China: Employment Law Update: New framework for dispatch services in China

Last Updated: 24 March 2014
Article by Maarten Roos and Victoria Lei

The Chinese legal framework is always in development, but no sector has received so much attention lately as that of dispatch services. The business of employing people and then dispatching them to another company for work has come under severe scrutiny, with a huge impact not only on foreign-invested companies that are engaging in this business, but also on their customers: subsidiaries of international companies who for one reason or another hire at least part of their workforce through dispatch service providers including FESCO (Foreign Enterprises Service Corporation) and CIIC (China International Intellectech Corp).

Rules for Labor Dispatch Service Providers

In late 2012, the PRC Labor Contract Law was amended to set new requirements on companies providing dispatch services. The amendments also established that dispatch could only be used for temporary, substitute or auxiliary positions, and disclosed that the State human resources administration would establish a maximum to the number of dispatched workers as a proportion of the total workforce. High penalties were introduced for companies that engage in labor dispatch services without the required license, at one to five times the income obtained from unlicensed labor dispatch services. The amendments took effect on 1 July 2013.

Another set of rules that went into effect on 1 July 2013 are the Implementing Rules for the Administrative Licensing of Labor Dispatch (published in June 2013). These mainly provide further detail to the labor dispatch provisions of the amended PRC Labor Contract Law, including specific rules on how a company can apply for the labor dispatch license, and what conditions are to be met. Among other things, the labor dispatch license requires newly-established companies and existing companies with labor dispatch in their business license before 1 July 2013 to have contributed CNY 2 million in registered capital.

This presents a particular challenge for foreign investors. As procedurally they can only contribute registered capital after the subsidiary has been established, there is no practical way for them to meet the capitalization requirements for newly registered entities to obtain the labor dispatch license at the time of establishment. As a result, government departments have grounds to refuse the granting of a labor dispatch license to any newly-establish foreign-invested companies. Whether or not the policies have been designed so intentionally, the result is that foreign investors need to be particularly creative in structuring their businesses if they want to legally engage in labor dispatch services.

Rules for Companies that Use Dispatched Workers

The legislative circle was completed with the Interim Provisions on Labour Dispatch Rules, which were promulgated in late January 2014 and came into effect on 1 March 2014. Applying to labor dispatch service providers as well as their customers, these provide important clarifications that can have an immediate impact on the business of many foreign-invested companies operating in China. And while further implementing rules are still expected, the most important provisions are already quite clear.

  1. When the Use of Dispatched Workers is Permitted

Dispatched workers are only permitted in temporary, substitute or auxiliary positions:

  • Temporary: Positions lasting for up to six months.
  • Substitute: positions for a certain period of time, during which direct employees are unable to work as a result of full-time study, leave, etc.
  • Auxiliary: Positions in non-core businesses that service core businesses, after discussions with the workers' general meeting or all workers, consultation with the labor union or workers' representatives, and an internal announcement.

The number of dispatched workers may not exceed 10% of a company's total work force, though a transitional period of two years is granted for dispatch already existing before the Interim Provisions became effective on 1 March 2014.

  1. Social Insurance Contributions

For dispatched workers, social insurance must be contributed at the place where the hiring company is registered, and according to the regulations of that locality.

This could have a huge impact. Many (foreign-invested) companies face the challenge of hiring staff in localities where they do not have a branch. These staff usually prefer to have social insurance contributed where they live rather than where the company is registered, and so a dispatch service provider is often used to hire the worker and pay social insurance. This practice is a clear violation of the Interim Provisions, and so companies that want to have staff operate outside their own locality are left with the following choices:

  • Convince dispatched workers to accept social insurance contributions at the place where the company is registered (which usually means that the benefits are less valuable);
  • Hire staff directly and convince them to accept social insurance contributions at the place where the company is registered; or
  • Establish a branch office in the place where the staff is located and make the branch the hiring company, so that social insurance can be paid locally.

Note that another practice, the direct hiring of staff but then using a service provider to assist with social insurance payments in another locality, is not covered by the dispatch framework because it does not involve labor dispatch. This approach involves payroll outsourcing. Strictly speaking the legality of this practice is arguable, though it is still widely spread and generally condoned, for now.

  1. Return of Dispatched Workers

The Interim Provisions provide companies with flexibility to return dispatched workers to the labor dispatch service provider in the following circumstances:

  1. Situations set out in articles 40(3) (change of objective circumstances on which the conclusion of the contract was based) and 41 (economic redundancy) of the PRC Labor Contract Law.
  2. Where the hiring entity is declared bankrupt, has its licence revoked, is ordered to close down or decides to liquidate,
  3. Upon expiry of the labor dispatch agreement.

If the dispatched worker has been returned but has no assignment, the service provider can pay him the minimum salary that is applicable in the locality of the service provider. As this is usually very low and the service provider can still require the employee to report to duty every day, this can be an effective way to force the employee to resign, thereby avoiding severance. Exceptions are only made for the conditions of Article 42 of the PRC Labor Contract Law (pregnancy, confinement or nursing period; work-related injuries and occupational disease, etc.); under these conditions, an employee cannot be returned and so continues to have the right to his or her regular salary.

The above reasons are an addition to the hiring companies' rights to return dispatched workers in case of situations set out in article 39 and 40(1) (2) of the PRC Labor Contract Law. The main difference is that under latter situations, the service provider may terminate the labor contract with the dispatched workers instead of keeping the employee on minimum salary until a new position has been found.

With the Interim Provisions, it now is clear that a return for any other reasons (incl. unlawful return) is not permitted, and could result in severance pay, economic compensation or even reinstatement of the employee with the hiring entity.

  1. Other Challenges

Other points of attention for labor dispatch service providers and their customers under the Interim Provisions include:

  • Various mandatory clauses are to be included in the Labor Dispatch Agreement between the service provider and its customer;
  • The labor dispatch service provider bears liability for work-related injury insurance, but the hiring entity has the obligation to investigate accidents and verify injuries, provide information on possible occupational diseases in the workplace; compensation may be shared if agreed;
  • Where an employees is retained under the name of hired work, outsourcing etc. but the relationship is in fact one of dispatch, then the provisions of the Interim Provisions will apply (Article 27).

What the Interim Provisions do not clarify, is whether the dispatch service provider is obliged to enter into an open-ended labor contract with its employee after two fixed terms (Article 5), as would be required by a regular employer. Subsequent issues to consider include what kind of contract should be signed (open-ended or fixed-term) and how to calculate the service tenure when the hiring entity transfers the employment into one of direct hire.

  1. Penalties

The Interim Provisions set out various different legal consequences for violation of its provisions thereof. The most important are:

  1. Unlawful use of dispatched workers: If the human resources authorities discover the use of dispatched workers beyond the legal scope (i.e. in positions that are not temporary, substitute or auxiliary), they can warn the hiring entity, while suffering employees can claim for damages. The Interim Provisions do not clarify whether the human resources authorities can also issue penalties in case of a hiring entity's continued violation, nor do they provide specifically that the dispatch service provider can be penalized. Practice will tell how this is to be resolved.
  2. Violation of the PRC Labor Contract Law and implementing rules is subject to Article 92 of the same law, namely (i) conducting labor dispatch business without a license may result in a penalty of one to five times illegal income, and (ii) other violations of labor dispatch provisions will result in a warning, and if correction is not made, both the service provider and the hiring entity can be fined at CNY 5,000-10,000 per employee while the service provider can also lose its dispatch license.
  3. Dispatched workers that suffer from violations should be compensated by the dispatch service provider and the hiring entity jointly and severally. If the license of a labor dispatch service provider expires, is withdrawn or revoked, it shall continue to perform the employment contracts until their expiry, unless the employee agrees to termination.
  4. Unlawful return of dispatched workers will trigger employer liabilities under the PRC Labor Contract Law, namely reinstatement or economic compensation. Moreover, this can also result in a warning from the human resources authorities, and a fine if the hiring entity does not correct its behaviour within the specified period.
  5. It is unclear how violations of the rules on social insurance will be penalized (e.g. payment of social insurance in place other than where the company is located), nor is it clear whether the hiring entity can be penalized for.

Rules for Representative Offices

Since representative offices of foreign companies are unable to hire Chinese employees directly, they have always had to hire based on the dispatch model. This has often been seen more as a disadvantage than an advantage, as the use of intermediary dispatch agents complicated relations and made it more difficult to control employees. It has even been a contributing factor to foreign investors replacing their representative office with a consultancy (though other factors, such as taxes and liabilities, arguably have played a greater role).

An unexpected consequence of the new framework on labor dispatch, however, is that the representative office may become more attractive for some foreign investors. The rules specifically allow representative offices of foreign companies to use dispatched workers for positions that are not temporary, substitute or auxiliary. Further, the representative office remains an investment-light vehicle that can be used to hire local staff in places where the company does not want to establish a branch or independent legal entity.

Preliminary Conclusions

Step by step, it is becoming clearer what kind of legal framework the Chinese government wants to put in place for dispatch services. For now, we can draw the following conclusions:

  1. Foreign-invested companies that engage in labor dispatch services without the proper licenses must reconsider their structures to legalize operations. The new penalties, and the additional scrutiny that the industry is receiving, will make it difficult and very risky to try to operate and develop dispatch businesses "under the radar", as many companies have done in recent years.
  2. Companies that hire a large proportion of their workforce through labor dispatch will have to review their policies, and gradually reduce this proportion. They should also carefully review whether dispatched workers really fall under the temporary, auxiliary, or substitute categories, and be aware of the potential penalties if they violate the rules.
  3. Companies that use dispatch services providers such as FESCO and CIIC to hire employees in places where they do not have a registered company or branch, should review their practices. Even if these employees can be considered temporary, auxiliary or substitute, social insurance for dispatched workers must be paid at the place where the hiring company is located.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Maarten Roos
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