China: China’s New Draft Labor Contract Law—Help or Hindrance?

Last Updated: 12 June 2006
Article by Meg Utterback

The State Council of the People’s Republic of China has issued for comment a draft of its new Labor Contract Law. That draft was recently released to the public and will likely go through at least one more iteration before a version of it is enacted. The seven-chapter draft is the country’s first law governing the establishment, revision, and termination of labor contracts in the People’s Republic of China. These new laws were designed to offset the abuses and poor working conditions particularly common to Chinese laborers, as well as to minimize labor-management disputes, and stabilize the job market. With China’s entry into the World Trade Organization (WTO) in 2001, China recognizes the need to improve the outdated labor law. However, the current draft of the new law may go too far in favoring workers’ rights and may create problematic employment situations for foreign-invested companies.

Under the existing labor contract system, employers can terminate contracts without notice, withhold workers’ wages, and refuse to renew contracts. The draft law is decidedly pro-worker, and includes many provisions that protect laborers who are in a disadvantaged position in the market economy. Sixty-five articles, in total, comprise the new draft law. Some of its more significant elements are summarized below.

Pro-Worker Provisions

The Draft adopts many pro-worker provisions in an attempt to address past harm. Some examples are:

1) Ambiguities are construed against the employer;

2) In the absence of a written agreement, the contract is deemed open-ended, terminable only for cause; and

3) After one year of employment through a labor agent, the employer must directly hire the employee.

In addition, the draft does not acknowledge grandfathering for fixed-term, preexisting labor relationships, which may mean that such contracts can only be terminated for cause. These provisions were not aimed specifically at foreign employers. The law recognizes that, for many years, immigrants to coastal cities entered into loose labor relations that afforded no protections, and these people were often overworked, not paid, and denied benefits and job security. Unfortunately, the unintended consequence is the creation of disadvantageous labor contracting conditions for foreign entities.

Fixed-Term Contracts

The draft law requires a written contract between the employer and employee for the purposes of recording an employer-employee relationship. Because there is no at-will employment, employees are usually under contract. Currently, employers often use fixed-term employment contracts. When the employee is not meeting expectations, the employer can allow fixed-term contract to expire, thus avoiding both a termination for cause and payment of severance. Under the new law, fixed-term contracts are still allowable, although their use is strongly discouraged. Incentives for employers to avoid using such contracts have been put in place, such as not allowing fixed-term contracts to be terminated early, except for cause, and in the case of mass lay-offs. An employer must also pay severance if a fixed-term contract expires and is not renewed.

Mass Layoffs

Under the draft law, employers are required to negotiate an agreement with the labor unions over any mass layoffs, which are defined as the need to lay off more than fifty workers. Under the draft law, a "change of objective circumstances" test is required of companies to determine the need for mass lay-offs. The question of what constitutes a change in objective circumstances remains—relocation or corporate reorganization through merger may be sufficient, but it appears that down-sizing of the company is not. Again, the grey areas of this provision will make it difficult to implement.

Non-Compete Agreements

Under the draft law, employees who leave a company are bound to a non-compete agreement for two years following termination. This marks a one-year reduction from the previously required three years. Employers are also required to pay the equivalent of 100% of the worker’s annual salary in order to make the non-competition restriction enforceable.

In the event that a non-compete clause is breached, the draft law limits the damages an employee must pay an employer to three times his or her annual salary.

Finally, the draft law sets new geographic limitations on the applicability of non-compete clauses.

Probationary Periods

The draft law dictates that the length of the probationary period must be based upon the type of work conducted by employees. Probationary periods will be:

  • No more than one month for workers in non-technical positions;

  • No more than two months for employees with technical positions; and

  • No more than six months for senior technical professional positions.

Currently, probationary periods are limited by the length of the employment contract, not the job function.

Severance Payments

Under the draft law, employers are required to pay severance pay to an employee whose fixed-term contract expires, if the employer chooses not to renew it. However, the employer does not have to pay the employee if the labor contract is renewed. The provision obviates a key benefit of the continued use of fixed-term contracts.

Compensation for Unlawful Dismissal

In cases of unlawful dismissal, under the draft, employers must pay two years salary for every year of service. The severance may also be calculated by the provincial labor authority, which could apply wage standards for industry or geographical location rather than the actual salary.

Role of Labor Union

Under the draft law, the role of labor unions has been strengthened. Currently, the labor union must be notified if a labor contract is to be terminated, and the draft does not change this rule. Foreign-invested businesses that do not have established labor unions are required to notify the union at the next higher level.

Unions may engage in collective bargaining and enter into collective contracts under the draft. This provision states that any act taken unilaterally by a company without required union consultation will be void.

Similarly, the draft requires that all rules that a company sets for its employees be reviewed and approved by the labor union. Rules issued unilaterally by the employer will be considered void. This provision has important intellectual property implications. All employee manuals and handbooks that relate these rules must also be approved but the union. In the past, worker handbooks, deemed and stamped confidential, have provided a means to protect production methods. This is especially important in a country like China with no "methods" patents. The requirement that such handbooks receive the sanction of the labor union may be construed as undoing much of the confidentiality sought. Additionally, allowing the labor union a say in corporate policy may run afoul of other internal corporate regulations and jurisdictional requirements. As currently drafted, the breadth of this provision is unclear and will require further definition if it is to be implemented.


The new draft law is expected to support worker’s rights and interests in a labor marketplace that has undergone dramatic changes in the wake of China’s rapid economic growth. Employers throughout China are concerned about the impact the new law will have on their business. If enacted in its current form, the draft law will likely require domestic and foreign companies to reform their labor contracts and human resources policies. However, the likelihood of the law being enacted in its current draft remains slim. Local chambers of commerce and individual businesses have submitted comments and criticism in hopes of improving the current draft. Ambiguities in the current draft are also likely to cause at least one more round of comment. Foreign companies should remain mindful that this law is in flux and may have implications down the road for hiring strategies and protection of intellectual property.

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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