In practice, when the employer faces substantial internal or external changes such as mergers, restructuring, or strategic adjustments that require workforce reductions, the preferred approach is always negotiating mutual termination agreement with the affected employee. However, when mutual termination agreement cannot be achieved, the employer might consider unilateral termination of employee pursuant to Article 40 (3) of PRC Labor Contract Law (劳动合同法) (“Law”)[ Labor Contract Law (as amended in 2012)
Article 40: Under any of the following circumstances, the employer may terminate the employment contract after providing thirty days' written notice to the employee or by paying the employee an additional month's salary: ...
(3) There is a significant change in the objective circumstances upon which the employment contract was concluded, rendering the employment contract impossible to perform, and both parties are unable to reach an agreement on variation of the contents of the employment contract upon negotiation.], on the grounds that significant changes in objective circumstances makes the performance of the employment contracts impossible.
This article aims to discuss key points of the aforementioned provision, together with judicial practice, to assist the employer in gaining a deeper understanding of the Law.
1. Significant Changes in Objective Circumstances Making the Employment Contract Impossible to Perform
According to Article 26 of the Explanation on Several Provisions of the Labor Law (关于〈劳动法〉若干条文的说明), objective circumstances refer to the occurrence of force majeure or other circumstances that makes it impossible to perform all or part of the employment contract, such as corporate relocation, mergers, or asset transfers. This does not include scenarios where the employer is undergoing statutory reorganization due to impending bankruptcy or severe operational difficulties that require workforce reductions.
The situations listed above are relatively limited, and the employer may encounter more ambiguous circumstances in practice, such as voluntary or involuntary organizational restructuring, elimination of departments, closure of business lines, or declining profits. Whether these situations fall within the scope of significant changes in objective circumstances varies across regions and is subject to judges’ interpretation on a case-by-case basis. Generally speaking, judicial practice in Shanghai is more lenient to the employer and is more willing to recognize significant changes in objective circumstances.
2. Failure to Reach Agreement with the Employee on Change of the Employment Contract
As a starting point, the employer is obligated to negotiate with the employee regarding any change (rather than termination) of the employment contract.
More importantly, the employer, when negotiating with the employee, shall act in good faith and provide the employee with alternative positions, ensuring the proposed position and salary are comparable to the current arrangements. During the process, the employer shall explain impact of the significant changes in objective circumstances on employment, and provide the employee sufficient time for consideration.
3. Legal Consequences of Unlawful Termination
Pursuant to Article 48 of the Law, where an employer unlawfully terminates an employment contract, the employee shall be entitled to request reinstatement of the employment relationship. If the employee does not request so, or if reinstatement is no longer feasible, the employer shall be liable to pay compensation.
Based on Shanghai's judicial practice, where an employee seeks reinstatement following an unlawful termination, the court typically evaluates feasibility of restoring the employment relationship based on factors including (i) whether the employee’s previous position still exists; (ii) whether there is mutual trust between the employee and the employer; and (iii) whether the employment contract has expired.
In conclusion, we suggest the employer carefully assess the above key points prior to terminating an employment contract on the grounds of significant changes in objective circumstances, in order to minimize the risk of unlawful termination claims.
Disclaimer: This article offers a general analysis and discussion of selected cases and related legal issues. It does not constitute any formal or informal legal opinion or advice from this firm or its attorneys. Given that each case presents unique circumstances, you are strongly encouraged to seek specific legal counsel and risk assessment from qualified professionals. For any opinions or suggestions, please feel free to contact us.
