Shanghai's Implementation of China's Labor Contract Law

In March of this year, the Shanghai High Court and the Shanghai Municipal Human Resources and Social Security Bureau jointly issued Several Opinions on the Application of the Labor Contract Law (the “Shanghai Implementation Interpretation”). Addressing matters related to the Labor Contract Law (2008)(“LCL”), the Shanghai Implementation Interpretation takes a markedly more balanced stance, in contrast to what many view as the LCL’s emphasis on employee rights. (Please also see our previous advisories on the LCL—sick leave, dismissing employees and initial regulatory implementation—and retrenchment in China.)

Double salary for delay of contract conclusion

The LCL requires an employer to pay double salary to an employee if no written labor contract is concluded. However, this provision may be abused by employees, as it does not account for reasonable grounds as cause for delay in contract conclusion. The Shanghai Implementation Interpretation addresses this issue by clarifying that no double salary payment would be due if the employee refuses to sign a contract. The criteria also take into account incidences of force majeure or whether the employer conducted bona fide negotiations with the employee.

Open-term contracts

The Shanghai Implementation Interpretation obliges an employee to request an open-term contract when the LCL requirement for an open-term contract is satisfied.¹ If an eligible employee enters into a fixed-term contract, the fixed term will be binding. This is a departure from the LCL, which requires that an employer and eligible employee enter into an open-term contract unless the employee requests otherwise. Under the Shanghai Implementation Interpretation a fixed-term contract is sufficient evidence that the eligible employee requested otherwise. It also clarifies that the second renewal (i.e., the third term) of a labor contract, following two fixed terms, establishes an employee’s right to an open-term contract.

Noncompete provisions

The LCL seems to indicate compensation as a prerequisite for an effective noncompete provision, and seemingly invalidates any noncompete agreement if no compensation is paid. Furthermore, it fails to provide guidance on the compensation standard. The Shanghai Implementation Interpretation fills this gap by specifying a range of 20 percent to 50 percent of an employee’s salary prior to termination as compensation for a noncompete obligation where the contracted amount is unstipulated or the parties cannot agree. In another departure from the LCL, the Shanghai Implementation Interpretation provides that a noncompete provision remains binding even if agreement has not been reached for compensation or for a specific amount; the provision remains valid provided the parties have expressed common intent.

Severance

If the terminated employee started his or her employment before Jan. 1, 2008, the effective date of the LCL, 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). 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).

Thus the total length of service may be longer than 12 months because it is divided into a pre-LCL period and a post-LCL period. The LCL provides that a pre-LCL period is subject to the old rules. However, the LCL does not clarify whether an employee’s salary for calculation of severance payment, both pre-LCL and post-LCL, must be the same.

The LCL provides a ceiling on salary for the calculation of severance (i.e., three times an employee’s salary. There is no ceiling requirement under the old rules. The Shanghai Implementation Interpretation forgoes the three-times ceiling and provides that severance is to be calculated separately for length of service before, and length of service after, the effective date of the LCL, using different base salaries, i.e., no three-times salary ceiling for severance for the pre-LCL period of service.

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 length of service (number of years served, capped at 12 years).

Representative offices

The Shanghai Implementation Interpretation provides that a representative office of a foreign company that hires employees through a foreign service organization can be made a party to a legal dispute. The dispute must be with the representative office and concerns labor-related rights and obligations. If a representative office unlawfully hires employees through such an organization, disputes will be treated as civil disputes, and the representative office can be made a party to civil proceedings.

Conclusion

In light of the current economic downturn, the Shanghai Implementation Interpretation is a slight retreat from the LCL’s perceived pro-employee posture. Under the Shanghai Implementation Interpretation, the onus is with the employee to secure an open term contract. A range is established for noncompete compensation and the effectiveness of a noncompete provision is better protected. It is also notable that the Shanghai Implementation Interpretation sustains the LCL’s rules on retrenchment; namely, requirements for 30 days’ advance consultation with the labor union or all employees and report to the local labor bureau.

FOOTNOTE