China Employment Contracts: Be Careful with the Penalty Provision

One of the more important things you should know about China employment law is that employees have many rights they CANNOT contract away. An employment contract in China (and pretty much every other country as well) is not a regular commercial contract where the parties have significant freedom to agree on anything. In China employment contracts are not governed by China’s Contract Law; rather, they are governed by the Labor Contract Law (among other numerous employee-friendly labor and employment laws, regulations, rules, directives, etc.). This is a critical distinction often missed to the peril of foreign employers in China.

Because Chinese employees are rarely free to contract away the vast majority of their rights, you as an employer need to think long and hard before trying to contractually (or otherwise) impose an extra burden or penalty on your employee. Generally, employees in China may bear no more obligations beyond those stipulated by law. For example, consider this somewhat classic example: can you have an employment contract that mandates your employees will automatically pay you a certain amount of salary if they fail to give at least 30 days written notice before resigning? Say, you try to be fair by asking each employee to pay you one day’s salary for each day he or she fails to give notice up to 30 days. Will such an employment contract provision be enforceable under Chinese law?

It depends on your locale, but generally speaking, in most locales, unless an exception applies (which I will explain below), this sort of arrangement constitutes a penalty against the employee and is therefore unenforceable under Chinese law. China’s Labor Contract Law says that so long as an employee provides 30 days written notice, he or she can terminate their employment relationship, with or without cause. This is generally interpreted as meaning that an employer cannot legally make it more difficult by essentially imposing a penalty for an employee terminating the employment contract early.

In this situation employers commonly argue that since the law is silent on what happens when an employee fails to the provide 30 days written notice the parties should be free to enter into their own agreement on this issue. In most locales, this argument has been stricken down for two reasons: (1) the law does NOT give an employer the right to penalize an employee for failing to give 30 days written notice; and (2) the employer already has the right to pursue the employee if the employer suffers actual damages as a result of the employee’s failure to give adequate notice. The burden is on the employer to show the damages and the causal connection between the employee’s behavior and such damages. So what if the employee gave only 20 days notice? If the employer suffers no harm, it would not be fair to penalize the employee for being 10 days short on giving resignation notice. Such an arrangement, without more, constitutes a penalty under Chinese laws and will not be deemed enforceable.

What are the exceptions? A penalty payable by the employee may be upheld under one of the following two circumstances:

• Pursuant to an education reimbursement agreement (sometimes called a service period agreement), an employer can require its employees reimburse the company for the education expenses if the company pays major expenses for an employee’s employment-related education or training, but soon after the training is complete, the employee quits.
• Pursuant to a non-compete agreement, an employer can require an employee pay a penalty to the employer for violating non-compete terms by joining a competitor after leaving employment.

In jurisdictions that prohibit penalize employees for shortened termination notice, it does not matter if the employer can prove it was the employee who insisted on this penalty arrangement. It also does not matter if the clause is in bold and in perfect Chinese.

If you have already invested a lot of time and money on one or more of your employees or you are planning to do so, you should consider adding a provision to your employment contract on education reimbursement. If your employee assures you not to worry because he or she will not leave you hanging and as proof of this offers to pay you for leaving without 30 days notice, you should know that what the employee will almost certainly not be enforceable. It’s just like when you present an unenforceable NDA (as opposed to a China-centric NNN) to your Chinese counterpart, and they are of course to happy to sign it, knowing it will carry no legal force in China.

Trust me when I tell you our Chinese lawyers constantly see Chinese individuals and companies willingly and knowing propose and then sign agreements knowing full well they are not enforceable!

Do your China employment contracts pass legal muster? Now is the time to check to make sure.

By the way, my book on China employment law, The China Employment Law Guide: What You Need to Know to Protect Your Company, just came out in paperback and you can buy it for the low low price of only $19.95 on Amazon. I realize this is considerably more than the Kindle price, but my intention with the book is for foreign employers and for expat employees to have this book available to them as a ready reference and that will be much better accomplished on a bookshelf in paperback form than on a Kindle or your computer. 

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.