The basic rule for foreign companies hiring an employee in China is that you cannot do so unless and until you have a Chinese legal entity (e.g., a WFOE), and violating this rule can (and nearly always does) cause problems. See Doing Business in China with Deportation or Worse Hanging Over Your Head.
What though do you do if you are in the process of forming your WFOE in China? Can you bring on employees during that time to assist with setup and other such things? Surely during this three to five month period it is okay to bring on people and pay them as “employees” and then “convert” them over to legal status employees as soon as the WFOE is formed.
Though nothing in Chinese law allows for “hiring” an “employee” before a WFOE is formed, but none of our Chinese lawyers have heard of anyone getting in trouble for doing this. This is not to say that bringing on workers during the formation phase of your WFOE is not without risks. Everything in China is somewhat local and that is particularly true of anything related to employment. See China Employment Law: Local and Not So Simple.
The biggest risk of bringing on workers during the formation phase of your WFOE probably comes from the workers themselves. If things go well with them, no problem. But things often do not go well with Chinese “employees.” Here is an all too common situation: a foreign company hires a Chinese person to work on the ground before the WFOE comes into existence. This Chinese person does something illegal in China and the foreign company fires the Chinese person. The Chinese person then says: “you cannot fire me because my engagement was illegal and that means you are operating illegally in China and everything I did that you say was illegal was done for the company and so you (the company) were doing illegal things too. I know more about these things because I am the one who was doing them, but if I report what “we” did to the government, I won’t get in trouble for them, you will.”
If the foreign company terminates the employee, that individual will likely file a lawsuit for unlawful termination AND report the foreign company to the Chinese government. The best resolution at this point will usually be to reach a settlement with the “employee,” but because the “employee” has so much leverage in this sort of situation, the company usually has to pay a lot to extricate itself from the rogue “employee.”
Even after the WFOE is formed, the new WFOE is at some risk of one of its pre-WFOE “employees” ratting it out for the pre-WFOE hiring, but that is much rarer. To ameliorate this risk, we advise you give your employees seniority and other credit for any time spent working for your company during its pre-WFOE days.
Not bringing on Chinese employees directly while in the process of forming your China WFOE can be inconvenient but it is the safest route.
