Recent Trends and Developments in Employee Incentives in China: Focus on Equity Incentives and Year-End Bonuses

Introduction

Employee incentives have long been a critical tool for organisations to motivate and retain talent in China. With the rapid development of China’s labour market and increasing competition for skilled professionals, equity incentives and year-end bonuses have become integral parts of the compensation packages in many companies. However, the judicial treatment of these incentives has evolved, and the legal landscape surrounding them has become increasingly complex. In particular, disputes over equity incentives and year-end bonuses are on the rise, as employees and employers seek to clarify their legal rights and obligations.

This article explores the recent trends and developments in China regarding employee equity incentives and year-end bonuses, with a particular focus on the judicial practices that have emerged in response to these incentives.

Equity incentives for employees in China

Equity incentives typically involve granting employees stock options, restricted stock units (RSUs), or direct equity in the company, often with vesting schedules tied to the employee’s tenure or performance.

While equity incentives are attractive to both employers and employees, they have also led to an increasing number of legal disputes, particularly in cases where employees leave the company or are terminated before the stock vests. In recent years, Chinese courts have had to grapple with the complexities surrounding these disputes, and the classification of these issues – whether they should be considered employment disputes or civil disputes – has been a key point of contention.

The legal classification of equity incentive disputes

In China, the classification of a dispute as an employment dispute or a civil dispute can have a significant impact on the applicable laws, the procedures involved, and the outcome of the case. Generally speaking, employment disputes in China are governed by specific legal protections, such as those provided by the Employment Contract Law, which offers additional safeguards for employees. On the other hand, civil disputes are governed by the Civil Code, which may offer fewer protections for employees.

In terms of equity incentives, Chinese courts have historically been divided on whether these disputes should be classified as employment disputes or civil disputes.

Employers often argue that equity incentives are not part of the standard remuneration and should therefore fall under civil law. They typically present the following arguments:

• Equity incentives are not salary. Unlike regular salaries and bonus, equity incentives are typically granted in the form of stock options or shares, which are not paid in cash and therefore do not constitute a “salary” under Chinese employment law.
• Equity incentives are a form of risk-sharing. Employers argue that these incentives are tied to the success of the company and involve a degree of risk. As a result, they are not mandatory compensation but rather a form of unguaranteed reward, which should be classified as a civil matter.
• The employer in question is not the entity that awarded the equity incentives. Many companies offering equity incentives are based outside of China, and the incentives are awarded by foreign entities. In such cases, the entity in China did not award any equity incentives to the employee, and the court should thus not support any of the employee’s claims relating to equity incentives against the entity in China.

However, recent judicial trends in China indicate that it is more likely for equity incentive disputes to be categorised as employment disputes, particularly when the employee’s claim is closely tied to the employment relationship. Some of the key developments in this area include:

• Beijing’s 2023 Initiative: On 5 May 2023, the Beijing First Intermediate People’s Court held a press conference where it outlined its approach to resolving equity incentive cases. The court emphasised that when an equity incentive is awarded as part of a broader compensation package tied to the employee’s employment relationship, disputes arising from this incentive should generally be treated as employment disputes.
• Supreme People’s Court’s Draft Interpretation (2023): On 12 December 2023, the Supreme People’s Court released a draft interpretation on hearing employment disputes. In this document, the court clarified that when an employer provides equity incentives to an employee as part of the employment contract, disputes regarding the transfer or compensation of such incentives should be treated as employment disputes, with one important exception being issues related to the exercise of the stock itself.

Implications of classification on procedures and outcomes

The classification of equity incentive disputes as employment disputes has important consequences for the procedural aspects of these cases. In China, employment disputes follow a distinct legal procedure, which includes the following steps:

• Employment Arbitration: In China, most employment disputes must first go through a mandatory arbitration process. The employment arbitration procedure is less formal than civil litigation, and it is free of charge for employees. This process allows for a quicker and more cost-effective resolution.
• Court Jurisdiction: If a dispute is classified as an employment dispute, the case will be heard by employment arbitration commissions and then courts’ employment judges, from the first instance court and appellate court, even if the employment contract specifies a foreign venue or jurisdiction. This will make it impossible to enforce foreign law or arbitration clauses that were agreed upon in the contract.

Employment disputes in China are designed to protect employees, who are considered the weaker party in an employment relationship. This means that employees enjoy certain legal advantages, such as lower legal costs and more favourable substantive protections in disputes over compensation or termination.

In contrast, civil disputes may involve more complex procedures, much higher legal costs, and a less favourable outcome for employees. Therefore, employers need to be cautious when structuring their equity incentive plans and should ensure that they clearly define the terms and conditions of these incentives to mitigate the risk of disputes.

Year-end bonuses in China

Year-end bonuses are a common feature of compensation packages in China that can be found in almost all types of companies. These bonuses are typically distributed at the end of the calendar year and are based on company performance, individual performance, or more frequently, both. They serve as a powerful incentive to encourage employees to work hard throughout the year and to remain with the company.

Due to the global economy that has been gloomy over the past few years, year-end bonuses are becoming one of the main sources of legal disputes in recent years. Employees often argue that the bonus is a contractual obligation or a salary that has become customary, and they seek legal recourse when it is denied or reduced.

Judicial trends regarding year-end bonuses

The Supreme People’s Court’s 2022 Guiding Case No 183 provided important guidance on how courts should handle disputes related to year-end bonuses. The case outlined several key factors that courts consider when determining whether an employee is entitled to a bonus, and in the past few years these key factors have been widely acknowledged and used by arbitrators and judges when trying cases.

• Performance Evaluations: Courts will consider the employee’s performance during the year, including any evaluations or reviews conducted by the employer.
• The Employee’s Contribution to the Company: Courts will also look at how much the employee’s efforts contributed to the company’s success.
• The Company’s Financial Situation: If the company is facing financial difficulties, it is more likely to be supported in withholding or reducing bonuses.
• The Standards and Internal Policies Relating to Bonuses: Courts will consider the standards and internal policies that have been adopted by the employer and whether these are reasonable in determining whether the employee is entitled to a bonus. For example, it may not be reasonable for an employer to not pay a bonus solely based on the employee’s departure prior to the payment of the bonus.
• The Company’s Past Practices: If the company has consistently paid bonuses in previous years, a sudden cessation or reduction of the bonus without a clear explanation may be viewed negatively by the courts – employees may have a stronger case for receiving a bonus, even if the employer claims that the bonus is discretionary.
• Employee Behaviour: If an employee has violated company policies, the employer may be justified in withholding or reducing the bonus if the termination of employment is considered lawful.
• The Timing of the Employee’s Departure: If an employee resigns or is dismissed before the bonus is paid, the circumstances surrounding their departure (eg, whether it was voluntary or involuntary) will influence the court’s decision. For example, if the employee resigned before the bonus is paid, then it is more likely for the employer to be supported in withholding or reducing the bonus.

The complexity of the bonus issue

In all cases, employers have the burden to prove that the bonus should not be paid – employers must be able to provide clear documentation and justification for their decisions regarding year-end bonuses, or it will be considered by courts that they have the obligation to pay the bonus. Courts are increasingly holding employers accountable for failing to pay bonuses when there is a clear expectation or established practice of doing so. This sets out strict requirements for employers when managing bonus payment.

In practice, cases are rarely decided based on a single determining factor. Instead, courts typically apply a comprehensive test, considering multiple factors simultaneously. For instance, if bonuses have been consistently paid in previous years, an employer must provide valid justification for any sudden cessation or reduction in the current year. Such justifications may include:

• Although bonuses have been paid consistently in the past, the amounts have varied each year, meaning there is no established obligation to pay a bonus annually when other factors are taken into account.
• The employee’s performance has not met the expectations as agreed upon by the employee and employer.

• The employer’s financial situation does not allow the employer to pay a bonus as provided in the relevant policies.
• The employee has committed gross misconduct in serious violation of internal policies, and under the relevant bonus policies, they are therefore not entitled to receive a bonus.

Conclusion

In conclusion, it is undeniable that Chinese employment law offers greater protection to employees, often placing employers at a disadvantage when it comes to employee management. This holds true for equity incentives and year-end bonuses. The rising number of disputes concerning equity incentives and year-end bonuses underscores the need for companies in China to carefully design their incentive programmes and adhere to established practices to minimise the risks of legal challenges.