How to reduce workforce for economic reasons?
Author: Yang Jie, Dong Baohua Office
The Labor Contract Law of the People’s Republic of China (hereinafter referred to as “Labor Contract Law”) provides strict protections against individual dismissals by regulating in great details the cause of dismissal, dismissal notification and economic compensation. It controls all the more strictly such collective dismissals as downsizing by imposing eight constraints.
Case example: A “rush to get pregnant” to avoid being dismissed
Mrs. Luo has been working in a foreign trade company for three years. In September this year, the secretary of the boss told Mrs. Luo that the company’s performance this year was really bad due to the global financial crisis, that the boss thereby was planning to dismiss four to five employees out of the current pool of ten employees, and that Mrs. Luo was very likely to be placed on the name list for redundancy. A few days later, the boss talked to Mrs. Luo alone. He initially praised Mrs. Luo’s performance over the past three years, and then suddenly mentioned the recent slump in the company’s business volume. He expected Mrs. Luo to actively look for another job and leave the company by the end of this year.
“At present, most companies are adopting conservative strategies. It is definitely not a good timing for job-hopping.” Mrs. Luo noted if she lost this job, she would find it very difficult to land a new one quickly. Moreover, she had been working in the company for three years with a nice position and income; even if she could find a new employer, the new position was very unlikely to provide what she currently enjoyed. Mrs. Luo, being depressed, noticed on a job search website that according to law, an employer may not dismiss a female employee during her pregnancy. Thus Mrs. Luo began to think about the idea of “getting pregnant to keep the job”. After discussing the idea with her family, Mrs. Luo decided to get pregnant as quickly as possible. In mid October, she became pregnant as she had wished and happily told the news to her boss immediately.
At the end of October, the boss again talked with Mrs. Luo on an individual basis. The boss directly told Mrs. Luo that he was very angry about what she had done, that she did not have to wait until December 1 when she would go through the dismissal process, that the corresponding economic compensation would be paid the same as other redundant staff according to law, and that the company would soon be shut down. Mrs. Luo discovered, however, that other than those who were leaving through dismissal, the remaining employees were not rushing to find new jobs and that the company still had new businesses coming in. Through hearsay Mrs. Luo realized that the boss’s wife had opened another foreign trade company with similar business, and that the boss planned to take the business and retained staff of this company to his wife’s company after shutting down his own company.
Eight constraints for downsizing
The staff reduction for economic reasons stipulated in the Labor Contract Law has a basic standard, i.e. an enterprise needs to reduce the workforce by 20 persons or more or by a number of persons that is less than 20 but accounting for 10 percent or more of the total number of the enterprise’s employees. But this standard has neglected the fact that the majority of Chinese enterprises are small and medium-sized enterprises. In the aforementioned case, the company only had ten employees. Dismissal of one employee will reach the 10% standard, therefore the procedures for downsizing need to be triggered, and relevant regulations on downsizing apply.
Staff reductions in the aggregate will leave many workers jobless. While the aim of enacting the Labor Contract Law is to establish stable employment relations, it provides strict protections for individual dismissal by regulating in great detail the cause of dismissal, dismissal notification and economic compensation; it controls all the more strictly such collective dismissal as downsizing by imposing eight constraints.
First, staff reduction must be pursuant to legal conditions. Staff reduction will be allowed only when it is pursuant to relevant legal conditions. The Employer may reduce the workforce under any of the following four circumstances: (1) Restructuring pursuant to the Enterprise Bankruptcy Law; (2) Serious difficulties in production and/or business operations; (3) The enterprise switches production, introduces a major technological innovation or revises its business method, and, after amendment of employment contracts, still needs to reduce its workforce; or (4) Another major change in the objective economic circumstances relied upon at the time of conclusion of the employment contracts, thus rendering them unperformable.
Secondly, circumstances where an employer may not terminate an employment relationship. In order to avoid increasing social burdens as a result of staff reduction, the legislature requests enterprises to fulfill the obligation of retaining some employees and not to terminate employment contracts with them. According to the Labor Contract Law, an employer may not terminate an employment contract if the employee: (1) is engaged in operations exposing him to occupational disease hazards and has not undergone a pre-departure occupational health check-up, or is suspected of having contracted an occupational disease and is being diagnosed or under medical observation; (2) Has been confirmed as having lost or partially lost his capacity to work due to an occupational disease contracted or a work-related injury sustained with the employer; (3) Has contracted an illness or sustained a non-work-related injury, and the set period of medical care therefore has not expired; (4) Is a female employee in her pregnancy, confinement or nursing period; (5) Has been working for the employer continuously for not less than 15 years and is less than 5 years away from his legal retirement age; (6) Finds himself in other circumstances stipulated by laws or administrative statutes.
Thirdly, mechanism of retention with priority. The mechanism of retention with priority, as a new mechanism prescribed by the Labor Contract Law, puts social objectives ahead of economic objectives. According to Article 41 of the Labor Contract Law, when reducing the workforce, the employer shall retain with priority two groups of persons: the first group comprises those who have concluded employment contracts of a relatively long term, including those who have concluded with the employer fixed-term employment contracts of a relatively long term and those who have concluded open-ended employment contracts with the employer. This requires the employer to sort the term of contracts before downsizing. The Employer shall retain with priority employees who have concluded open-ended employment contracts and fixed-term employment contracts of a relatively long term, while dismissing with priority employees who have concluded employment contract of a relatively short term. After satisfying this statutory prerequisite, the employer may further identify redundancies on the name list based on such criteria as company developmental needs and labor costs; the first group comprises those in difficulties. According to the Labor Contract Law, when reducing the workforce, the employer shall retain with priority those who are the only ones in their families to be employed and whose families have an elderly person or a minor for whom they need to provide. Because these employees bear a heavy family burden, now that the society currently is unable to provide sufficient social aids, once they lose their jobs, their family life will fall into extreme difficulties and hence require government assistance. Therefore, the new law requires the employer to bear certain social responsibilities by retaining these two groups of people with priority.
Fourth, mechanism of hiring on preferential basis. According to the Labor Contract Law, an employer has the obligation to hire persons dismissed by the employer on a preferential basis. If an employer that has reduced its workforce hires again within six months, it shall give notice to the persons dismissed at the time of the reduction and, all things being equal, hire them on a preferential basis.
Fifth, mechanism of prior notice. The Labor Contract Law prohibits sudden downsizing by requiring the Employer to explain the circumstances to its trade union or to all of its employees 30 days in advance.
Sixth, mechanism of trade union participation. The employer should explain the circumstances to its trade union or to all of its employees 30 days in advance, and consider the opinions of the trade union or the employees.
Seventh, mechanism of reporting to administration. The Labor Contract Law stipulates that staff reductions should be reported to three parties. Apart from the employees and trade union, the employer should also report the workforce reduction plan to the Labor Administration Department. The word “report” hereof should mean explanation of the circumstances without having to get the approval of the Labor Administration Department. However, in practice, the Labor Administration Department will usually intervene in the matter.
Eighth, mechanism of economic compensation. When reducing the workforce, the employer shall pay economic compensation to the employees dismissed.
Downsizing or bankruptcy?
The aforesaid eight constraints have left little room for an employer to reduce its workforce. Downsizing has almost become a “mission impossible”. Under such circumstances, bankruptcy has become a common alternative solution. According to the Labor Contract Law, an employment contract shall end if the employer has its business license revoked, is ordered to close or is closed down, or the employer decides on early liquidation. In such cases, the employer only needs to pay the employee economic compensation. There are no other legal constraints for the employer. As a consequence, the employer in the aforementioned case example made a choice of economic rationality after comparing the alternatives of downsizing versus bankruptcy.
This is a legal paradox where a company that needs to cut 10% of its jobs to survive will face many legal constraints, and a company that shuts down leaving all employees jobless will face almost no legal constraint. Intuitively, one can imagine an enterprise’s choice between downsizing and bankruptcy, particularly small and medium-sized enterprises. Hence the 90% of employees suffer, too. The National Development and Reform Commission (NDRC) declared that 67,000 small and medium-sized enterprises of critical mass became bankrupt in the first half of this year. One of the reasons might be the difficulties in the staff reduction process.
The author thinks we should take a dialectical view of staff reductions. On one hand, staff reduction no doubt results in unemployment, but on the other, it is a necessary adjustment for enterprises to survive. Too many restrictions will only push enterprises to bankruptcy, leaving more people jobless. The law must strike a rational balance between protecting labor rights and keeping the agility and competiveness of enterprises.

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