Termination for ‘change of situation’ or layoff – which to use for cutting employment?

The Covid-19 pandemic has presented an unprecedented challenge to the global economy. A lot of businesses ran into severe difficulty and even went on the verge of bankruptcy. Many employers cut employment directly by terminating employment contracts with employees instead of reducing salaries or arranging for employees to await job assignments to reduce labour costs. When cutting employment, many employers first consulted with their employees about mutual termination and then terminated employment contracts by entering into mutual separation agreements with the employees to mitigate the legal risk that the employers’ unilateral termination may incur. If the consultation failed, employers would have to go to unilateral termination.

China’s labour and employment legislation have provided limited statutory grounds on which employers are allowed to unilaterally terminate. In cases where employers need to cut employment due to adjustment of business strategy or organisational structure etc, the only two legal grounds for the employers’ to unilaterally terminate are ‘termination based on a 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.

These two legal grounds are different in terms of their statutory conditions, complexity and legal risks.

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 % 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

  1. Termination based on ‘change of situation’ is not subject to procedural requirements other than a 30-day prior written notice to the employees. Employers who fail to give the 30-day prior notice, may terminate the employment contract immediately by giving the employees one month’s salary in lieu of such prior notice.
  2. 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 a plan with the competent labour authority. Should an employer skip the filing procedures or fail to complete the filing procedures due to the competent labour authority’s not accepting filing documents, the employer will be put at high legal risk of being considered to have unlawfully terminated employment contracts with the laid-off employees by the labour arbitration committee and the court in the case of a labour dispute. It is 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 be more prudent in accepting employers’ layoff filing, therefore, the uncertainty and difficulty for employers to complete layoff filing will multiply.

It’s more difficult to achieve lawful termination based on material change of objective circumstance

  1. According to the law and Beijing courts’ opinions in adjudication of relevant cases, force majeure, relocation, being merged, asset transfer, production halt or switch and restructure are deemed as material changes of objective circumstance under Article 40 Item 3 of the Labour Contract Law. However, it is hardly the case for employers’ adjustment of internal organisational structure, merger of departments, or cancellation of positions. If an employer unilaterally terminated an employment contract based on any of such circumstances, there is high risk that the employer’s termination may be deemed illegal in the case of dispute over the lawfulness of termination.
  2. 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 circumstances where an employer may lay off employees, including the case where the employer’s production and/or operation ran into severe trouble. 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 analysed above, they can have employment contracts lawfully terminated by way of layoff, because such circumstances are among the statutory circumstances where layoff is allowed.

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 rehired 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 organisational 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.