Frontline Asia-Pacific Employment Law Update: China

China Updates

In this edition of Frontline, we are focusing on recent developments across the Chinese employment landscape. We cover regulatory developments relating to social insurance, employer responsibilities in preventing workplace inequality and sexual harassment against women, recent judicial practices on noncompetition covenants, and a recently released Supreme Court draft interpretation clarifying the application of PRC labor law. Please read on to learn more about these topics.

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China's Changing Social Security Landscape and Implications for Employers

In 2023, the Chinese central government and local administration authorities implemented a number of measures to clarify expectations of employers with regard to social insurance contributions and to enforce compliance with social insurance laws. This article explores these measures and their potential impact on employers who have historically followed common practices that are not strictly compliant, and which the authorities are now taking steps to prevent.

• 3-Unification Requirement

Under PRC Social Insurance Law, an employer is obligated to make, and can only make, social insurance contributions for its employees at the employer’s place of registration. This rule applies regardless of where the employees are located. However, employees are often requested or permitted to work in cities where the employer is not registered. The practical effect of this is that these employees may find they are unable to obtain certain public benefits (such as housing fund loans, children’s education and housing purchase quota) in the city where they reside, as their social insurance contributions are not being made there. This can also present challenges for employees seeking to receive social insurance benefits (such as maternity allowances, medical expense reimbursements, unemployment subsidies and work-related injury insurance benefits), as this requires them to apply for these benefits with the relevant authorities at the employer’s place of registration. This has led to many employers historically arranging for social insurance contributions to be made through third-party HR agencies to the location where their employees reside.

However, this practice has been expressly prohibited by law since March 2022 when the Ministry of Human Resource and Social Security (“MHRSS”) promulgated the PRC Measures for Administrative Supervision of Social Insurance Funds (“Social Insurance Measures”). This regulation expressly prohibits any acts of registering or participating in social insurance using fictitious employment relationships. Under this enactment, third-party HR agencies are prohibited from making social insurance contributions for employees who are employed by other companies. A failure to comply with the Social Insurance Measures can lead to the forfeiture of social insurance benefits and administrative fines.

In 2023, to enhance the implementation of the Social Insurance Measures, many local administration authorities across mainland China took steps to supervise and monitor social insurance practices with the aim to ensure that (i) the entity signing the employment contract with the employee, (ii) the entity withholding the employee’s individual income tax, and (iii) the entity contributing to the social insurance fund for the employee are the same entity (“3-Unification Requirement”). Employers who fail to meet the 3-Unification Requirement will be required to take corrective actions.

At the judicial level, courts in China have also confirmed in their rulings that an employer’s social insurance contribution obligations cannot be deemed as duly discharged by contributions made through third-party agencies. This means that employers who have used such third-party arrangements to make social insurance contributions face the risk of being required to make up contributions for affected employees at the place where the employer is registered.

• Optimization of Declaration and Payment Processes

In 2023, a number of places in Mainland China, including Yunnan Province, Chongqing, Zhejiang Province, Jiangxi Province, Guangdong Province, Shanghai and Beijing, introduced specific policies to further optimize and adjust the process of declaring and paying social insurance premiums. Before the promulgation of these policies, (i) enterprises would first declare the amount of payable premiums to the social security agencies, (ii) the social security agencies would provide the figures to the tax authorities, and (iii) the tax authorities would collect the social insurance premiums.

The newly-released policies have adjusted this process, such that enterprises are now required to declare and pay the social insurance premiums directly to the tax authorities. As a result of this change, companies that have been engaging third-party agencies to make social insurance contributions or who have not fully complied with social insurance legal requirements have started to be identified by the tax authorities. It is believed that this change is partly an effort by the PRC government to enhance oversight of social security contributions and to realize the 3-Unification Requirement.

• Supervision and Reporting of Social Insurance Violations

In 2023, a series of rules on the supervision and reporting of social insurance violations was also issued. At the national level, the MHRSS has issued Administrative Measures for the Supervision and Reporting of Violations Concerning Social Insurance Funds and the Implementing Rules for Rewarding the Reporting of Violations Related to Social Insurance Funds Supervision (“Social Insurance Non-Compliance Reporting Rules”). The Social Insurance Non-compliance Reporting Rules stipulate that whistleblowers may receive rewards if social insurance violations reported by them to the authorities are verified to be true. The amount of the reward is equal to 2% of the loss of social insurance funds caused by the verified violations, subject to a minimum of RMB 200 and a maximum of RMB 100,000. A number of provinces and municipalities, including Beijing, Shanghai, Tianjin, Shanxi Province, Hebei Province, Jiangxi Province, Hunan Province, Anhui Province, Inner Mongolia, Guangxi Province and Gansu, have subsequently introduced measures relating to rewards for the supervision and reporting of social insurance violations. The introduction of these policies has signaled the government’s increasing efforts to monitor social security contributions and to clamp down on non-compliance.

• Expanded Social Insurance Coverage

Notably, there is a policy trend toward expanding social security coverage. In 2023, several locations, including Shanghai, Zhejiang Province, Hainan Province and Hubei Province, released policies or draft policies aimed at extending work-related injury insurance to individuals who do not have formal employment relationships, including interns, retirees, platform workers and shared economy workers.

Takeaways

With the rollout of these policies and measures in 2023, it is expected that the Chinese government’s supervision and oversight of social insurance will be stepped up in 2024. To navigate this evolving landscape, companies are strongly advised to review their level of adherence to social insurance obligations and to stay vigilant regarding changes in social security policies. Employers currently arranging social insurance contributions through third-party agencies are advised to take prompt corrective measures. Companies may wish to assess their employment strategy, including whether to establish branch operations, in order to address the conflict between talent retention and legal compliance.

Enhanced PRC Legal Protections for Women in the Workplace

In a significant stride towards gender equality, China implemented the new PRC Law on Protection of Women’s Rights and Interests in 2023. This enactment reflects a strong commitment by the Chinese government to combating gender discrimination and sexual harassment in the workplace.

• Strong Commitment Against Gender Discrimination

This legislation takes a firm stance against discriminatory practices throughout the employment cycle. Notable provisions include the following:

1. Recruitment Practices - Employers are prohibited from engaging in discriminatory recruitment practices such as limiting candidates to male-only or adopting males-first policies. Additionally, inquiries about marital and childbirth status, pregnancy tests during pre-onboarding health examinations, and other discriminatory recruitment practices are expressly forbidden.
2. Salary and Benefits - The law bars employers from reducing the salary and benefits of female employees and impeding their promotion or rankings, and from making evaluations based on circumstances such as marriage, pregnancy, childbirth, maternity leave or breastfeeding.
3. Labor Security Inspections - Gender discrimination in job recruitment, admissions, promotions and dismissals is now within the purview of labor security inspections. This empowers labor authorities to actively monitor workplaces for discriminatory practices.
4. Regulatory Penalties - Clear regulatory penalties are stipulated for violations. Employers who fail to adhere to the regulations and refuse to rectify non-compliant practices may face fines ranging from RMB10,000 to RMB50,000, and individuals in charge may be subject to administrative penalties.

• Employer Responsibilities to Prevent Harassment

The law expressly prohibits any form of unwelcome sexual harassment towards women, covering verbal, written, visual, or physical misconduct.

It further prescribes a set of mandatory measures to be taken by employers to prevent and address sexual harassment in the workplace. These include implementing a policy against sexual harassment, appointing designated personnel or a department responsible for addressing workplace sexual harassment, conducting anti-harassment training, adopting safeguards in the workplace to prevent sexual harassment, establishing a practical reporting system, establishing procedures for investigations of harassment incidents, establishing disciplinary policies and taking disciplinary action to address incidents of sexual harassment. The law also empowers women to take legal action, including reporting incidents to the police and filing civil lawsuits against sexual harassment, with employers being required to support female employees in defending their rights.

Under the legislation, if an employer fails to take necessary measures to prevent sexual harassment, resulting in women’s rights and interests being infringed, the competent authority is empowered to order the employer to take corrective action. If the employer fails to make comply with the order or the circumstances are serious, the directly responsible officers and other personnel will be subject to administrative penalties. In addition, the law enables China’s procuratorates to initiate public interest lawsuits against employers who fail to implement proper measures to effectively prevent and address workplace sexual harassment.

• Judicial Developments

At the judicial level, the PRC Supreme People’s Court issued two guiding judgments concerning workplace sexual harassment. In one case, the court ruled that employers’ managers must take reasonable measures to address complaints from sexually harassed employees. A failure to do so, or indulging in workplace harassment, may result in summary dismissal for gross neglect of duties and serious violation of the company’s anti-harassment rules. In another case, the court supported claims by a sexually harassed employee for mental damages and for payment of her medical treatment expenses.

Takeaways

The implementation of this law is anticipated to lead to an increase in disputes related to sex discrimination and sexual harassment, as heightened awareness is likely to prompt individuals to assert their rights. In response to this evolving landscape, both judicial and regulatory bodies in China are expected to take more proactive measures to combat workplace sexual harassment and discriminatory practices. This may involve proactive enforcement, landmark legal decisions, and an increased focus on fostering a culture of inclusivity and respect in workplaces. Employers are therefore advised to review their existing practices, to ensure they implement the required measures and to educate their employees on proper workplace conduct.

Recent Judicial Practices in China on Non-Competition Covenants

Under PRC labor law, employers are permitted to agree on post-contractual non-competition obligations with senior management, senior technicians and other employees under confidentiality obligations. Employees subject to this obligation are prohibited from working for competitors or engaging in competing activities for an agreed period after the termination of their employment, during which time they are entitled to be compensated. However, this legal mechanism, which was designed to safeguard employers’ trade secrets has been misapplied to employees without access to trade secrets, impacting their employment rights. Partly in response to media reports regarding alleged abuses by employers, Chinese courts have recently adopted a more cautious approach in enforcing non-competition covenants.

In December 2023, the Shanghai Second Intermediate People’s Court issued a judgment addressing the issue of inadequately low non-competition compensation. The court ruled in favor of an employee who argued that the agreed non-competition compensation, set at the minimum wage standard for Shanghai, was insufficient compared to the substantial liquidated damages of RMB 1 million for the employee’s breach of the non-competition obligation. The court deemed the compensation clause to be invalid, emphasizing that it appeared to be a standard provision intended to diminish the employer's obligations. The court ruling required the employer to increase the non-competition compensation to 30% of the employee's prior monthly salary.

Similarly, in a non-competition case adjudicated by the Beijing First Intermediate People’s Court, the court emphasized that the range of employees who are subject to post-termination non-competition restrictions is inherently limited. It held that such restrictions extend only to employees with knowledge of an employer’s trade secrets and confidential information related to intellectual property. Employers are not permitted to indiscriminately extend such restrictions to employees without such access to trade secrets and confidential information.

The court cautioned against presuming an employee’s awareness of trade secrets solely based on confidentiality clauses agreed in the employment contract. The court also stressed the necessity for employers to clearly demonstrate an employee’s awareness of, and access to, protected information when enforcing non-competition agreements.

In this case, the court invalidated the non-competition agreement, as the employer failed to provide cogent evidence proving that the employee had access to trade secrets during employment. This case signals a heightened judicial scrutiny by the courts to ensure non-competition agreements are appropriately applied to safeguard an employer’s legitimate business interests without unduly restricting employees who lack access to sensitive information.

Takeaways

In the context of economic challenges and high unemployment rates in China, it is expected that the Chinese courts will maintain a cautious stance in evaluating the application of non-competition covenants. This will include scrutiny of compensation payments, ensuring they are fair and reasonable. In addition, it is anticipated that the courts will uphold the limited application of non-competition agreements, emphasizing the necessity for employers to demonstrate a legitimate connection between an employee's role, access to trade secrets, and the application of non-competition restrictions. Employers are encouraged to consult with legal professionals to ensure that their non-competition agreements align with this evolving judicial approach.

Draft Interpretation of Labor Law May Create More Onerous Obligations for Employers

On 12 December 2023, the PRC Supreme People’s Court (“SPC”) issued the “Interpretation on Issues Concerning the Application of Law in the Trial of Labor Dispute Cases (II) (Draft for Public Comments)” (“Draft SPC Interpretation”). In this article, we look at the Draft SPC Interpretation pertaining to (i) annual leave compensation, which reflects a significant departure from current practice, and (ii) a possible stricter approach being taken towards employment practices after expiry of an employee’s second fixed term contract.

• Statutory Limitation Period for Unused Annual Leave Compensation

The Draft SPC Interpretation deviates significantly from the prevailing judicial stance on annual leave compensation claims. Currently, Chinese courts commonly hold that the limitation period for employees’ claims for unused annual leave compensation is one year from the date that the employee knew of, or should have known about, the infringement of their rights. However, the Draft SPC Interpretation stipulates that the limitation period is one year from the termination date of the employment relationship.

Chinese courts generally deem that the one-year limitation period for compensation claims for unused annual leave accrued in a specific year is calculated as Y+2 years, where (i) Y is the specific year in which the unused annual leave has accrued, and (ii) the year runs from 1 January to 31 December. For instance, if an employee wishes to claim compensation for unused annual leave which accrued in 2022, the employee is required to raise a claim before 31 December 2024, otherwise the claim will be time-barred.

If the Draft SPC Interpretation comes into effect as drafted, employees could potentially claim compensation for unused annual leave accrued throughout their entire employment period. This has the potential to impose significant economic pressure on employers compared with the current judicial practice. This is compounded by the fact that payment of unused annual leave on termination of employment is calculated at 300% of an employee’s daily wage.

To avoid onerous payment obligations on termination of employment, employers are encouraged to audit their current annual leave records, proactively monitor employees’ annual leave consumption to ensure that leave entitlements are taken in a timely manner and require previously accumulated but unused annual leave to be taken within a reasonable period.

• Renewal of Fixed-Term Contracts

Under PRC law, employees generally have the right to request an open-term employment contract upon the expiration of two consecutive fixed-term contracts with the same employer. The Draft SPC Interpretation further clarifies situations constituting the conclusion of two consecutive fixed-term contracts. These include scenarios where: (i) the employment contract term is extended for a cumulative period of one year or more; (ii) the employment contract is automatically renewed after the expiry of the term based on the contractual agreement between the employer and the employee; (iii) the employer signs the second employment contract in the name of a different entity, but the employee continues working at the original workplace and position; and (iv) the second employment contract is concluded through other acts by the employer to circumvent the obligation to enter into an open-term contract.

This Draft SPC Interpretation reflects a stricter stance being taken by Chinese courts to prevent employers from circumventing the spirit of the law and to reinforce the obligation to provide employees with open-term contracts once they have fulfilled the requirements of their second fixed-term contract.

Takeaways

After public consultation, the content of the Draft SPC Interpretation is likely to be revised and updated. The SPC has not indicated when this interpretation is scheduled to be officially issued and implemented. Employers are encouraged to closely monitor developments and seek legal advice to understand the implications and potential adjustments needed in their employment practices. Adapting to these potential changes will be crucial to ensure compliance with evolving employment laws and to effectively manage the economic and legal impacts that may arise.