Fixed-term contracts can be a poisoned chalice
The New Ordinance
With Hong Kong's new Companies Ordinance coming into effect in March, businesses are coming to grips with a raft of changes to the way they operate. One of the lesser-known changes effectively prohibits companies from employing executives on fixed-term contracts longer than three years in length, unless they obtain shareholder approval. While that will affect a relatively small number of businesses, it poses a far more fundamental question: are fixed-term appointments in the interest of a company in the first place?
There can be sound commercial reasons for a fixed-term contract. If the executive is a star performer, or the company demands extraordinary stability at the top, then a fixed-term contract is an attractive option. This could particularly be the case for businesses that are looking to demonstrate a long-term commitment to an employee who relocates from abroad.
However, companies must weigh these incentives against the inflexibility they are creating for themselves.
Standard contracts - often referred to as permanent contracts - are a more conventional option for employers. At the executive level, these contracts typically come with extended notice periods of between three and 12 months. While these contracts lack the same guaranteed length of service fixed-term contracts offer, they maintain flexibility if the employee's performance drops or if business priorities change.
If an employer was to build in a notice period of a year, they are essentially affording themselves one-third of the longest possible contract under the new Companies Ordinance, while preserving a greater breadth of employer rights - including the right to terminate employment without significant compensation.
Companies that opt for fixed-term contracts need to know what they are exposing themselves to. If an employee, and in particular an executive, starts to perform below expectations or business needs, the options to deal with the situation are fairly narrow.
Terminating an executive's employment can be a very costly exercise. Depending on the structure of the contract, a company may be required to pay the totality of the fixed-term contract to the dismissed employee. In contrast, a standard agreement requires only the payment of the notice period.
However, it is the non-cash consequences of terminations that can most harm a business. Where an employer chooses to terminate a fixed-term contract before the term expires, the employer will often be in breach of the contract. If that is the case, then the contract may be invalidated - meaning that other protections, such as non-compete clauses and confidentiality provisions, are null and void. This could expose companies to threats such as client poaching, employee headhunting and a loss of control over confidential business information.
If these fixed-term agreements are executed poorly, companies can be putting themselves in a hostage situation without realising it.
As any small business owner will tell you, a contract is only as good as the people on either side of it. While it is possible to contractually tie an employee into staying on for a fixed period, the truth is that if they are unhappy in their position, they will find a way to leave. In the worst situations, this can mean they will actively incentivise their own termination through poor performance and behaviour that damages wider company affairs.
In our experience, fixed-term contracts are sometimes more trouble than they are worth. There are ways to recruit and preserve top-shelf talent without subjecting your company to the inflexibility and potentially expensive exit costs of a fixed-term contract. Employers should consider more positive forms of retention incentives, such as time-limited agreements on relocation, well-defined performance bonuses and structured notice periods - for example, front-loading the beginning of a contract with a longer notice period.
Fixed-term contracts can incentivise an employee's presence, but they don't guarantee outcomes. Companies that opt to use fixed-term contracts need to recognise that an ironclad contract cannot take the place of good management, a strong company culture and recruiting the right people to begin with.
Kathleen Healy is a partner in Freshfield’s expanding Employment, Pensions and Benefits practice in Asia. Based in Hong Kong, she specialises in advising on Asia-Pacific employment and HR projects, and on the multijurisdictional employment aspects of internal investigations.
The information contained in this article should not be relied on as legal advice and should not be regarded as a substitute for detailed advice in individual cases. If advice concerning individual problems or other expert assistance is required, the service of a competent professional adviser should be sought.