By Yin Juquan, Zhang and Yuanhao. King & Wood Mallesons’ Commercial & Regulatory group.

yin_juquanReduction of an employee’s salary is often a consequence of the employer’s decision to demote the employee for some reason. However, the employer should refrain from meting out a pay cut arbitrarily. Usually, lawful pay cuts occur in two circumstances – when both employer and employee agree on it, or when the employer enforces it by law.

Pay cut agreement between employer and employee

Remuneration is a necessary clause of an employment contract. Article 35 of the Labor Contract Law provides that the terms and conditions of an employment contract may be modified if employer and employee agree so, and any modification must be made in writing. A pay cut derived from consultation and confirmed in writing is of course in accordance with legal requirements.

By nature, successful consultation means that the employee accepts, or has no express objection to, the pay-cut decision. The employer may ask the employee to sign a new payroll or a pay-cut notification, which serves as written evidence of the employee’s consent. For the employer, reaching agreement with the employee on pay cuts is the most effective way to avoid labor-related legal risks.

Employer’s unilateral pay-cut decision

Absent an agreement, what else could the employer do? In fact, the employer may legally slash an employee’s salary in certain circumstances.

1. The employer may downward adjust the employee’s salary pursuant to its internal policies if the latter proves incompetent for his or her job.

The law does not explicitly provide whether the employer has the right to reduce an employee’s wages if he or she cannot perform competently in a changed position. Under Article 40.2 of the Labor Contract Law, however, the employer may terminate the employment contract by giving a 30-day prior written notice or immediately by paying an extra month’s salary, if the employee cannot do his or her job satisfactorily and remains so even after adequate training or adjustment. It is certain that the employer has the right to unilaterally change an incompetent employee’s role. Although it is not clear whether a pay cut is permissible in such a situation, the employer stands the chance of winning support of an arbitral tribunal or a court when a dispute arises,  if it reduces the employee’s salary along with the demotion in line with its internal rules and policies, provided that the reduction is in a reasonable range,

A lawful pay cut on account of incompetence must meet the following requirements:

  • The employee has agreed in the employment contract that the employer may adjust his or her position and reduce remuneration according to internal regulations when the employee is found incompetent;
  • The employer’s policies on salary management, performance assessment, qualification management, etc. established under the law have been openly discussed and publicized, and explicit procedures for performance assessment, position adjustment and pay cuts have been put in place;
  • The employee is actually incompetent for his/her position as shown by results of performance assessment conducted according to the employer’s internal policies;
  • The new job is suitable for the employee’s continued service and is not insulting or punitive;
  • The demotion and reduction of remuneration are within reasonable ranges.

It must be noted that there is no clear provision on “a reasonable range”. In practice, what is “a reasonable range” is at the discretion of arbitrators or judges in a labor dispute. Although employer and employee may agree upon such ranges in the employment contract, a job adjustment may still be illegal when arbitrators or judges deem them unreasonable. While the employer can change the job for an incompetent employee, it still risks breaking applicable laws if the change leads to a reduction of wages. To avoid such risk, the employer had better obtain a written confirmation from the employee of the job adjustment and pay cut.

2. The employer may legally reduce an employee’s salary if he or she violates its policies.

The Labor Contract Law does not provide for pay cuts due to an employee’s misconduct. Under Article 39 of the Labor Contract Law, an employee who severely violates the employer’s rules and policies may receive the highest penalty, i.e., unilateral termination of the employment contract by the employer. But if the violation is not so severe as warrants a dismissal, he or she may be given a demotion or a pay cut by the employer under the employment contract, provided:

  • The employee agrees in the employment contract that the employer has the right to give penalties, including pay cuts, for any violation of the employer’s rules and policies,;
  • The employer’s rules and policies contain explicit provisions on pay cuts, and have been openly discussed and publicized;
  • The employee actually violates the employer’s rules and policies;
  • The demotion and cut pay are within the reasonable ranges.

As with an employee’s incompetence, determination of “reasonable ranges” of demotions and pay cuts rests with arbitrators and judges in a labor dispute.

In conclusion, as there are numerous legal restraints on the reduction of an employee’s salary, the employer must exercise caution when it considers pay cuts for its employees.