China Employer Audits: Not Just for WFOEs

China employment lawyer

Our China employment lawyers conducted more than double the number of employer audits in the last year as in the year before and we expect to double last year’s number this year. Foreign company employers in China face growing heat for all sorts of reasons, including the following:

1. The government in Beijing views its compact with its citizenry as including taking care of employees.

2. Many local governments view their compact with their citizenry as including taking care of employees.

3. There is a lot of pressure on both Beijing and on local governments — from both employees and from competitor businesses — to make sure foreign companies are abiding by all of China’s laws, including all of its employment laws.

4. There is massive pressure on both Beijing and on local governments — from both employees and from competitor businesses — to make sure American companies are abiding by all of China’s laws, including all of its employment laws. If Trump’s next round of tariffs goes into effect, this pressure will only increase.

5. China’s employment laws and rules just keep getting more complicated, more pro-employee, and more localized. See China Employment Law: Local and Not So Simple.

An HR audit can range from just reviewing documents off-site to having a bilingual Chinese-English employment attorney go to your facility(ies) for an on-site document review and to interview key personnel. Employer audits begin with a document-based review and nearly always continue with revising (and/or creating brand new) company employment documents and contracts and meeting with Chinese government officials to remedy problems found.
What sorts of foreign companies should undergo such an audit and how often? Pretty much any foreign company with employees and once a year is typical. By any foreign company, I mean to include WFOEs, Rep Offices and Joint Ventures. Rep Offices and Joint Ventures? Absolutely. If anything, an audit for these sorts of China entities is more important than for a WFOE.

Let me explain.

An American company has set up a representative office in China. The American company and the rep office then rely heavily on a third party labor dispatch agency such as FESCO or CIIC to employ and manage the employees. This makes sense, since the Rep Office cannot directly employ anyone in China. In this sort of labor agency arrangement, the labor agency is the employer of record and it is the one on the hook for all employment law violations. This, however, does not mean the American company/Rep Office need not be concerned about whether their HR program is in good shape or whether what the labor dispatch agency does is adequate. If anything, our employer audits usually find more problems with third party hiring agencies than with WFOEs. And when you think about it, this should not be all that surprising.

The problem with third party hiring agencies is that they care way more about their own company than about your company. Their goal is to protect themselves, not you. Do their employment contracts include provisions requiring “their” employees  not reveal your trade secrets? Do their employment contracts include provisions preventing “their” employees from going off and competing against you the day after they quit working for your company or get fired? Unless you make sure their employment contracts include such provisions they almost certainly do not. And unless you make sure every new/subsequent employment contract includes such provisions they almost certainly will not.

Another big problem we see with third party agency employment contracts is that they are rarely kept up to date. The problem here is that when a foreign company that uses a labor dispatch company changes its terms of employment with all or some or even one of its third party “employees” it seldom communicates this change to the labor dispatch agency. This means the official employment contract between the third party agency and its employee(s) does not get updated.

The same holds true for the rules and regulations used to set out the employee conduct that will be deemed inappropriate and will therefore be punished. If you are using whatever your third party hiring agency has provided you, do the rules and regulations actually make sense for your business? Are those rules and regulations being modified to reflect changes in your business? Has everyone who does work for you signed the right set of rules and regulations? It is not uncommon for us to find situations where third party employees have signed on to rules and regulations for various different foreign companies that use the third party hiring agency — without ever having signed the rules and regulations of the foreign company for whom the employee is actually doing the work.

Next situation. The foreign company has a joint venture in China. The foreign company’s Chinese joint venture partner supplies all the employment documents. Did you review them before they were signed by the Joint Venture employees or did you just assume your Joint Venture partner would take care of all that?

I am going to be blunt here. For two very important reasons, you really should carefully review your Joint Venture employment contracts. The first and most important reason is that your interests and the interests of your China Joint Venture partner are not the same. Your Joint Venture partner has incentive to hire his or her sons and daughters and cousins and nieces and nephews and to do the same with those to whom it owes a financial or moral or social debt.

The second reason is that Chinese companies are not under nearly the same employment law scrutiny as foreign (especially American) companies and so they typically do not take employment issues as seriously as foreign companies (especially American companies) should. And yet, Joint Venture entities (especially those with an American Joint Venture partner and especially those in certain industries) will be viewed by both the various governments in China and by its own employees as being a foreign company.  When our China employment lawyers conduct HR audits of China Joint Venture entities, we nearly always find a lot more problems than with our HR audits of WFOEs.

First off, the employment documents (to the extent there are any and far too often there are not) are in only Chinese and the foreign partner has either never seen them or does not understand them. It is never pleasant having to tell a client whose Joint Venture has never once made a profit that its Joint Venture has 300 employees, not the 200 it believed. Or that 15 of its employees appear to be relatives of the Chinese JV partner and are being paid double what others in the same position in the company are making. Or that all or most of the employees are getting a portion of their salaries in cash so as to reduce required employer social benefit contributions and employer (and employee) taxes. Not only does this mean the JV has unrecorded debt, it also means the American side will face a huge problem if it ever wants to shut down the JV or do some other sort of business in China. This is just the tip of the iceberg in terms of the employment problems Joint Venture HR audits reveal.

Not surprisingly, our China employment lawyers also advocate employer audits as an essential element of the due diligence on any M&A deal. Our employer audits in those situations often find the employment documents of the company to be acquired — especially the employment contracts and the employer rules and regulations — were prepared a long time ago and are now outdated. It is also quite common to see a situation where the acquired company started in one city and then grew to include a number of additional cities and yet its employment contracts and its rules and regulations were never localized to reflect its multi-city reality. Even in the rare instance when the acquired company’s employment documents are in good order, the new employer almost always wants to introduce some changes — perhaps a new bonus program to encourage certain employees from the acquired company to stay on after the deal. An employer audit helps identify what is in place and what makes sense to change.
So as you can see, China employment audits should not be limited to just WFOEs.

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