list of all laid-off employees (name, identification, employment term), and a description of the preparation of economic compensation and any remedies the enterprise has taken;
   
   
4. Materials concerning the enterprise's explanation of its layoff plan to the union or the employee representative, and any opinions and comments the enterprise has received; and
   
   
5. Materials including the reasons for layoff, the date and specific method of the enterprise's explanation to the union or the employee representative, and opinions solicited by the enterprise from the union or the employee representative.

In Fujian Province, if an enterprise proposes to lay off more than 100 employees, the labor administrative department of the city or county (district) must report to the municipality labor administration prior to implementing the layoff plan; if an enterprise proposes to lay off more than 200 employees, the labor administrative department of the municipality must report to the labor administration at the provincial level prior to implementation of the plan.

In the city of Jinan, if an employer proposes to lay off more than 40 employees, it is required to notify the local labor protection administration with the following:

1. The layoff plan (in duplicate);
   
   
2. Details regarding the employees to be laid off (in quadruplicate);
   
   
3. A photocopy of the Enterprise Legal Person Business License of the employer;
   
   
4. A written explanation illustrating the opinion of the trade union or all employees; and
   
   
5. Other relevant documentation, financial statements, explanations and supporting material.

As another example, in Dalian, in a requirement that differs from the LCL timetable, an enterprise must submit its plan 10 days before implementing the layoff.

Severance payments

Severance payments must be made in a massive layoff. Two service periods must be considered when calculating severance: (i) length of service before the effective date of the LCL (applying the old rules), and (ii) length of service after the effective date (applying the LCL). If an employee joins before, and is terminated after, the effective date of the LCL, their length of service spans both of these periods. In other words, their total severance consists of severance before the effective date (calculated under the old rules) and severance after the effective date (calculated under the LCL). If an employee joins after the effective date, their length of service falls within the above-mentioned second period and their severance is calculated under the LCL. If an employee is terminated before the effective date, their entire length of service falls within the above-mentioned first period, so only the old rules apply to their severance.

Severance payments are subject to individual income tax (IIT) in China. However, China provides an IIT exemption of three times the local municipal average salary on severance payments. The formula to calculate IIT on severance payments is as follows:

(Severance  Payment - 3x the  Local  Average  Salary) x the Applicable Tax Rate

China further minimizes the IIT burden on severance payments by applying a lower tax rate to severance. An employee is not subject to the tax rate corresponding with the total amount of a severance payment. Rather, the applicable tax rate will be lower, consistent with the total amount of the severance divided by the length of service (number of years served, capped at 12 years).

Union committee members and employees in other localities

Pursuant to China's Labor Union Law, the employment contracts of labor union committee members are to extend automatically to the end date of their term of service for the union, unless they commit a serious offense or reach mandatory retirement age during their term. As a labor union may have several subcommittees, such as a finance committee, a female employee committee, etc., it is unclear whether this protection covers such subcommittees.

In addition to national laws, local regulations and policies where the employer is registered govern a layoff. Employees in other localities are to be treated the same as employees located in the company's place of registration; this requirement includes severance compensation.  

Potential disputes and arbitration/lawsuits

Employees may bring legal proceedings against a company conducting a massive layoff. When any labor dispute arises in China, the parties may try to resolve it first by mediation, then by arbitration, and finally, if mediation fails, and either party is not satisfied with the arbitration ruling, either party may appeal to the courts. An appellate court is the final judicial tribunal for labor disputes.

Conclusion

The Chinese government has formulated policies to encourage retention of employees during these trying economic times and to promote reemployment of laid-off workers: providing subsidies and tax incentives for certain hiring and employee retention, increasing financial input, and strengthening skills training, among other measures. Although some rules for implementing a layoff vary by locality, labor union involvement, severance payment and official sanction are constant elements that need to be considered before effecting retrenchment measures in China. Further economy-boosting policies and local rules are likely to be issued in the coming months as China's leaders steer the country through the global downturn.

FOOTNOTES

1 Article 41 of China's Labor Contract Law provides that an enterprise may effect a massive layoff if the enterprise: (i) goes bankrupt; (ii) encounters serious difficulties in production and operation; (iii) undergoes a change in production or significant reform in operation that results in variation of existing employment contracts; (iv) the circumstance for conclusion of existing employment contracts undergoes signification change and the contracts can no longer be performed.

2 Report to the labor authority is only a procedural requirement, and no approval for the layoff by the local labor authority is required.

3 (1) Some local labor bureaus may interpret the starting date and end date differently.
(2) Some local rules and labor bureaus seem to suggest that “reporting” effectively means a positive reply from the labor bureau is needed for the lay off.