Economic Compensation for Terminating Foreign Employees' Contracts in China

Whether an employer must pay economic compensation or damages when terminating a foreign employee's contract is one of the most frequently litigated questions in Chinese employment law. The answer depends significantly on where the case is heard, as courts in different regions of China have developed divergent approaches. This article examines the prevailing judicial views across Chinese jurisdictions, with particular focus on Shanghai, whose courts handle the largest volume of foreign employment cases.

The Shanghai Approach: Contract Terms Prevail

Shanghai courts have developed a distinctive approach that treats the foreign employee's individual contract as the primary source of rights and obligations, superseding the Labor Contract Law in most respects. Under this framework, only the five basic labor standards — minimum wage, working hours, rest and vacation, occupational safety, and social insurance — are governed by Chinese statutory law. All other matters, including termination compensation, are determined by the terms of the employment contract.

This approach was affirmed by the Shanghai Higher People's Court in two landmark decisions. In both cases, the court held that where the employment contract does not expressly provide for economic compensation or damages upon termination — or where it explicitly excludes such payments — the employer is not required to pay them. The logic is that foreign employees and their employers have greater contractual freedom to define their relationship, and the court should respect the bargain they have struck.

In one notable case, a foreign employee's contract contained a clause stating that any matters not covered by the contract would be handled in accordance with relevant laws and regulations. The labor arbitration commission initially awarded the employee compensation for wrongful termination. However, the Shanghai First Intermediate Court reversed this decision, finding that the clause was too vague to constitute an agreement to apply Chinese statutory compensation rules. Because the contract did not explicitly provide for termination compensation, none was owed.

Approaches in Other Jurisdictions

Courts in Beijing have taken a somewhat different approach, generally applying the Labor Contract Law's compensation provisions to foreign employees who hold valid work permits, while acknowledging that the maximum five-year contract term means there is no entitlement to an open-term contract. The Beijing courts have not adopted the Shanghai approach of deferring entirely to the contract terms.

Guangdong courts have been more closely aligned with Beijing, applying the statutory compensation framework while recognizing that the fixed-term nature of foreign employment contracts may affect the calculation. Courts in this jurisdiction have generally held that foreign employees with valid work permits are entitled to statutory economic compensation upon termination, unless their contract explicitly excludes it.

This lack of uniformity across jurisdictions creates uncertainty for both employers and foreign employees. Employers with operations in multiple Chinese cities should carefully review their foreign employee contracts and ensure consistency with the local judicial approach.

Practical Recommendations for Employers

Given the divergence in judicial approaches, employers should consider the following steps: first, ensure all foreign employee contracts are reviewed by local counsel familiar with the prevailing judicial view in the relevant jurisdiction. Second, consider including an explicit clause addressing termination compensation to eliminate ambiguity. In Shanghai, a clause stating that no economic compensation is payable upon termination will likely be enforced; in other jurisdictions, such clauses may be subject to closer scrutiny. Third, maintain clear documentation of performance issues if termination for cause may be necessary, as statutory protections against wrongful termination apply to foreign employees with valid work permits.

For foreign employees, understanding the compensation terms in their contract is equally important. Before signing, request clarification on whether the contract provides for economic compensation upon termination without cause. If the contract is silent on this point and the employment is in Shanghai, the employer likely has no obligation to pay — a significant departure from the protections available to Chinese employees under the Labor Contract Law.

The Role of Work Permits

Across all jurisdictions, one consistent principle is that a foreign employee without a valid work permit cannot claim economic compensation upon termination. Courts uniformly hold that employment without a valid permit is illegal and therefore not protected by the Labor Contract Law. Employers and employees should prioritize obtaining the work permit before the employee commences work, as even a short period of unpermitted work can affect the legal characterization of the relationship and the availability of statutory protections.