what we think

This article was written for, and first appeared in the March 2011 issue of China Law & Practice, a Euromoney publication.

One of the sections (Chapter 5, Section 2) of the PRC Labor Contract Law that altered China’s employment law landscape from 1 January 2008 onwards for the first time provided strict rules on the dealings of staffing firms. The services of Chinese staffing firms, also referred to as labor agents or by the acronym “FESCO” after the most famous staffing organization in China (see below), continue to be popular among foreign companies in particular, whether out of necessity, convenience or even in some cases ignorance. Two questions need to be revisited from time to time to ensure that companies make the optimum choice in regards to using staffing firms: is using such a company still a good choice? And if so, what best practices can be applied to minimize costs and risks?

Selecting the Right Staffing Firm

Staffing firms are an important and even irreplaceable part of China’s employment landscape. Originating from the time when under socialist principles foreign companies were not sought capable of selecting and employing their own staff, many companies continue to outsource part of or all their human resource functions to these agents. The most common staffing firm is the Foreign Enterprise Service Corporation (FESCO), a semi-state organization with independent branches all over the country including several in big cities such as Shanghai, Beijing and Guangzhou. Another big state-wide organization, albeit with less branches, is China International Intellectech Corporation (CIIC). In addition, an increasing number of private companies including even some foreign-invested companies are permitted to engage in staffing agency services.
A widely held misconception is that all these organizations provide the same level service. Some staffing agents try hard to provide high-quality services to the companies they serve, while others see their role in a more formalistic sense. It is therefore extremely important to choose a firm with a good reputation. Other conditions are flexibility on some of the terms and conditions (see below), and that they have the proper licenses. Many foreign-invested consultancy companies for example offer staffing services but do not have the proper licenses, which brings unnecessary risk to the staffing relationship and to the employees.

Considering Staffing Needs

Representing Offices

Under certain circumstances, there is no way around using a staffing firm. The resident representative office of a foreign company, for example, cannot directly hire Chinese employees in China, and so their employment relationships must be retained through a staffing firm. The staffing firm officially employs those persons selected by the representative office, and these employees are then seconded (dispatched) to the representative office under a staffing- or secondment agreement between the staffing firm and the representative office. To close the triangle, the representative office can (and should!) sign a supplementary agreement directly with the employees to detail certain conditions to their work.

We analyze these relationships in more detail:

a. Rights and obligations between the staffing firm and the employee

The relationship between the staffing firm and the employee is one of employment, but it is different from traditional employment relations because the employment and the actual labor services are separated. As per article 59 of the PRC Labor Contract Law, this employment falls into the category of labor contract relationship, under which the
staffing agent shall assume the obligations as employer according to law.

b. Rights and obligations between the staffing firm and the representative office

The staffing firm and the representative office have a civil contractual relationship, with rights and obligations agreed in the staffing agreement. In terms of actual legal activities, the rights and obligations of respectively the staffing firm and the representative office are effective and binding on these parties. This means that an employee’s right of claim against either the staffing firm or the representative office is
not curtailed by the staffing agreement between these two parties.

c. Rights and obligations between the representative office and the employee

There is no employment relationship between the employee and the representative office, even though the employee provides labor services to the representative office.
According to the Article 62 and 63 of PRC Labor Contract Law, the representative office shall provide safe and healthy working conditions and work protection, equal pay for equal work, benefits appropriate for the job position, a wage not lower than the legal minimum wage standard, etc. In breach, the staffing firm and real employer shall assume joint and several liabilities by law, a responsibility which cannot be mitigated.

Any commitments of the employee to the real employer, on the other hand, should be fixed in writing. To this end, the representative office will often sign a supplementary
agreement with the employee, which deals with work discipline (working hours, reporting etc) and the employee’s obligations on confidentiality, non-compete and nonsolicitation – terms that in a direct employment relationship are usually included in the employment contract. As contractual terms agreed between the parties, these will be binding upon the parties as per the said contract, giving the representative office a legal basis to terminate a secondment based on breach, or to claim against a (former) employee for damages.

Foreign- and Foreign Invested companies

Foreign companies with no office in China also sometimes use staffing firms to avoid the legal prohibitions and impracticalities of hiring in China directly. While not illegal to
work with a foreign company, few legitimate staffing firms are open to such arrangements. The most cited reason is that if the foreign company fails to compensate the staffing firm for expenses (e.g. at termination of an employment contract), it would be difficult and expensive to file a claim for damages.

In some case, providing monetary guarantees to cover any potential costs may be persuasive. Usually however, a foreign company will have to choose either to hire through an informal agent, to hire directly without legal coverage, or to establish a representative office or limited company.

Many Chinese-registered, foreign-invested companies also use staffing firms, but not always in the same way. While some prefer to copy the representative office model to hire staff indirectly, this has clear drawbacks. For example, if an employee is returned to the staffing firm based on a material change of economic circumstances at the real employer, the latter shall still pay remaining wages, social insurance and housing fund for the rest of the term. The reason is that the staffing firm cannot terminate the employee on the economic circumstances of the real employer (as contemplated for direct employment relationships under Article 40.3 of the PRC Labor Contract Law).
More generally, most companies see the benefits of transparency and control to having a direct employment relationship with its employees, but even then, a staffing firm may be useful in two circumstances:

1. Companies that are established in one place but have employees (especially sales people) in other regions, also turn to staffing firms. The law does not restrict companies from sending people to other cities in China to engage in activities such as (after-) sales, liaison and quality control, but a practical challenge is that a company registered in one city cannot pay social insurance premiums for an employee in another city. Thus if a Shanghai company wants to hire a Beijing employee, the latter will have to give up existing benefits in Beijing. One way to resolve this is to establish a branch, but this is subject to further procedures and cost. A more popular alternative is that the company engages a staffing firm to employ the person in the other city (as specifically permitted under Article 61 of the PRC Labor Contract Law), which can then withhold individual income tax, pay social insurance and housing fund contributions. Under the dispatch contract, the employee is seconded to the company, but continues to work in the city where the staffing firm is registered.

2. Even if employees are hired directly, the staffing agent can still be retained for payroll services. Managing payroll, including withholding and contributing individual income tax, social insurance contributions and housing fund payments, can be complicated and time-consuming. Private staffing firms in particular are increasingly focusing on this market. Note that in this context, only certain HR functions are sourced out; the employment relationship remains between the limited company and the employee, with due consequences for control and management.

Negotiate the right terms

If the staffing firm only provides payroll services, negotiations will simply be about price: against what cost can a company outsource this HR function. In the case of representative offices that must work with staffing firms and in those cases where foreign-invested companies use a staffing firm to employ people, getting the best deal is more difficult. In practice it is common that the terms are dictated by the staffing firm. One important reason is that the arrangements with the staffing firm are often portrayed as standardized, which implies there is little for the company to negotiate. Another is that because using a staffing firm is compulsory for representative offices that want to retain Chinese staff, the choices that the representative office has in selecting the staffing firm and structuring the staffing relationship are frequently overseen.

Both reasons are misleading. The principle to a staffing arrangement is clear – the representative office or company should take on the staffing firm’s liabilities towards the employee in accordance with the law. However it is very common to see staffing firms include terms in their standard contract which go beyond this standard to provide additional protection and benefits to the staffing firm. If the staffing firm insists on unreasonable terms, it may be time to select a staffing firm which takes a more reasonable position.

Based on our experience in negotiating staffing agreements, we summarize some of the key points that can sometimes be negotiated:

a. Wages Upon Employee Return

Because the relationship between the enterprise and staffing firm is a civil contract, the staffing agreement is the legal basis for both parties’ rights and obligations. While staffing agreements generally include clear and fair stipulations on the use of the employee, the responsibility for an unexpected return of the employee to the staffing firm is more controversial. Where a company or representative office returns an employee to the staffing firm before expiry of the agreed term based on a material change of circumstance, the staffing firm often asks assumption of liabilities to pay for full wages (and other costs, see below) until expiry of the employment contract between the staffing firm and the employee. In practice however, if the employee is returned on this basis,, the staffing firm will often pay him only the minimum legal salary as wages, and not his previously-agreed salary.

b. Extra compensation

Standard contracts often include a clause on return compensation, which should be calculated according to law, and extra compensation, which is introduced by the staffing firm to cover its own liabilities. In standard contracts, the staffing firm usually demands that if an employee is returned but there is not sufficient legal reason for the staffing firm to terminate his (her) employment contract, then the enterprise shall pay the staffing firm, usually in lump-sum, all the wages, social insurance, housing fund contribution, severance pay, as well as corresponding management fee (due to the staffing firm) that would be due if the employee was not returned. This is unreasonable to the enterprise as it does not take into account a very common situation: that a settlement is reached with the employee on termination or that the employee leaves himself as he does not want to continue working for the staffing firm at minimum wage.

c. Others Matters

Standard agreements include many clauses that have only limited consequences to the enterprise, but could still impact their position in case the relationship with the employee sours. One example is a clause under which an employee, after having signed two fixed-term employment contracts, has the right to an open-ended employment contract, with the dispatch contract between the enterprise and the staffing firm also open-ended. While this reflects a well-known principle of the PRC Labor Contract Law, it also conflicts with Article 58 of the same law, under which a contract with a staffing firm must be a fixed-term contract of at least two years. While it is unclear how this conflict would be resolved in practice, there is no good reason for the enterprise to compromise on this matter to its disadvantage in advance.

Conclusions

When confronting the staffing firm with the above and other issues during negotiations over a dispatch agreement, the principle that an enterprise can fall back upon is that the staffing firm provides a service for which it is paid. Any negative impact from that service – especially as a consequence of the enterprise’s return of the employee before expiry of the term – should be the liability of the real employer, i.e. the enterprise.

However sometimes staffing firms insist on compensation for damages that do not exist, or which can or may be mitigated. Although not always easy, where the damages are unclear or even arguable it is more reasonable to simply make reference to the staffing principle and the law: the enterprise should cover all liabilities due by the staffing firm to the employee as required by law.

This works most effectively if the staffing firm also tries (and if possible, is obligated) to mitigate those damages. One of the reasons that companies turn to a staffing firm is that it should have more knowledge, experience and resources to manage employees and deal with disputes. The enterprise, which after all is the staffing firm’s customer, may reasonably expect that such resources are utilized to resolve problems as effectively as possible and mitigate damages to itself and to its customer (i.e. the enterprise). Including a term to this effect in the dispatch agreement is one option, but more important is to use a staffing firm that agrees with this in principle. A good staffing firm can offer tremendous support in managing staff and HR-related problems, whether in a dispatch relationship (mainly for representative offices) or only as a payroll services provider. On the other hand, depending on a staffing firm that offers poor services, or entering into a disadvantageous agreement, can only cause more problems. In that case, a direct employment relationship is preferred, even if it means replacing the representative office with a wholly-owned subsidiary.