The COVID-19 pandemic has presented an unprecedented challenge to the global economy. A lot businesses ran into severe difficulty and even went on the verge of bankruptcy. Those which temporarily survived the economic recession have realized that the pandemic's impact on the economy will remain for long and that to better survive and keep the economy booming in the ever-changing future, they must keep high financial strength against potential financial risk.
To lower down manpower cost, instead of salary cut or arranging employees to await for job assignments, quite a number of employers cut employment directly by terminating employment contracts with employees. When cutting employment, many employers first consult with employees about mutual termination of employment, and then have the employment contracts terminated by entering into mutual separation agreements with the employees, so as to mitigate the legal risk that may be incurred by the employers' unilateral termination. If the consultation failed, employers would have to go to unilateral termination. China's labour and employment legislation has provided limited statutory grounds for employers' unilateral termination, only on which employers are allowed of unilateral termination. In the case where employers need to cut employment due to adjustment of business strategy or organizational structure, etc., "termination based on material change of objective circumstance" under Article 40 Item 3 of the Labour Contract Law and "layoff" under Article 41 of the Labour Contract Law are the only 2 legal grounds to base on for the employers' unilateral termination. This article analyzes and compares these 2 legal grounds in terms of their statutory conditions, complexity and legal risks based on the law and judicial practice in Beijing, China.
I Statutory Conditions
- Termination Based on "Change of Situation"
Article 40 Item 3 of the Labour Contract Law provides that where the objective circumstance relied on which an employment contract was concluded has changed materially, making the continued performance of the employment contract impossible, and, after consultation, the employer and the employee failed to reach an agreement on amending the employment contract, the employer may unilaterally terminate the employment contract. This is how the change of situation principle under the civil law is followed in labour legislation, therefore, such termination is also known as "termination based on change of situation".
- Substantive Conditions
(1) The objective circumstance relied on which an employment contract was concluded has changed so materially that the continued performance of the employment contract has become impossible.
(2) The employer and the employee consulted about amendment of the employment contract but failed to reach an agreement.
- Procedural Conditions
The employer needs to give the employee a 30-day prior notice or one month's salary in lieu of such notice.
- Substantive Conditions
(1) The employees to be laid off are no less than 20, or, if less than 20, account for no less than 10 percent of the employer's total employees.
(2) The employer falls in any of the following circumstances: restructuring pursuant to the Enterprise Bankruptcy Law; the employer's production and/or operation ran into severe trouble; the employer switched production, introduced significant technological innovation or adjusted its business model but still needed to reduce its workforce after amending employment contracts; the objective economic conditions taken as the basis for conclusion of employment contracts have so greatly changed that the original employment contracts become unable to be performed.
- Procedural Conditions
(1) The employer has explained the layoff plan to its labour union or all employees 30 days in advance.
(2) The employer has filed its layoff plan with competent labor authority.
II Comparison of Complexity and Legal Risk
- Number of employees to be laid off is subject to a threshold.
- Layoff is subject to a statutory minimum number of employees to be laid off, which is no less than 20 or, if less than 20, accounts for no less than 10 percent of the employer's total employees.
- Termination based on "change of situation" is not subject to any requirement on the number or percentage of employees terminated.
- Procedural requirements for layoff are harder to reach.
- Termination based on "change of situation" is subject to no other procedural requirements than a 30-day prior written notice to the employee. And the employer who fails to give the 30-day prior notice may terminate the employment contract immediately by giving the employee one month's salary in lieu of such prior notice.
- Layoff, by contrast, is subject to higher procedural requirements. Not only should an employer explain the plan for layoff to its labour union or all of its employees 30 days in advance, but it also has to file such plan with competent labour authority. Take, for example, the requirements of Beijing Human Resources and Social Security Bureau of Chaoyang District on the filing documents for layoff. Employers in Chaoyang District are required to file a layoff plan which should set forth the background information, legal grounds, plan and schedule, and compensation scheme of the layoff project, and opinions from labour union or the general meeting of employees, etc. Should the labour authority consider an employer meets the statutory conditions for layoff, it would issue a "certificate of receipt" to such employer. It should be noted that such certificate of receipt is not of the nature of administrative permit or approval. And in case of labour dispute, labour arbitration committees and courts will still review whether the employer has met all statutory conditions for layoff in substance, but usually, if an employer has obtained such a certificate of receipt for its layoff project, the labour arbitration committee and the court tend to consider such layoff project lawful.
It is also worth noting that in the context of the government's call for reducing or avoiding layoff due to the COVID-19 pandemic, we believe labour authorities will likely to be more prudent in accepting employers' layoff filing and issuing certificate of receipt, therefore, the uncertainty and difficulty for employers to obtain the certificate of receipt will multiply.
Filing layoff plan with the competent labour authority is one of the prerequisite conditions for layoff as required by the law. Should an employer skip the filing procedures or fail to complete the filing procedures due to the competent labour authority's denial of certificate of receipt, in case of labour dispute, the employer will be put at high legal risk of being considered by the labour arbitration committee and the court as having unlawfully terminated employment contracts with the laid-off employees.
iii. In judicial practice, it's more difficult to achieve lawful termination based on material change of objective circumstance.
- The Labour Contract Law doesn't define the "material change of objective circumstance" under Article 40 Item 3 thereof or give any interpretation. Article 261 of the Explanation on Certain Clauses of the Labour Law by the original Ministry of Labour further defines "force majeure", "relocation", "being merged", and "asset transfer" as the "objective circumstances" under Article 40 Item 3 of the Labour Contract Law.
In judicial practice, arbitration committees and courts in Beijing have relatively strict standards on determining whether the objective circumstance has materially changed. In addition to force majeure and employers' relocation, being merged or asset transfer as mentioned above, employers' production halt or switch and restructure, etc. are usually deemed as the material change of objective circumstance under Article 40 Item 3 of the Labour Contract Law2, but it's hardly the case for employers' adjustment of internal organizational structure, merger of departments, or cancellation of positions. If an employer unilaterally terminated employment contract based on any of such circumstances, in case of dispute over the lawfulness of termination, there is high risk that the employer's termination may be deemed illegal.
- Unlike the substantive requirements for termination based on "change of situation", those for layoff are more specific and inclusive, and thus relatively more reachable. Article 41 Paragraph 1 of the Labour Contract Law lists out the 3 circumstances where an employer may lay off employees (i.e. restructuring pursuant to the Enterprise Bankruptcy Law; the employer's production and/or operation ran into severe trouble; the employer switched production, introduced significant technological innovation or adjusted its business model but still needed to reduce its workforce after amending employment contracts) and has those circumstances unable to be exhausted covered by the circumstance where "the objective economic conditions taken as the basis for conclusion of employment contracts have so greatly changed that the original employment contracts become unable to be performed." Under some circumstances, such as years of deficit, although employers can hardly justify their unilateral termination according to Article 40 Item 3 of the Labour Contract Law as analyzed above, they can have employment contracts lawfully terminated by way of layoff, because such circumstances are among the statutory circumstances where layoff is allowed.
In addition, as described above, if an employer has obtained a certificate of receipt from the labour authority for its layoff project, the labour arbitration committee and the court tend to hold the employer has met the substantive conditions for layoff.
- Layoff is subject to retention and recruitment of special employees.
According to Article 41 Item 2 and Item 3 of the Labour Contract Law, when laying off employees, the employer should retain in priority employees who have concluded relatively long fixed-term employment contracts with the employer and who have concluded open-ended employment contracts with the employer, etc. If the employer intends to hire new employees within six months since the layoff, it should notify the laid-off employees and such employees should have priority to be re-hired under the same conditions. Termination based on "change of situation" is not subject to such requirements.
To sum up, termination based on "change of situation" is looser in procedural requirements but much stricter in substantive conditions. In Beijing's judicial practice, it's quite difficult to ensure that employers' adjustment of internal organizational structure, merger of departments, and cancellation of positions, etc. can be considered as material change of objective circumstance. Unilateral termination under the above circumstances will put employers at high legal risk. Layoff is subject to relatively looser substantive requirements but stricter procedural requirements as well as retention and recruitment requirements.
Therefore, we suggest employers who intend to cut employment take mutual termination as their Plan A. They are suggested to draw up a rational and lawful plan and consult with employees fully for mutual termination. If the mutual termination fails, it is advisable that employers choose cautiously between termination based on "change of situation" and layoff, based on the employers' features and after sufficiently evaluating the complexity and potential legal risks thereof.
1. Explanation on Certain Clauses of the Labour Law (Lao Ban Fa  No. 289)
Article 26 Paragraph 3 provides that "The 'objective situation' in this Article 26 refers to force majeure events or other situations which prevent all or partial terms and conditions of a labor contract from being performed, such as relocation, being consolidated, and assets being transferred, excluding the objective situations listed in Article 27 of this Law (i.e. the circumstance where the employer is on the verge of bankruptcy and carries out legal consolidation or where the production and operation face severe difficulty, and it is really necessary to cut employment) shall be excluded."
2. Answers of Beijing High People's Court and Beijing Municipal Labour Dispute Arbitration Committee to Questions Regarding Application of Law in Trial of Labour Disputes
Article 12 Circumstances that may be deemed as "material change of the objective circumstance upon which the employment contract was concluded" under Article 40 Item 3 of the Labour Contract Law
The "material change of the objective circumstance upon which the employment contract was concluded" shall refer to the circumstance where change unable to be foreseen by the employer and the employee at the conclusion of employment contract has occurred after the conclusion thereof, rendering all or main parts of the clauses of the employment contract unable to be performed or making it difficult to realize the purpose of the employment contract due to high cost or other obviously unfair situation for continued performance.
The following circumstances shall be deemed as "material change of the objective circumstance upon which the employment contract was concluded": (1) earthquake, fire, flood, and other force majeure arising from natural disaster, (2) employer's relocation, asset transfer, production halt or switch, restructure, or other major change due to revision of laws, regulations and policies, and (3) change of business scope of the employer who is a franchisee.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.