How SOEs use employee co-investment mechanism

Under the call of the State-owned Assets Supervision and Administration Commission of the State Council to deepen the reform of state-owned enterprises (SOEs), a growing number of SOEs have in recent years begun to implement the co-investment mechanism for employees. This article analyses the legal risks that may arise from the mechanism according to the Labour Law, and offers compliance suggestions.

Risks under the Labour Law

Wage deduction. SOEs implementing an employee co-investment mechanism often mandate employees to contribute a portion of their post-tax performance bonuses as co-investment capital. In cases where employees do not voluntarily contribute, the company may directly deduct from their basic salary, which is likely to be identified as a “malicious wage deduction” or “bonus deduction”.

According to the Labour Law and the Labour Contract Law of China, employers shall not deduct employee wages and compensation in any form. On the one hand, performance bonuses disbursed to employees are, in principle, already part of their legitimate income and there is no legal basis to mandate employees to return part of their income. On the other hand, directly deducting the basic salary of an employee who does not voluntarily co-invest can also be identified as a wage deduction.

Therefore, SOEs are advised to place conditions on bonus distribution, specifying the co-investment principal as a bonus subject to conditions, which will be paid to employees only when the conditions are fulfilled.

Unlawful dismissal. SOEs often regard the behaviour of employees who refuse to take part in co-investment as a serious violation of the company’s rules, and deal with it according to relevant laws and rules.

The Labour Law and the Labour Contract Law stipulate that the employer enjoys autonomy in management, can set rules and regulations as the employee’s code of conduct through democratic publicity procedures, and can unilaterally dismiss employees who commit a serious violation.

However, as current judicial practice in labour disputes still tends to protect the employees’ rights and interests, it would be hard to exclude the risk of committing unlawful dismissal if an employee is punished or unilaterally dismissed.

Return of investment on dismission. Currently, publicly available and effective judgments on labour disputes arising from the mandatory co-investment mechanism in SOEs are very limited. Some courts have held that a co-investment agreement is based on the labour relationship and that the investment should be returned after the relationship is dissolved. But some courts have also paid attention to the company’s evidence and have mostly approved employees’ claims for wages or bonuses due to insufficient evidence.

In Beijing Longzhiyi Investment v Zhang Tianhai (2017), the employee left the company and requested the return of the investment. The court ruled that the project co-investment agreement involved constraints on Zhang Tianhai as a party to the labour relationship. Therefore, its formation was based on the labour relationship, and if the labour relationship was terminated, the company should return the investment.

In Zhongji Investment v Zhao Wei (2018), the company’s debt collection was overdue and the court supported its resulting suspension of the monthly performance bonus, and the employee’s claim that the company had deducted wages. The company provided the Remuneration Management System, the Investment Accountability Management Measures and the labourer’s performance appraisal form in a democratic process. The court held that there was nothing wrong with the company’s payment of wages and non-payment of year-end bonuses.

In the two cases regarding a Chongqing non-performing assets project and a Guangdong property project, the company either pegged commission to the project recovery or set aside part of the year-end bonus as project investment income. The courts all decided that the company’s evidence was insufficient and therefore supported the employees’ claim for wages.

If an SOE requests its employees to not withdraw from the co-investment project when they leave the company, and decides whether to pay bonuses and return the investment principal according to the future profitability of the project, given that there is still no consensus in judicial practice, the court may directly conclude that the co-investment agreement is based on the labour relationship and that the company should return the profitability and the principal by the end of the relationship.

In addition, deducting the co-investment principal of employees who leave at fault also poses a high compliance risk. On the one hand, the investment is mandatory based on the labour relationship. On the other hand, even if employees agree not to withdraw from the project after leaving the company, it does not mean the company is entitled to deduct their principal due to their dismission at fault.

Compliance suggestions

Set up deferred conditional bonuses. If the performance bonus has already been disbursed to the employee, there would be a compliance risk to ask the employee to return a portion of it as a co-investment principal. However, if the performance bonus is agreed as a conditional bonus, the related risks can be reduced.

The condition is that the employee must not withdraw from the investment project, and only if the project achieves an agreed profit will the bonus be paid at the agreed percentage. Meanwhile, the bonus will be deferred after the employee leaves the company, contingent on project progress. Until the exit or end of the project, the employee cannot withdraw, otherwise, the company may withhold the bonus.

Strictly implement democratic disclosure procedures. To hedge risks in the event of project deficit resulting in deductions from employees’ salaries, bonuses or principal, SOEs need to strictly implement the democratic disclosure procedures of the co-investment mechanism.

After the mechanism is finalised and approved by the labour union and workers’ congress, all employees should sign the confirmation of the mechanism and the paper version of the confirmation should be retained. However, it cannot be ruled out that the confirmation may be invalidated by a court or arbitration commission for violating mandatory legal provisions.

Shaw Zhao is a partner and Mia Wang is an associate at Jingtian & Gongcheng