“Labor dispatch” is an arrangement under which an employee is hired by an employment agent (i.e., nominal employer) and then dispatched to work for another company (i.e., actual employer). Typically, there would be (i) an employment agreement between the employment agent and the employee and (ii) a business service agreement between the employment agent and the actual employer.

If a multinational company only has a representative office rather than an incorporated subsidiary in China, it can only engage domestic employees through the labor dispatch structure. In addition, any type of company is allowed to use dispatched employees to fulfill temporary, replaceable or auxiliary positions. 

Set forth below is a summary of certain recent judicial decisions concerning labor dispatch, published by Shanghai No.1 Intermediate People’s Court and Shanghai No.2 Intermediate Court, the only two appellate courts in Shanghai. Chinese courts have been publishing their decisions only since July 2013. Although the Chinese courts are not bound by prior decisions, these decisions are helpful in understanding how the Chinese courts review and address issues of this type.

The first and the second cases discuss when the actual employer and the nominal employer will be held jointly and severally liable. The third case stresses the importance to have a non-competition agreement between the actual employer and the dispatched employee. The fourth case highlights the necessity to check the nominal employer’s proper license before engaging it.

Joint and several liability under labor dispatch

Legal rules
The Chinese Employment Contract Law provides that the actual employer can return the employee to the employment agent prior to the end of the term of the dispatch services agreement only where there is a statutory basis for such action. Examples where early return is permitted include the employee’s severe violation of the actual employer’s internal policies or termination of the dispatch service agreement between the employment agent and the actual employer. Similarly, the employment agent can terminate the employee only where there is a statutory ground to do so¹.

The Employment Contract Law further provides that if the employee’s rights and benefits are harmed by the actual employer, the employment agent and the actual employer are jointly and several liable.

Case 1:

• Facts: Mr. A was employed by an employment agency (“Agency B”) and dispatched to work for an actual employer (“Company C”). Mr. A was later returned by Company C to Agency B based on Mr. A’s serious violation of Company C’s internal policies. Agency B then fired Mr. A due to his serious violation of Company C’s internal policies. The employee filed a labor arbitration against Agency B and Company C for illegal termination of his employment². The arbitration committee decided that Agency B’s termination of Mr. A was illegal, but did not find Company C to be jointly and severally liable. Agency B then applied to the court for the revocation of the arbitration award on the ground that Company C should be held jointly and severally liable.
• Issue: The issue is whether Company C should be jointly and severally liable for Agency B’s termination of Mr. A’s employment, if such termination was in violation of the law.
• Judgment: The Shanghai No.2 Intermediate People’s Court held that, if Company C returned Mr. A without a statutory cause, such action was illegal and Company C was jointly and severally liable for Agency B’s illegal termination. However, the arbitration committee did not determine whether Agency B returned Mr. A with a statutory cause, and simply held that Company C was not jointly and severally liable. Hence, the Shanghai No.2 Intermediate People’s Court decided that (i) the arbitration award should be revoked, and (ii) the parties should have their disputes tried in court. 

Case 2:

• Facts: Ms. D was employed by an employment agency (“Agency E”) and dispatched to work for the actual employer (“Company F”). Ms. D was later returned by Company F to Agency E on the grounds that Ms. D had seriously violated Company F’s internal policies by organizing people to block the gate of Company F. After Ms. D was returned, Agency E fired Ms. D on the ground of absenteeism rather than her violation of Company F’s policies. Ms. D filed a labor arbitration against Agency E and Company F, claiming that they should be jointly and severally liable for the illegal termination of her employment. The labor arbitration committee decided that Agency E’s termination was illegal and Company F was jointly and severally liable with Agency E. Company F filed an application to the court for revocation of the arbitration award, arguing that it should not be held jointly and severally liable with Agency E, as Company F’s basis for returning Ms. D was legitimate and had a statutory reason.
• Issue: The issue is whether Company F should be jointly and severally liable for Agency E’s termination of the employment with Ms. D where Agency E’s termination was in violation of law.
• Judgment: Shanghai No. 1 Intermediate People’s Court held that (i) Agency E terminated the employment with Ms. D based on a reason different from that for Company F’s return of Ms. D, and (ii) there was no evidence proving that Company F’s return of Ms. D caused harm to her legal rights and benefits (which seems to imply that the court was of the view that the returning of Ms. D by Company F was legitimate). Therefore, the court held that Company F was not jointly and severally liable and revoked the arbitration award. 

Implications in practices
Many multinational companies, especially those that only have a representative office in China, use labor dispatch to hire employees. Under such a circumstance, once an employee is returned by the actual employer, there may be no one to compensate the employment agent for the costs of the employee. Under such circumstances, it would not be surprising that the employment agent will try to fire the employee as quickly as possible, if it cannot dispatch the employee to work for another company.

There are very strict rules with respect to the termination of employment under Chinese law, i.e. there must be a statutory ground for the termination. If the employment agent does not follow such rules in terminating the employee, the actual employer may be held jointly and severally liable for the wrongful termination.

As reflected in the two cases above, a critical element in deciding whether the actual employer should be jointly and severally liable is whether the actual employer returned the employee with a statutory reason. If the court finds that the actual employer returned the employee with a statutory reason, then the actual employer is not liable even if the employment agent later fires the employee without a statutory reason.

As such, it is very important for the actual employer to have a statutory basis to return the dispatched employee to the employment agent.

Non-competition covenant

Legal rules
The Company Law provides that directors and “high-level management staff,” so long as they are employed, should not engage in any business that competes with their company’s business. The Company Law further provides that high-level management staff includes the general manager, vice general manager, financial manager, board secretary of a listed company and other persons specified in the company’s articles of association. The Company Law does not require an actual non-competition agreement as a pre-condition for a high-level manager’s non-competition covenant.

The Employment Contract Law provides that the details of non-competition obligations are subject to the agreement between the employee and the employer. A non-competition agreement is a pre-condition for a lower-level employee’s non-competition covenant under the Employment Contract Law.

The Company Law and the Employment Contract Law are both silent on whether the non-competition covenant is applicable to a dispatched employee.

Case 3:

• Facts: Mr. G was employed by an employment agency (“Agency H”) and dispatched to work for an actual employer (“Company I”) as Company I’s sales director. The articles of association of Company I did not specify whether the sales director position was a “high-level manager”. There was no non-competition agreement between Mr. G and Company I. While still serving as sales director for Company I, Mr. G set up a company whose business directly competed with Company I, which sued Mr. G for violation of non-competition covenant.
• Issue: The issue is whether Mr. G was allowed to compete with Company I as a dispatched employee.
• Judgment: The trial court held that Mr. G was not subject to any non-competition covenant since (i) Mr. G was not a high-level manager identified in the Chinese Company Law, (ii) the articles of association of Company I did not specify that a sales director was one of the company’s high-level managers, and (iii) there was no non-competition agreement between Mr. G and Company I. As such, Mr. G was not subject to non-competition obligations under either the Company Law or the Employment Contract Law. 
  
  The Shanghai No. 1 Intermediate People’s Court affirmed the trial court’s judgment. 

Implications in practices
The implication is that non-competition covenant may be applicable to dispatched employees, provided that (i) the dispatched employee holds a position of a high-level manager, or (ii) there is a non-competition agreement between the actual employer and the dispatched employee.

Multinational companies should be careful when hiring high-level managers through labor dispatch.  The scope of “high-level managers” in the articles of association may not be broad enough to cover each employee the company wishes to subject to non-competition obligations. In addition, an actual employer typically does not have a non-competition agreement with the dispatched employee, since there is no direct employment relationship with the employee.

When such hiring is unavoidable (e.g. a multinational company only has a representative office in China), it is advisable that a separate non-compete agreement be signed with the employee. Otherwise, it may be difficult to prohibit the employee from competing with the company.

Labor dispatch by unlicensed labor dispatch

Legal rules
The Employment Contract Law stipulates that the employment agent must have a license for the labor dispatch business, and companies cannot hire employees through unlicensed employment agents. However, the law is silent on the consequences of labor dispatch by unlicensed employment agents.

Case 4:

• Facts: Ms. J was employed by an employment agency (“Agency K”) and dispatched to work for an actual employer (“Company L”). However, Agency K did not have a license to engage in the labor dispatch business. Later, Ms. J was returned by Company L without a statutory basis. Company L neither arranged Ms. J to work for another company nor paid salary to her. Ms. J filed for labor arbitration against Company L, claiming that there was a de facto employment between Ms. J and Company L and that Company L should pay (i) compensation for the illegal termination of the de facto employment and (ii) double salary for the period without a written employment contract between them³ .
• Issue: The issue is (i) whether there was a de facto employment between Company L and Ms. J because Agency K was not licensed to operate a labor dispatch business, and, if so, (ii) whether Company L was liable to pay double salary for the period without a written employment agreement.
• Judgment: The labor arbitration committee held that, while Agency K was not licensed to operate a labor dispatch business, a de facto employment agreement between Mr. J and Company L was be deemed to exist, and that L was liable to pay compensation for its illegal termination of the employment. However, the labor arbitration committee did not order Company L to pay double salary for the period without a written employment agreement.
  
  Shanghai No.1 Intermediate People’s Court later affirmed the arbitration award.

Implications in practices
In a legitimate labor dispatch, even if the actual employer returns the employee without a statutory reason, the employee typically cannot file directly for labor arbitration against the actual employer since there is no employment agreement between them. If the employment agent does not fire the employee on the same basis that he/she is returned by the actual employer, it would be difficult for the employee to hold the actual employer jointly and severally liable as well. 

However, if the employment agent does not have a valid license to engage in the labor dispatch business, a de facto employment could be deemed to exist between the employee and the actual employer. Under such a circumstance, the employee could file labor arbitration against the actual employer directly. 

In addition, although the court in the present case found that Company L was not liable for the double salary for the period when there was no written employment agreement with Ms. J, since a de facto employment has already existed, there is some risk the actual employer may be held liable to pay double salary for the period without a written employment agreement.

Therefore, it is important to confirm the existence of a labor dispatch license before entering into any service agreement with an employment agent.

FOOTNOTES
1The statutory reasons for terminating an employment agreement and those for returning a dispatched employee are very similar, requiring that the employment agent (in case of firing the employee) or the actual employer (in case of returning the dispatched employee) prove that the employee is at fault (e.g. severe violation of company policies) or is unable to continue to work (e.g. sickness or incompetency), etc.
2Under Chinese law, any employment dispute must be arbitrated by a local arbitration committee before it may be subject to court review. Courts will not accept any labor dispute complaint if it has not been arbitrated. If the arbitration award has not taken effect, i.e. either party files litigation within 15 days after the receipt of arbitration award, the court will try the case de novo as if there was no arbitration. However, if the arbitration award has already taken effect, i.e. no party files litigation within the aforesaid 15 days, either party may still apply to the court to revoke the arbitration award. Under such a circumstance, the court can only review whether the arbitration committee applied the law correctly or whether the disputes fell within the scope of labor arbitrations, etc. Such review is a limited review.
3According to the Employment Contract Law, if an employer fails to sign a written agreement with an employee within one month after the employee actually starts working for the employer, then the employer is required to pay double salary to the employee for the period without a written employment agreement.