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Power Shift

American policy regarding China's labor laws always has been a double-edged sword. On the one hand, the U.S. continues to demand compliance with WTO standards, claiming China's failure to comply gives it an unfair competitive advantage. On the other hand, such compliance could prove costly for the hundreds of U.S. companies operating on the Chinese mainland.

The dilemma has crystallized with the promulgation of The Labor Contract Law of the People's Republic of China, now scheduled for a second reading by the Standing Committee of the National People's Congress. Although unionization is not mandatory in China, this pending law greatly expands the role of labor unions--known as "work councils"--by strengthening their right to engage in collective bargaining and making employers' operational decisions subject to their approval.

"This law is very broad, decidedly pro-worker and includes many provisions to protect workers who are disadvantaged in a market economy," says Meg Utterback, a partner in Thelen Reid & Priest's China practice in San Francisco.

Indeed, the legislation, which might be enacted by the end of 2006, governs the establishment, revision and termination of labor contracts in China generally. It represents a major change from the existing system, where employers have the right to terminate labor contracts without notice and withhold wages in the event of a dispute with workers.

"Most foreign investors see this law as pretty drastic," says Andreas Lauffs, a partner in Baker & McKenzie's Hong Kong office. "If enacted in its current form, it will force employers to review and restructure their labor contracts and human resource policies, and it also will cause them to look at the competitiveness of Chinese products from a new perspective."

The difficulty is that perspective in China rarely affords a clear vista.

Contract Battles

As foreigners doing business there have learned, the devil is in the details when it comes to Chinese legislation. For the most part, the Chinese government drafts statutes in broad terms, meaning that their ultimate impact can be hard to gauge until officials come up with detailed regulations.

The Labor Contract Law is no exception--but it has a twist. The statute provides that authorities must interpret any ambiguity found in labor contracts in favor of the employee. Because the draft legislation doesn't specifically "grandfather" existing contracts, the ambiguity as to their status will likely have the effect of making preexisting contracts subject to the new legislation.

The difficulty is that short-term employment contracts are common in China. Because China has never allowed the dismissal of employees during the term of their employment contract except on narrow grounds, such as non-performance and incompetence, most employers have signed their employees to short-term contracts.

Under the current law, employers could allow these contracts to expire and simply dismiss the employee when the term was up without paying severance. However, the new law requires a company to pay severance of one month's salary for every year of service where it does not renew a fixed-term contract of any duration.

But even that requirement is not as simple as it sounds. Complicating matters is the fact that the Act doesn't calculate severance on the basis of the affected employee's salary, but leaves the formula in the hands of provincial labor authorities.

"This may mean that an average salary of employees in a particular industry or geographical area will be used," Lauffs says.

Mass layoffs--defined as those affecting more than 50 employees--would create even more liabilities.

Layoff Penalties

Current law allows mass layoffs when the employer is in financial straits or experiences major production difficulties. However, the new Labor Contract Law allows mass layoffs only within narrow situations defined as a "change of objective circumstances." These include the relocation of a business, merger or transfer of major assets.

"It would appear that a mere downsizing would not justify mass layoffs," Lauffs says.

Even where the company does meet the statutory criteria, however, it cannot act unilaterally but must negotiate the terms of the layoff with a labor union. This provision extends the existing law, which requires employers to notify unions before terminating a labor contract for any reason--even for cause.

The rub is that Shanghai courts have ruled that even a company that does not employ union workers must notify the union at the "next higher level." Chinese unions are not the same animals American companies are accustomed to seeing. Ultimately, all Chinese unions are linked to the All-China Federation of Trade Unions (ACFTU), which is responsible to the Communist Party.

"The ACFTU is not independent," Lauffs says. "Its first obligation is to the state, and representing the workers is secondary to that."

As Lauffs sees it, the consequence is that political considerations will dominate the employer-union relationship.

"Work councils have such broad powers [under the Labor Contract Law]--you can't even have an employee handbook or work rules without their approval--that they could make it quite impossible to run a business," he says. "We haven't seen a lot of that kind of interference so far, but we're seeing more. It's a time bomb that's ticking. What I'm telling my clients is to think of the future of labor law in China as similar or worse than France or Germany."

Not everyone, however, sees the situation so harshly.

Foreign Influence

"Despite China's pretensions to being heaven for workers, the labor laws here have always been quite weak," says Robert Kwauk, managing partner of Blake Cassels & Graydon's Beijing office. "I'm telling my clients not to panic because the new rules are still very reasonable compared to the labor laws to which many of them are exposed otherwise in their domestic and international operations," he adds.

Leo Seewald, a partner at the Guangzhou office of King & Wood, China's largest domestic law firm, says the Act may still change substantially before the congress enacts it. He notes that the Chinese government has asked for comments on the legislation from foreign companies and chambers of commerce.

"That's extraordinary," Seewald says. "I can't imagine that the U.S. government would seek the comments of foreign companies on U.S. law."

What remains to be seen, of course, is whether Chinese authorities will listen to the response.

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Julius Melnitzer

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