A. Introduction
Driven by the economic downturn and technological shifts, many enterprises are facing financial pressures and market uncertainties. In such a dynamic business landscape, companies are forced to reorganize their operations to reduce costs and maximize efficiency. For multinational corporations, global restructuring has become a common trend, often leading to job eliminations and downsizing.
However, navigating the complex legal landscape in the People’s Republic of China (“PRC”) may be challenging, especially as different regions may interpret the same case differently. The PRC Employment Contract Law (“ECL”), effective from January 1, 2008, provides various grounds for terminating employment relationships. Decision – makers often find it confusing to determine the most appropriate and compliant method. In this article, we will clarify the common approaches to layoffs in the PRC market practices, outline the associated risks, and provide practical suggestions for companies.
B. Different Approaches to Terminating Employment in the Context of Restructuring
When conducting layoffs during restructuring, the employer can consider four termination approaches. Below, we will introduce each approach by answering 5 key questions:
- What is the legal threshold?
- What evidence is required?
- Is any category of employees entitled to special protections?
- Is a prior notice required?
- Is severance pay required?
1. Unilateral Termination of Employment under Significant Change Clause
Item 3 under Article 40 of the ECL entitles the employer to terminate an employment contract when the objective circumstances under which the employment contract was executed have significantly changed, which renders the contract unperformable, and the employer and employee fail to reach an agreement on amending the contract after consultation (“Significant Change Clause”).
1.1 What is the legal threshold?
To apply “Significant Change Clause”, the below pre-conditions must be met:
(1) Significant change of objective circumstances
Objective circumstances refer to the conditions upon which the employment contract was based. And their change shall be a material one that renders the employment contract unperformable.
The former PRC Ministry of Labor once defined “Significant Change of Objective Circumstances” as the occurrence of force majeure or other situations that render all or part of the employment contract unenforceable, such as company relocation, merger or asset transfer. This definition suggests that the “objective circumstances” are relatively stringent.
While in judicial practice, arbitration committees and courts in different regions adopt inconsistent standards, with some adopting a relatively looser standard (such as Shanghai) while others remain very strict (such as Beijing).
For example, enterprises often invoke the concept of “Significant Change of Objective Circumstance” in departmental reorganization. In Beijing, such reorganizations are generally not deemed to constitute a “Significant Change of Objective Circumstance” whereas in Shanghai the restructuring may be more easily recognized. Nevertheless, in Shanghai, if the restructuring results in the elimination of only one or a few positions within a department or function, rather than all positions, the arbitrator or judge normally will not consider this situation to be a “Significant Change of Objective Circumstance”.
(2) Unsuccessful negotiation with employees
In addition to objective changes, the employer is still obligated to negotiate with the employee to amend the employment contract. In practice, such negotiation typically involves offering another position within the employer.
Furthermore, the employer’s new job proposal should be made in good faith and in a reasonable manner. This generally requires the employer to provide a new position that is similar to the employee’s original one and matches the employee’s current level, educational background, working experience and expertise. Also, there should be no salary reduction or change in working location. Or, if a change in salary or working location is necessary, it should be within a reasonable limit.
If, after consultation, the employer and the employee fail to reach an agreement on amending the employment contract, the employer has the right to take the unilateral termination.
1.2 What evidence is required?
According to the PRC labor law, the burden of proving that a termination was lawful falls on the employer. To minimize legal risks, the employer needs to prepare following evidences to prove that the above two pre-conditions are met.
Evidences on “Significant Changes of Objective Circumstances”:
- government’s announcement;
- global-level announcement of the organizational restructuring;
- relevant resolutions of the shareholders and the board of directors for the organizational restructuring;
- valid outsourcing agreement with a third party if the employer decides to outsource the business operation; and/or
- organizational structure charts of the employer before and after the restructuring, reflecting the elimination of the affected employee’s position.
Evidences on unsuccessful negotiation with employees:
- documentation of the offer of new position;
- records of negotiations between the employer and employee regarding new position;
- written acceptance or refusal of the new position by the employee.
1.3 Is any category of employees entitled to special protections?
According to Article 42 of the ECL, employees with any of the following circumstances (“Special Employees”) cannot be unilaterally terminated per “Significant Change Clause”:
- being engaged in operations that expose them to occupational disease hazards but not having undergone a pre-departure occupational health check-up, or being suspected of having contracted an occupational disease and being diagnosed or under medical observation;
- having been confirmed to have lost (or partially lost) work capacity due to an occupational disease or work-related injury sustained with their current employer;
- having contracted an illness or sustained a non-work-related injury, and the statutory medical period has not expired;
- female employees in their pregnancy, maternity, or breastfeeding period; or
- having been working for the employer continuously for at least 15 years and having less than 5 years before the statutory retirement age.
1.4 Is a prior notice required?
The employer is required to provide a 30-day advanced notice in writing to the employee, or pay one-month’s pay in lieu.
1.5 Is severance payment required?
The employer is obliged to pay the statutory severance pay (see Section 1 under Chapter C below, Statutory Severance Pay) to the employee.
2. Unilateral Termination of Employment under Economic Redundancy Clause
Article 41 of the ECL grants the employer the right to unilaterally dismiss 20 or more employees, or 10% or more of the total number of employees (“Economic Redundancy Clause”).
2.1 What is the legal threshold?
The following preconditions shall be met when revoking Economic Redundancy Clause:
(1) Statutory Redundancy Circumstances
The statutory redundancy circumstances include:
- the employer is restructuring pursuant to the PRC Enterprise Bankruptcy Law;
- the employer has serious difficulties in production and/or business operations;
- the employer switches production, introduces a major technological innovation or revises its business method, and after amendment of employment contracts, still needs to reduce its workforce; or
- the employer has other major changes in the objective economic circumstances relied upon when concluding the employment contracts, rendering them unperformable.
(2) Procedural Requirements
Before the redundancy is conducted, an employer shall complete the following procedures:
- explain the circumstances and layoff plan to its trade union or to all of its employees 30 days in advance;
- consider the opinions of the trade union or the employees; and
- report the redundancy plan to the competent labor bureau.
As the employer is legally obliged to notify its redundancy plan to the relevant labor bureau, the feasibility of applying this clause depends mainly on the bureau’s attitude. Even if the employer has obtained the acceptance letter from the labor bureau, in case any employee files an arbitration or litigation case, some arbitrators/judges may still conduct a substantive review of the legality of the termination.
(3) Employees Remained in Priority
The following employees shall be given priority in being retained:
- who have entered into a fixed-term employment contract of a longer period with the employer;
- who have entered into a non-fixed-term employment contract with the employer; and
- whose family members are not employed or who need to support aged or under-aged family members.
2.2 What evidence is required?
Employers need to prove that their layoff actions have met the conditions and procedures stipulated by law. Specifically, employers must provide:
Evidence on statutory redundancy circumstances, using “serious difficulties in production and/or business operations” as an example, includes:
- Financial statements, business data indicating that there are economic difficulties for certain years;
- Documents showing that the company has attempted other measures to alleviate these difficulties but turned out to be unsuccessful.
Evidence on procedural requirements:
- Written records of the notification to the trade union and its opinions;
- Receipts or records proving that the layoff plan was reported to the local labor bureau.
2.3 Is any category of employees entitled to special protections?
The Special Employees cannot be unilaterally terminated per “Economic Redundancy Clause”.
2.4 Is a prior notice required?
The employer is only legally obliged to explain the circumstances and the redundancy plan to its trade union or to all employees 30 days in advance, while no specific requirement on giving advance written notice to employees to be terminated.
2.5 Is severance payment required?
The employer is obliged to pay the statutory severance pay to the employee.
3. Unilateral End of Employment under Early Liquidation Clause
According to Item 5 of Article 44 of the ECL, the employer can end employment contracts if they decide to dissolve early (“Early Liquidation Clause”).
3.1 What is the legal threshold?
The employer has the right to unilaterally end employment contracts with all its employees by applying Early Liquidation Clause. There are no further specific preconditions under this clause in the ECL.
3.2 What evidence is required?
In the event of a labor dispute as a result of the unilateral termination by the Early Liquidation Clause, the employer shall prove the fact that it is actually in the process of liquidation. Based on the practices, the employer must normally provide the following evidence:
- relevant resolutions of the shareholders and the board of directors regarding the early liquidation; and
- materials showing that the employer is actually in the liquidation process, such as the engagement agreement with a tax or accounting firm regarding the tax deregistration.
3.3 Is any category of employees entitled to special protections?
The ECL does not forbid the employer to unilaterally end the employment with Special Employees.
3.4 Is a prior notice required?
No prior notice is legally required by applying the Early Liquidation Clause.
3.5 Is severance payment required?
The employer is obliged to pay the statutory severance pay to the employee.
4. Mutual Termination of Employment
A mutual termination would be considered the best approach to reduce the risk of being sued for illegal termination.
4.1 What is the legal threshold?
Under Article 36 of the ECL, an employer and an employee may terminate the employment contract if they agree upon negotiations.
4.2 What evidence is required?
Once the employee agrees to terminate the employment contract, the employer needs to enter into a written mutual termination agreement with the employee individually.
4.2 Is any category of employees entitled to special protections?
The ECL does not forbid the employer to reach a mutual termination with the Special Employees. However, it should be noted that according to the Regulations on Work-related Injury Insurance, if an employee sustains a work-related injury w degree of disability of 1 to 4, their employment must be retained. If the employee is determined as degree of disability of 5 to 10, in the case of mutual termination, the initiative to terminate the employment should come from the employee rather than the employer.
4.3 Is a prior notice required?
No prior notice is legally required under mutual termination scenario.
4.5 Is severance payment required?
The employer is obliged to pay the statutory severance pay to the employee.
However, in a mutual termination scenario, companies usually offer a favorable compensation package higher than the statutory severance pay, in order to persuade employees to accept. Market practice of the mutual termination package commonly ranges from “N+1” to “N+6”.
C. Compensation Package
In this chapter, we will further explain the calculation of the statutory severance pay and highlight other potential payments upon the termination of employment.
1. Statutory Severance Pay
Pursuant to the ECL, the statutory severance pay shall be calculated based on the length of service period multiplied by the employee’s average monthly remuneration.
1.1 Length of service
The length of service refers to the number of years the employee has worked for the employer. The calculation rules vary depending on whether the period includes years before January 1, 2008, i.e. the effective date of the ECL.
- For service years after January 1, 2008, any period of not less than six months but less than one year will be counted as one year, and any period of less than six months will be counted as half a year.
- For service years before January 1, 2008, the calculation rules vary under different termination scenarios in different PRC cities, which needs to be confirmed case-by-case.
1.2 Monthly remuneration
Monthly remuneration is the employee’s average monthly income for the 12 months preceding the termination or end of their employment contract. All forms of salary including wages, bonus and allowances capable of being expressed in a currency must be included, while earnings from investments including shares, options and dividends are excluded.
1.3 Statutory severance pay caps
The ECL sets caps on the statutory severance pay for high-income employees. If the employee’s monthly remuneration exceeds three times the local average monthly salary in the previous year (“3 Times Cap”), the statutory severance pay shall be counted as 3 Times Cap multiplied by the length of service, and the total length of service shall be capped at 12 years from January 1, 2008.
2. Other Payments Upon Termination
Based on PRC law, the employee’s individual employment contract and the employer’s internal rules and regulations, the employee may be entitled to other payments, in addition to the severance payment, such as compensation for unused annual leave, pro-rata 13th month bonus, year-end bonus and other entitlements upon termination of employment. Therefore, we recommend that the employer internally check whether any of the above is payable and, if so, pay the employee accordingly.
D. Risks of Different Approaches
It’s important for employers to understand that unlawful dismissal can have unintended consequences in legal and other commercial aspects.
1. Unilateral Termination
1.1 What are the legal liabilities for employers on illegal unilateral termination?
Employees considering the unilateral termination is illegal have the right to file labor arbitration against the employer, claiming:
- Reinstatement; or
- Double their statutory severance pay.
Furthermore, if the arbitrator or judge upholds the reinstatement claim, the employer must pay the employee the same salary from the termination date to reinstatement date.
1.2 What are other hidden risks?
In addition to the above, employees often raise many other claims in the event of unilateral termination, such as overtime pay, compensation for unused annual leave, bonuses and other entitlements. These claims may result in additional legal and financial burdens for the employer.
Furthermore, in the scenario of unilateral termination by the Early Liquidation Clause, although the employer has the right to unilaterally end the employment, it is still possible that any employee dissatisfied with the end raises labor disputes. If so, unresolved labor disputes may prevent the employer from completing its liquidation, thereby delaying the liquidation process.
Lastly, the unilateral termination may trigger hostility on employee’s part. This could potentially lead to risks of allegations raised against the employer for any compliance issues.
2. Mutual Termination
In general, mutual termination does not pose a legal risk if it is done properly. However, in rare cases, the employee may argue for the revocation of the agreement or challenge its validity if, between the signing of the mutual termination agreement and the agreed termination date, a circumstance under Article 42 of the ECL arises (such as pregnancy, medical treatment period and work – related injuries). Normally, this will not affect the validity of the mutual termination agreement, especially if the mutual termination agreement stipulates that the validity of the agreement will not be affected even if the employee has any of the above special circumstances. However, in extreme cases where the employee has a serious illness or work-related injury, it should be determined case by case.
E. Conclusive Remarks and Suggestions
Before planning redundancies, companies need to have a thorough understanding of the business context and commercial considerations in order to choose the most suitable and appropriate redundancy reason.
Firstly, it is advised to determine whether any legal entity (including the branch) in the PRC is to be closed or deregistered as a result of the reorganization. If so, the entity to be deregistered will have the right to terminate all employment relationships with its employees under the Early Liquidation Clause.
Secondly, it is also suggested to consider whether Significant Changes Clause is feasible, but under which case the employer must prove that there has indeed been a “Significant Change of Objective Circumstances” and that it has negotiated an amendment to the employment contract with the affected employees.
Lastly, the Economic Redundancy Clause can also be an option for dismissing employees of 20 or more, or 10% or more of the total workforce. However, this clause is not very frequently utilized in practice due to the numerous procedural requirements.
Still, mutual termination always remains the safest method. Companies should prioritize negotiation to minimize litigation risks and consider unilateral termination approaches as a backup. In the absence of valid unilateral grounds, it is advisable to offer more attractive severance packages to encourage agreement. If mutual negotiation fails and unilateral action is taken, leading to a labor dispute, it is still possible to try to reach a mediation in the arbitration and litigation proceedings.