Anti-abuse rules against entities avoiding employer responsibilities through ambiguous and complex structures

Sometimes, companies try to evade legal responsibility as employers through complex employment structures. Interpretation II stipulates that when project owners subcontract/assign their business to entities without legal business qualifications, or when an entity without the corresponding qualifications conducts business activities externally through "affiliation" with a unit with legal business qualifications, the contractor/affiliated entity with legal business qualification will be legally recognized as the entity bearing the main responsibility as employer. This clarification aims to afford employees with a better protection of their rights in seeking payment of salaries and social insurance benefits because the responsibility for such claims will be borne by entities with legal status and (hopefully) sufficient financial means to honour such commitments.

In cases of so-called "group employment" or "affiliated company employment" (i.e. employment models where within a group of affiliated companies’ staff is transferred across different entities/units), it is often difficult to determine which particular entity is the “true” employer. Interpretation II provides that in determining the true employer, priority shall be given to the entity who signed the labour contract. If no written contract exists, the overall management behaviour and other comprehensive factors shall be considered. Specifically, one shall not only focus on formal aspects such as which entity pays salary and social security but also on actual factors such as which entity manages the staff, allocates work tasks, controls working hours, conducts performance evaluations, etc. and in such case the affiliated entities jointly are liable for salary payment and insurance benefits. This rule aims to better protect employees subject to business outsourcing models involving low-cost models and questionable third parties and is aimed to steer companies to simplify structures they may have set up to evade legal liability through untransparent structures.

Situations qualifying as “two consecutive fixed-term labour contracts” entitling employees to open-term labour contracts

PRC labour laws provide that in certain cases employees are entitled to ask for an open-term contract. Among others, employees are entitled to request an open-term contract after two consecutive fixed-term labour contracts with the same employer. 

Interpretation II provides that any of the following situations shall be considered as "consecutive conclusion of two fixed-term labour contracts":

• The parties agreed to extend the term of the first labour contract for at least one more year and such extension period has expired.

• The labour contract stipulates that the contract automatically renews upon the expiration of the first term for another fixed term and such second fixed term has expired.

• The employee “for reasons not attributable to himself” continues to work at his original workplace or job position after the first term of the contract expires and the employer merely changes the contracting entity of the (new) labour contract but continues to exercise labour management over the employee and the contract term expires. 

This addresses a scenario where the employee continues working in the same position/location after his contract has expired, even though the employer has changed the formal "party" (such as the company or organization) responsible for the contract, but the initial employer continues to manage the worker as before. In such cases, the court may treat this as a continuation of the same employment relationship and recognize it as meeting the conditions for signing two fixed-term contracts in a row, provided the continued performance at the same workplace/position with a new contract party did not stem from a voluntary decision of the employee himself. 

• After the expiration of the first contract, a new labour contract is signed by engaging in other actions that violate the principle of good faith to avoid obligations, and the contract term expires.

This refers to a situation where the employer signs a new labour contract under circumstances that violate good faith principles after the initial contract expires. Despite these circumstances, the contract is still recognized as having expired and requires legal consideration.

In essence, the last two bullet points focus on identifying situations where employers may try to circumvent labour laws by changing the structure of contracts or manipulating conditions, and the courts should still recognize the contracts as consecutive fixed-term contracts under those conditions.

Also, where, after the expiration of a given labour contract, the employee continues to work for his employer and the employer does not raise any objections against such continued performance for more than one month after the previous contract expired, the employee is entitled to a renewed labour contract under the terms of the expired contract. If at this point in time circumstances warranting the conclusion of an open-term labour contract exist, the renewed contract shall be entered into for an open-term if so requested by the employee. Should the employer rather choose to terminate the labour contract, this will subject the employer to bear liability for termination of a labour contract according to law (e.g. make severance payment if so required by law).

Consequences of failure to enter into written labour contracts

Under Chinese labour laws, not entering into a written labour contract with an employee carries serious legal and financial consequences for employers. An employer must sign a written labour contract within one month from the employee’s first day of work.

If the employer fails to sign a written contract within more than one month but less than one year, the employee is entitled to claim double his monthly wage for each full month worked without a written contract, starting from the second month. Interpretation II specifies that for a period of less than one month, the payment shall be calculated according to the employee’s actual working days in that month.  However, the employer is exempt from liability for double wage payment if it can prove any of the following circumstances:

• The labour contract could not be concluded in a timely manner due to force majeure.

• The failure to conclude the labour contract is attributable to the employee's own fault (e.g. refusal to provide necessary information).

• Other circumstances as stipulated in laws and regulations on this subject matter.

If the employer still fails to sign a written contract within one year from the employee’s  work start date, the employee is deemed to have entered into an open-term contract starting from the second year. In this regard, Interpretation II specifies that while the employee is entitled to sign an open-ended labour contract as of such second year, the employee is not entitled to claim double wages for the period as of such second year. The employee however remains entitled to claim double wages from the day following the expiration of one month from his work start date until the day before the expiration of one year from the work start date (so basically up to eleven months of a double wage claim).

Interpretation II further provides that where the term of a labour contract expires under any of the following circumstances and the court determines that the term of the labour contract automatically renewed/extended by operation of law, this situation shall not be regarded as a “failure to conclude a written labour contract”:

• The employer terminated the labour contract despite the terminated employee being under statutory protection against dismissal pursuant to Art. 42 Labour Contract Law (which lists situations such as medical treatment, occupational hazards/disease, maternity, other legally protected conditions). 

• The initial term of the labour contract expired but has been automatically extended 

in accordance with Art. 17 Labour Contract Law Implementing Regulations (extension until the agreed end of the service period after specific technical training under Art. 22 Labour Contract Law).

• The labour relationship is extended in accordance with Art. 19 Trade Union Law under the framework of a valid collective bargaining agreement. 

Clarifications for cases of breach of service period and non-compete agreements

Breach of Service Period: If the parties to a labour contract agreed on a minimum service period for the employee (e.g. following specialized training) and the employee breaches such obligation, PRC labour laws allow the employer to claim compensation for the resulting losses. Such labour contracts or training agreements often stipulate formulas for calculating such compensation. Interpretation II provides that courts shall not rigidly enforce such agreed formulas but comprehensively consider all actual losses of employers, such as the training expenses, housing subsidies, travel costs, the length of service that the employee has fulfilled and other special benefits granted to the employee. The compensation amount shall be proportionately adjusted based on factors such as the degree of fault of both parties regarding the employee's resignation. 

Validity of Non-compete Agreements: Under PRC labour laws non-compete obligations can only be imposed on employees having knowledge of and access to employers’ trade secrets and/or confidential information relating to intellectual property rights. Thus, in case of dispute, employers bear the burden of proof to demonstrate that the obliged employees did in fact have such knowledge/access during their employment period. If employers fail in such demonstration, the non-compete agreement is not binding on the employees. Additionally, when assessing the validity of non-compete agreements, court will put the substance scope, geographical area and duration of the non-compete restrictions into relation to the nature and scope of trade secrets and other protected information that the employee had access to. If a court finds that certain parts of the non-compete restrictions are incompatible with the trade secrets the employee had access to and thus the non-compete restrictions exceed the necessary scope for protecting the trade secrets, courts may determine such parts of the non-compete agreement invalid. Thus, employers are compelled to tailor the scope, geographical location and duration of non-compete restrictions based to the nature of the employee's position, job description and trade secrets he has access to because if excessive in nature/scope, the validity of the non-compete agreement can be challenged.

Procedural aspects regarding labour termination / labour disputes

A labour contract cannot continue to be performed: If an employer terminates a labour contract without being entitled to do so, PRC labour laws provide that employees can either claim for double severance payment or for reinstatement of the labour relationship if it is possible to continue to perform the labour relationship. Regarding the latter, Interpretation II provides that in the following cases, a labour contract cannot continue to be performed (thus making the reinstatement claim mute and compelling the employer to pay double severance):

• The labour contract expires during the labour dispute process and there are no legal requirements that mandate a renewal or extension of the labour contract.

• The employee has begun to enjoy the basic old-age insurance benefits according to law.

• The employer has undergone bankruptcy liquidation, had its business license revoked, been ordered to close down, been dissolved, or has decided to liquidate voluntarily.

• The employee has already been employed by another employer and the new labour relationship seriously affects the continued performance of the original labour relationship or the employee refuses to terminate the labour contract with the new employer. 

• Other circumstances exist make it objectively impossible to restore the labour relationship.

Salary calculation during the period until resumption of contract performance: If the employer is ordered to resume the performance of a labour contract with an employee, the employee's salary during the period from the termination date until the date of work resumption shall generally be calculated based on the normal labour wage standard of the employee (i.e. including base pay and fixed allowances but excluding performance-based salary/bonus, overtime pay and year-end bonuses). However, if the employee contributed to his dismissal and only the employer's dismissal procedure does not comply with the law, the court may, based on the degree of the employee's fault, proportionally reduce the wages that the employer should make up for.

Off-boarding occupational health examination: For employees engaged in operations with occupational disease hazards, conducting pre-departure occupational health examinations is a legal prerequisite for employers to dismiss such employees. If an employer terminates a labour contract without conducting a pre-departure occupational health examination for the employee as required, the employee has the right to request the continuation of the labour contract unless any of the following circumstances can be proven by the employer to exist:

• the pre-departure occupational health examination is completed before the conclusion of the first-instance court hearing, and the examination results show that the employee has no (suspected) occupational disease. 

• The employee refuses to undergo the pre-departure occupational health examination without a valid reason.

Defense of statute of limitation: In legal terms, "statute of limitation" refers to the maximum time within which a party can initiate legal action, such as a labour arbitration claim. If the time limit expires, the party may be barred from pursuing their case. In this regard, Interpretation II provides the following clarifications:

• No Raising the Defense During Arbitration: If a party did not raise the statute of limitations defense during the arbitration process (because of their own reasons), it cannot later use this defense during the litigation process (whether during the first or second instance of litigation). The court will not accept this defense in such cases.

• New Evidence: If the party has new evidence showing that the statute of limitations has indeed expired for the other party’s claim, the court will support this defense even during the litigation process.

• Failure to Raise the Defense in the Proper Time: If a party fails to raise the statute of limitations defense in arbitration or during the early stages of litigation, it cannot later seek a retrial or raise the statute of limitations defense during a retrial. The court will not entertain this defense in such cases.

This clarification encourages parties to raise relevant defenses (like the statute of limitation) in a timely manner during arbitration or earlier litigation stages. This rule prevents parties from using the statute of limitation defense as an afterthought if they failed to address it at the appropriate time.

Cases involving foreign nationals or entities

Foreigners asking for confirmation of their employment relationship: Interpretation II stipulates that foreigners employed in China by local employers are entitles to request courts to confirm the existence of their local employment relationship in the following cases:

• The foreigner obtained Chinese permanent residence status (aka Greencard).

• The foreigner obtained a Chinese work permit and resides legally in China.

• The foreigner has otherwise gone through the relevant legal procedures to work/reside in China.

Labor disputes involving foreign representative offices (FROs): According to Chinese law, FROs do not hold independent legal person status and are not entitled to directly hire Chinese nationals as employees. Rather, FROs must enter into labour dispatch agreements with qualified PRC human resources agencies to hire such Chinese staff through a three-party arrangement where the Chinese staff enters into the labour contract with the qualified agency and the agency in turn enters into a labour dispatch agreement with the FRO (or its foreign parent company). This arrangement has it made debatable how to involve the FRO/its foreign parent company in case of labour disputes involving dispatched staff. Interpretation II now confirms that legally established FROs may be parties to labour dispute cases and that in case any party to such cases applies for the participation of the foreign parent of the FRO to the lawsuit, the courts shall support such requests.

Opting out of mandatory social insurance is illegal 

According to PRC labour and social insurance laws, both employers and employees are obliged to participate in the mandatory basic social insurance in China. 

Any agreement between the parties to a labour contract, or any undertaking by the employee, waiving the employer’s obligation to pay social insurance contributions is invalid. 

If an employer fails to pay mandatory social insurance, the employee may terminate the labour contract for that reason and the employer must pay the statutory severance payment to the employee. 

If under any of these above circumstances the employer makes up the social insurance payments in accordance with the law, he is entitled to recover from the employee the employee portion of contributions.

Susanne Rademacher
Dr Jenna Wang-Metzner
Kelly Tang

1. Data Security & Cross-Border Data Transfers

China’s data regulation regime remains a top concern.

Laws Involved:

• Personal Information Protection Law (PIPL)
• Data Security Law (DSL)
• Cybersecurity Law
• Cross-Border Data Transfer Assessment Measures

Issues for FIEs:

• Whether their operations involve "important data" or large volumes of personal data that must undergo security assessments before export.
• Mandatory localization of certain data.
• Uncertainty around Standard Contract Clauses vs. government-led security assessments.

To-Do’s for FIEs:

• Assess compliance with the PIPL, DSL and Cybersecurity Law.
• Ensure data localization for sensitive or important data, including personal information and key business data.
• Conduct cross-border data transfer assessments and consider Standard Contract Clauses or government reviews.
• Review data-related contracts for data processing and privacy policies aligned with Chinese regulations.

2. National Security Reviews & Anti-Espionage Law

National Security Review Mechanism has been expanding in scope, especially for:

• Investments in sensitive sectors like semiconductors, defence, biotech, energy, and AI.
• Acquisitions of Chinese companies by foreign firms.
• Anti-Espionage Law (revised 2023) now includes broader definitions (e.g., data theft), impacting due diligence, audits, and market intelligence work by FIEs.

To-Do’s for FIEs:

• Review investment in sensitive sectors (e.g., tech, AI, semiconductors, defence).
• Evaluate acquisition targets for national security review risks and submit for approval when necessary.
• Train staff on espionage laws, particularly those handling proprietary data or conducting market intelligence.
• Ensure compliance with China’s Anti-Espionage Law; check protocols for sensitive information handling.

3. Corporate Governance & Compliance Under the Revised Company Law 

The amended Company Law impacts both domestic and foreign-invested entities:

• Capital Contribution Rules: Paid-in capital must be contributed within 5 years, not the open-ended terms allowed before.
• Increased Director Duties: Enhanced obligations on directors and supervisors for corporate misconduct.
• Stronger Compliance Culture: Regulatory expectations for internal compliance systems are increasing, especially in listed companies and FIEs in regulated industries.

To-Do’s for FIEs:

• Update company articles of association to reflect the latest Company Law revision, particularly around capital contributions, director duties, and supervisor roles.
• Enhance internal compliance systems for ensuring corporate governance practices meet legal standards.
• Establish and monitor an effective system for director responsibilities and liabilities under the new laws.

4. ESG, Supply Chain Transparency, and Forced Labor Allegations

Driven partly by Western regulatory pressure (e.g., U.S. Uyghur Forced Labor Prevention Act, EU CSDDD), foreign companies are under pressure to audit and verify supply chains.

China has pushed back, citing sovereignty, but companies need:

• Detailed supply chain due diligence.
• Legal strategies for reconciling Chinese anti-sanctions laws and Western compliance expectations.
• Legal complexity arises when complying with foreign extraterritorial laws might contradict China's Anti-Foreign Sanctions Law.

To-Do’s for FIEs:

• Conduct supply chain audits for forced labour risks, including compliance with the U.S. Uyghur Forced Labor Prevention Act and similar EU regulations.
• Ensure internal systems can track ESG criteria like emissions, human rights, and anti-corruption.
• Assess risk of reputational harm from not meeting global or domestic ESG standards.
• Review supplier contracts and ensure supply chain transparency practices are in place.

5. Foreign Investment Negative List & Encouraged Industries Catalogue

• Although the Negative List has been gradually reduced, some strategic sectors remain restricted or sensitive.
• There’s growing incentive alignment through the Encouraged Industries Catalogue, which offers tax and land policy incentives for investments in western/central China and green technologies.
• Companies must evaluate corporate structure and local partnerships carefully.

To-Do’s for FIEs:

• Ensure compliance with the Foreign Investment Negative List and Encouraged Industries Catalogue.
• Assess potential investments and verify capital structure (e.g., joint ventures, VIEs, wholly foreign-owned enterprises).
• Explore tax incentives and investment opportunities in western/central China or in green tech sectors.

6. Intellectual Property (IP) Protection & Technology Transfer

Enforcement is improving, particularly in IP courts, but:

• Concerns remain about compulsory licensing, local joint venture pressures, and protection of trade secrets.
• Legal scrutiny over non-compete clauses and employee mobility is increasing.

To-Do’s for FIEs:

• Review IP portfolios to ensure it is adequately protected under Chinese IP laws, including trademark, patent, and copyright laws.
• Evaluate risks around tech transfer requirements, especially in joint ventures or local partnerships.
• Strengthen trade secret protection measures for R&D operations in China.
• Stay updated on IP litigation trends in China and enforcement practices in specialized IP courts.

7. Employment Law and Workforce Localization

• Labor disputes are rising, particularly regarding layoffs, contract terminations, and salary adjustments.
• FIEs are being pushed to localize leadership or reduce expat headcounts due to cost and availability reasons.
• Social insurance audits and back payments are becoming more frequent.

To-Do’s for FIEs:

• Review labour contracts and employee handbooks to comply with Chinese labour law, including termination conditions, non-compete clauses, and social insurance.
• Prepare for potential labour disputes by establishing internal dispute resolution procedures.
• Verify social insurance contributions and ensure compliance with local regulations.

8. Exit Barriers & Capital Controls

• Repatriation of profits, dividends, or liquidation proceeds can be delayed due to forex controls.
• Government increasingly monitors suspicious outbound payments under FDI and transfer pricing rules.
• Legal due diligence is critical for structuring exits (e.g., sale vs. asset transfer).

To-Do’s for FIEs:

• Where needed, develop an exit strategy for potential sale, liquidation, or other exit events.
• Review capital controls and profit repatriation procedures to ensure compliance with foreign exchange regulations.
• Consider structure of divestments to minimize regulatory hurdles (asset vs. stock sale, etc.).
• Assess the impact of outbound investment restrictions and foreign exchange controls on your business in general and on any exit plan.

9. Anti-Monopoly Law & Fair Competition Review

China's Anti-Monopoly Bureau (SAMR) is actively reviewing:

• M&A deals involving foreign parties.
• Platform economies and abuses of dominance.
• New focus on fair competition reviews during tendering or market access, especially where foreign companies are bidding against SOEs or domestic champions.

To-Do’s for FIEs:

• Review mergers and acquisitions for potential anti-monopoly issues, especially for deals involving foreign players.
• Conduct fair competition review when participating in government tenders or other market access procedures.
• Evaluate market dominance risks if operating in platform-based businesses or highly regulated sectors.

10. Anti-Money Laundering Law and Disclosure of Beneficial Owners

• With the recent tightening of China's Anti-Money Laundering Law (last revised in 2024), foreign-invested enterprises (FIEs) are also increasingly coming under the scrutiny of regulators.
• A key innovation concerns the obligation to disclose ultimate beneficial owners (UBOs) to financial institutions and potentially also to competent authorities when establishing a company, changing its structure, or conducting certain business transactions.
• The definition of beneficial owner is increasingly aligned with international standards (e.g., FATF), but with local interpretations and implementation requirements.

To-Do’s for FIEs:

• Identify and document the beneficial owners of your Chinese companies in accordance with the current requirements. This includes, for example, natural persons who directly or indirectly exercise control over the company or receive significant economic benefits.
• Review group structures and shareholdings, particularly in complex holding structures, trusts, or cross-border constellations, to meet transparency requirements.
• Ensure compliance with disclosure obligations to banks, authorities, or business registrations, particularly for account openings, corporate actions, or other compliance-relevant events.
• Update internal compliance policies to meet anti-money laundering requirements and train relevant employees on identity verification and reporting requirements.

Susanne Rademacher
Dr Jenna Wang-Metzner