China Employment Disputes: How Foreign Companies Can Defend Termination and Severance Claims

The following is general information on Chinese employment law, not legal advice for any specific case. Every matter turns on its own facts; consult a qualified PRC lawyer before acting on a termination.

Why terminations go wrong in China

Foreign employers routinely underestimate China's Labor Contract Law (劳动合同法). It is employee-protective, procedural, and strict about the grounds on which an employer may end a contract. A termination that would be routine in the US or Europe can be found "unlawful" in China — and an unlawful termination flips the cost from severance to double severance. Understanding the arithmetic is the first step to avoiding the penalty.

The three legal routes to termination

The Labor Contract Law (effective January 1, 2008; amended in 2012) sets out the employer's options in Articles 39, 40 and 41:

• Immediate termination with no severance (Article 39) — employee fault. This covers, among others, a serious violation of employer rules, dereliction of duty causing major damage, serious fraud in entering into the contract, and criminal liability. The burden is on the employer to prove the rules existed, were published, and were breached.
• Termination with notice or pay in lieu, plus severance (Article 40) — non-fault grounds: incompetence that persists after training or reassignment, inability to work after medical treatment, or a major change in objective circumstances that frustrates the contract.
• Economic layoffs (Article 41) — restructuring affecting 20 or more employees, or 10% or more of the workforce, with strict procedural duties to consult the union or all employees.

The severance arithmetic: N versus 2N

• Severance (经济补偿金, "N") — under Article 47, one month's salary for each year of service, with six months or more counting as one year and less than six months counting as half a year. Salary for this purpose is capped at three times the local average monthly wage, and for high earners the number of years is capped at twelve.
• Unlawful-termination damages (赔偿金, "2N") — under Article 87, if a court or tribunal finds the termination unlawful, the employer pays double severance. That is the penalty for guessing wrong on the ground or skipping the procedure.

There is also a separate, non-termination exposure many employers miss: if a written labor contract is not concluded within one month of the employee starting work, Article 82 exposes the employer to double wages for each month without a contract (up to a twelve-month run).

The process: arbitration before court

Employment disputes in China are resolved through a special channel. Under the Labor Dispute Mediation and Arbitration Law (effective May 1, 2008), a labor dispute must go through labor arbitration before it can be heard by a court — there is no direct litigation. Key points:

• Arbitration is a mandatory first step for most claims (wages, severance, unlawful termination, social insurance disputes).
• The limitation period is one year from when the employee knew or should have known of the infringement, with the clock reset by a written claim or by the employee acknowledging the dispute.
• The employer carries the evidentiary burden for most termination disputes — documents such as the signed contract, employee handbook acknowledgements, performance records and disciplinary notices decide the case.
• Either side may appeal the arbitral award to court, which means a full dispute can run through arbitration and two court instances.

How foreign employers should prepare

• Keep a signed written contract and a published, acknowledged employee handbook. These two documents carry more weight than any argument after the fact.
• Document performance and discipline in real time. Article 39 dismissals in particular live or die on contemporaneous records.
• Pay social insurance on the actual salary base. Under-contribution is a common source of employee claims and administrative exposure.
• Calculate the exposure before acting. A negotiated separation agreement — if properly drafted — is often cheaper and faster than losing a 2N case.

For a broader look at the hiring side, see China Employment Law: Hiring Staff for Your WFOE, or contact us to discuss a specific termination or dispute.