Factory restructuring in China

Dr. Kuang-Hua Lin
Business team looking through the office window, view from the back

Factory restructurings in China can hold numerous nasty surprises in store, even for the most experienced renovator. As closures usually point to extensive arrears, a swift turnaround or sale are typically the best options – although it is not unusual for Chinese employees to sabotage plans.

The starting point of almost every turnaround and renovation project by external consultants is the failure of efforts made by a German parent company to have factories or subsidiaries in China renovated by their own employees. As a result, these kinds of projects are not always easy undertakings. Usually, German factories in China that are to be renovated all have one thing in common: problems do not only lie in the production processes but are rooted much deeper within the entire structure, organization and mentality of the local workforce.

From experience, a major element of all renovation projects is that they were originally shutdown jobs, i.e. the German parent company wanted to close down the subsidiary in China after futile refurbishment attempts. However, on reviewing the books on site, it often turns out that this is not really advisable or feasible. Since it is not uncommon to discover that the company has evaded social-security contributions on a massive scale and – significantly less frequently – also taxes, contributions or taxes have to be paid plus default interest in the case of a closure. In China, default interest amount to 0.05% per day, which when calculated on a yearly basis corresponds to a whopping 20%. Unfortunately, this case is not uncommon – despite annual auditing by chartered accountants who had certified above-board accounting at all times. Understandably enough, not all German parent companies are able to raise this sum immediately, and definitely not when factories have already existed for more than 10 years. For example, cases have already arisen where the social-security contributions owed plus default interest have amounted to more than €1 million or even €10 million.

Failure to pay duties

At the beginning of a project, companies invariably believe that their subsidiaries in China have always paid all taxes and social-security contributions accurately. During subsequent local reviews, however, there has so far never been a case where a factory had indeed paid all duties correctly. Although income tax and social-security contributions for monthly wages and salaries are normally calculated and paid precisely, this is often not the case for overtime allowances and premiums or indeed for annual bonuses and special payments. In particular, as regards cash or gift-card presents to employees for the Chinese New Year and diverse non-cash benefits, income tax is seldom paid, let alone social-security contributions. Non-cash benefits, such as allowances for flats, food or cars are actually only tax-free for foreigners. For Chinese employees, such expenses are non-cash benefits and are subject not only to income tax but also to full social-security contributions.

Perhaps most surprising of all, even to experienced company restructuring experts, is the fact that employees of Chinese subsidiaries are often not interested in a rehabilitation of the company and thus in continued employment, the reason for this being the Chinese insolvency law. It stipulates that outstanding salaries as well as the statutory redundancy compensation for employees must be paid as a first priority, even before paying taxes to the tax authorities. Combined with the fact that employees trained in German companies are everywhere in China, and above all working for Chinese competitors, greeted with a kiss on the hand, employees are rarely prepared to make concessions.

Employees are hoping for severance payments

There are also several cases where Chinese employees have actively tried to give a final fatal blow to the weakened company by pushing them into bankruptcy in order to obtain the statutory redundancy compensation. Starting from sabotaging machinery, products and manufacture via destruction, theft or resale of company property and confidential information right up to an organized conspiracy of the entire sales force of no longer accepting any orders. For instance, such disloyal acts culminated in the behaviour of a Chinese finance manager who had secretly stopped all payments to the suppliers, including the rent for the factory hall. All reminders from suppliers and landlords were concealed. Even in the monthly financial reports and the liquidity statement, the suspension of payments was kept secret thus ultimately leading to a judicial eviction note due to the outstanding rental payments. The suspended payments resulted in liquid funds sufficient for the statutory redundancy compensations for all employees, in said case the value of at least one annual salary, since the majority of the employees had been employed with the company for more than ten years. During working hours, even in the presence of the unsuspecting German managing director, the employees openly discussed what they would do with the statutory redundancy compensations.

If, in the scope of a restructuring process, employees are not prepared to make concessions, this often results in the dismissal of some employees. The Chinese labour law and the jurisdiction of many labour courts in China, however, make this so-called downsizing extremely expensive and very difficult to enforce. Very often employees showing the worst performance will be long-standing employees because they are not able to obtain such high wages and salaries in other companies. As a result, their dismissals are extremely expensive as, for each year of service, a monthly salary must be paid as statutory redundancy compensation.

Difficulties in the event of redundancies

Furthermore, it is often very difficult to motivate employees showing below-average performance towards more productivity. Since almost all German factories in China pay hourly rates (as opposed to Chinese factories that almost exclusively pay piecework rates), employees are not interested in working more efficiently. In principle, overtime pay is always substantially higher than the performance-related bonus offered. A subsequent changeover from hourly rates to piecework rates requires the approval of the employees and is only rarely enforceable in practise.

If an employer wants to dismiss employees in China due to poor performance the employer first has to prove the poor performance, for example via a formal and well documented evaluation. The employer is furthermore obliged to give the employee a second chance, either via training or a transfer. And only if performance is still poor afterwards the employee may be dismissed. In practise, the problem is how frequently employees may be assessed. Various labour courts have already ruled that an additionally introduced assessment is invalid, i.e. the employees concerned may only be assessed by their superiors exactly as often as all other employees – thus generally once per year.

To dismiss employees for disciplinary reasons is even more difficult. In addition to irrefutable proof of the misconduct, labour courts in China also demand proof:

  • that such a disciplinary regulation can actually be found in the employee handbook.
  • that the handbook was actually published and known to each employee (to be proven by photos of the postings on the noticeboard as well as examination results on the contents of the handbook from all employees).
  • that the handbook was adopted democratically (by signed minutes of the general assembly from the year when the handbook was adopted).

Since, in China, a factory restructuring must often be carried out against the will of the employees, and Chinese employees are normally covering up for each other where misconduct is concerned, the renovator can unfortunately not hope for an honest cooperation of the workforce. This means that a successful restructuring in China almost always requires an entire consultancy team. As a rule, the renovator does not only assume the role of the management but also sends specialists as “watchdogs” to the local factory who are to “support” the finance and HR manager as well as the purchasing director and production manager. Simply put, this means: a 4- to 5-head team including conscientious and reliable Chinese employees is imperative for each successful restructuring in China. This team strength is also necessary for one’s own safety as it has definitely already happened that renovators were physically threatened by factory workers.

Restructuring as a joint venture

When the consultant assigned with the restructuring project starts his job, an immediate public address to all employees is advisable. On the one hand, the objective of the restructuring measure and the entire restructuring team is presented and all questions answered, in order to prevent possible rumours from the beginning. On the other hand, the attempt should already be made at this point to motivate the entire workforce to cooperate with the restructuring. As a rule, it is possible to reach one to two thirds of the employees by this approach who will then collaborate with the restructuring team more or less constructively. It is also advisable to publish an e-mail address and a telephone number for all upcoming complaints and questions during this assembly to provide the employees with the possibility to ask questions anonymously or be able to report any misconduct observed. This has proved a very useful tool to obtain constructive hints.

Even if dismissals are difficult in China, nevertheless, every possibility should be used that the law and the existing employee handbook allows. This requires excellent lawyers specialised in labour law who are extremely knowledgeable with regard to local jurisdiction of the labour courts and know what is feasible and what not.

Do not leave any scope for interpretation

Since Chinese employees often only pretend to collaborate cooperatively, all instructions must not only be given in writing but also in a very detailed way. Otherwise, employees will take advantage of the ambiguity of the instructions and act stupid. For instance, in one project there were concrete indications of corruption where the entire finance department was involved. In order to secure evidence until the financial auditors arrived the project leader had decreed to replace the lock of the finance department. The factory locksmith did in fact exchange the lock immediately, however, during the following night all evidence from the room of the finance department was destroyed. It subsequently appeared that the locksmith had not built in a new lock but had exchanged the lock from the finance department only with an old lock from the storage room. During the ensuing hearing, he acted stupid and said that it had not been requested to build in a newly purchased lock.

Even if it does not happen often, people opposing restructuring measures are sometimes well organised and almost act like organized criminals. Thus, once there was a case where the head of a restructuring project arrived late at night unexpectedly at the plant and had to find out that somebody was copying customer records and drawings. However, this person was warned by an accomplice who had been on guard outside and was thus able to flee in time. Afterwards, the police found out that both the surveillance video and the access data – it was only possible to open the door via a fingerprint scanner – had been completely deleted.

Despite all difficulties during a company restructuring process, normally a significant improvement of results can be seen after six months and this not only by cost-cutting but also by a sales increase. This can only be realised through a close collaboration of a well-coordinated team of specialists. A restructuring with only one lone warrior such as an interim manager has hardly any chances of success in China. Due to the ever-increasing wages in China, at present the demand from German medium-sized businesses increases to shut down local factories or to relocate the factory location which is equivalent to a shutdown and new founding. As an alternative to closing down a factory, a restructuring or a sale are both options worth considering – and both should be seriously taken into contemplated prior to any closing application.

Dieser Beitrag ist erschienen in:

Asia Bridge, 06:2017

Original title: Störenfriede nicht unterschätzen

Image source: @ Dragonimages – fotolia.de

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