China's latest Employment Contract Law, which came into effect on January 1 this year has had broad implications for foreign-invested enterprises on the mainland and unintended consequences for the central government, according to legal practitioners in Hong Kong. The law applies employment standards that are similar to those of the International Labour Organisation and principles that are generally applied or incorporated by European Union legislation. That means much more protection of individual employees' rights and more collective rights with regards to labour unions and associations. While seeking to protect labour rights and prevent the exploitation of migrant workers was a good starting point, the Employment Contract Law had brought about some unintended consequences, Carson Wen, Of Counsel at law firm Jones Day, said. 'I have heard that lawyers in Guangdong are offering their services pro bono, giving free advice to workers who are suing their employers and taking a contingency out of whatever the workers can recover. 'Unfortunately, this means that - along with the impact of the global financial crisis - companies are closing down factories because employers are having to meet sudden legal burdens that they had not made provision for,' he said. 'So the outcome of the new labour law has become rather different from the law that was passed and from the original intentions of the law, which was to help build a more just society.' The new law has ushered in several improvements in employment conditions to benefit employees. It requires a written labour contract to be entered into to establish an employment relationship between employee and employer. Employers must sign this written contract within one month of the start of employment. Failure to do so may result in penalties for the employer. The Employment Contract Law also establishes a non-fixed-term contract system. Employees can still be terminated on the same statutory termination grounds that exist for fixed-term contracts, but because there is no at-will employment, actually proving that the grounds for dismissal exist is difficult in practice. Before the new law, employers allowed short-term, often one-year contracts to expire and did not have to look for termination grounds. The new law essentially says employees can only have one fixed contract. If the employer renews the contract, the employee will be able to claim an open-term contract that will give him or her long-term protection. The new law appears to strengthen the role of trade unions by requiring employers to consult with them in promulgating rules and regulations regarding compensation, wage and hour issues, and benefits. The impact of these changes has been significant. Small and medium-sized enterprises, many of them Hong Kong manufacturing companies with operations in Guangdong, are pointing to increasing labour costs as the main reason why they are having to close operations in China. United States toymaker Hasbro was reported as saying the cost of its toys sourced from Chinese vendors had increased by 15 per cent this year. Some manufacturers said their labour costs had doubled this year though it was not clear if this was because of the new labour law, or a combination of this with new tax rules and higher raw material costs. Most noticeably, in Guangdong, there has been a tripling of labour disputes after the new law became effective, according to Andreas Lauffs, a partner and head of the employment law practice group at Baker & McKenzie. 'That's pretty dramatic. A lot of factory closures are partly related to the new law and some of them apparently with sit-in strikes as a result. This may be hand-in-hand with the fact that the new law pushed to establish labour unions and once the union is running there is added emphasis to do collective bargaining.' Wal-Mart reported that it signed collective bargaining agreements on a two-year basis increasing payroll costs and salaries every year by 8 to 9 per cent over the previous year. The impact of the Employment Contract Law on cross-border transactions is also expected to be significant. All the changes brought in by the law will have a direct impact on existing employees of a target company for an investor buying into that company or buying assets from a Chinese company. A regulation added to the new law that became effective on September 18 has a provision that deals with recognition of service in the case of a transfer of business. The simplest way to interpret the significance of the regulation is to apply it in the case of a factory with two production lines, one of which is sold to another company. Mr Lauffs said in Europe, there was an automatic transfer of business and workers moved with the production plant to the buyer. But in China there was a termination and rehire in the middle of the process so employees could say they did not want to transfer to the buyer. 'In practice, most employees do move to the buyer, but the new law says the buyer must treat those employees as if they had been working with the buyer's company the same number of years they had been at the vendor's company. That could mean the buyer has to give them open-term contracts immediately or pay them severance according to the number of years they were employed at the vendor company,' Mr Lauffs said. 'In some cities and jurisdictions you would have to deal with unfunded pension liabilities. If, for example, you took over an employee and he or she retired you would have to either pay monthly retirement benefits or a lump sum to the local authorities. 'In China, this is a dramatic change of the landscape and it could make acquisitions a lot more expensive potentially.'