China: How to understand - Material Change of Objective Circumstance - in the termination of employment contracts

Last Updated: 25 June 2015
Article by Lucy Lu and Lexina Li

There were increasing labor disputes arising from the termination of employment contracts by the employer on the basis of material change of objective circumstance in recent times, which has caused many controversies about how to apply this clause in practice. We reviewed the following case which happened in Suzhou, Jiangsu Province and would like to discuss the application of this clause on the basis of the judgment of this case.

1. Summary of the Case

  1. Background

Mr. Ding entered into an open-ended employment contract with an electronic technology company addressed in Suzhou (hereinafter as "Company A") on 2001, which had been duly performed. From 2012, the order quantity of Company A decreased drastically, which resulted in the serious conditions of personnel redundancy and a lower profitability. Under such circumstance, Company A held a board meeting on June 26, 2012 and made an important resolution to adjust its business structure to deal with the dramatic change of market situation and operation conditions. In the meantime, Company A also would like to make a settlement of its employees who were influenced by the adjustment of the business structure according to the laws. After discussing with the trade union and obtaining its written approval, Company A tried to negotiate with Mr. Ding to terminate his employment contract. However, it was turned down by the employee. In early August, Company A renegotiated with Mr. Ding regarding adjustment of his position, which was still turned down by Mr. Ding. On August 8, 2012, Company A unilaterally terminated the employment contract with Mr. Ding according to article 40.3 of the Employment Contract, which stipulates the situation of "Material Change of Objective Circumstance" and paid him economic compensation and one month's salary in lieu of written notice.

Mr. Ding was not satisfied with the termination decision made by Company A and filed for a labor arbitration claiming for the compensation for illegal termination, as he thought the reason of termination is invalid, which shall be deemed as illegal termination of employment contract. After the labor arbitration and the first instance of litigation, Company A finally got an effective judgment.

  1. Judgment and Reasons

The Arbitration Committee held that, the special auditor's report issued by professional institute confirmed the reasonableness of Company A's profit prediction statement from August of 2012 to February of 2013. This report also affirmed that Company A would suffer huge losses in the following months if it didn't terminate a certain number of employees. On this ground, this evidence could be used as the basis to prove the facts that Company A's production and management situation was in great difficulty and there was a material change of objective economic circumstance in this case. Besides, according to the evidence such as the decision of Company A's board resolution, the communication letters with the employees, the opinion of the trade union, the notice of unilateral termination of employment contract and other related evidences submitted by Company A, it had fulfilled the statutory procedures of terminating an employment contract in accordance with the law. Thus, this termination was in compliance with applicable laws and regulations in both procedural and substantial perspectives. The arbitration committee thus rejected Mr. Ding's claim for compensation for illegal termination of employment contract.

The Court of First Instance held that, Company A's situation is that it couldn't maintain the profit pattern of "large quantity with low profit" because of the remarkable reduction of order quantity. Under the high pressure of labor cost, Company A had to reduce employees to alleviate the pressure of decrease of profits. This situation is inconsistent with the rule of "material change of objective circumstance" as stated in the law. Legitimate objective circumstances shall refer to the circumstances which are beyond the control of the employer, such as being forced to relocate by the government due to local policy or being ordered to cease certain business as required by the laws and regulations. Even though Company A's decision of reducing employees was made due to the economic depression and the decrease of order quantity, it is still a business decision under Company A's discretion, rather than material change of objective circumstance that renders the employment contract unable to be performed. Thus Company A's termination of the employment contract shall still be deemed as illegal.

2. Case Analysis

The key point of this case is to determine whether the situation faced by Company A was "material change of objective circumstance". On this point, the arbitration committee and the court of first instance held different opinions. The arbitration committee held that Company A made the decision of reducing employees due to the economic environment and the reduction of order quantity, and according to the auditor's prediction report, Company A would indeed face unbearable loss if no redundancy measure is taken; which situation could be deemed as a material change of objective circumstance. However, the court held that this decision was a subjective business decision made by Company A to relieve its economic pressure, and the condition of Company A did not reach the level that the employment contract with Mr. Ding was unable to be performed; therefore it shall not be deemed as a material change of objective circumstances. Actually, there is no detailed legal standard on whether certain situation is a material change of objective circumstances in practice, and it is mostly based on the discretion of the arbitrator or judge according to the actual situation of the case.

According to Article 26.3 of the Interpretation of Several Provisions of Labor Law, if there is a material change of objective circumstances relied upon which the employment contract was executed rendering the original employment contract unable to be performed, the employer can terminate the employment contract provided it can't reach an agreement with its employee about the amendment of the contract. The "objective circumstances" in this article meant the force majeure or other situations which result in the non-performance of all or part clauses of the employment contract, such as relocation of the employer, merger and transfer of assets.

The opinion of the arbitration committee in this case provides a relatively broad interpretation of "material change of objective circumstance", while the court of first instance held a more prudent opinion. In this case, the fundamental reason of Company A to reduce its employees is the decrease of order quantity which leads to increasing labor cost. This is exactly the consequence of Company A's independent business decision rather than the objective circumstances. Therefore this situation can't be deemed as a material change of objective circumstances.

In judicial practice regarding labor dispute cases, many employers will make a broad interpretation and understanding of "material change of objective circumstance" purposely when they need to terminate their employees but fail to find a suitable situation in applicable laws and regulations. However, what should be reminded is that the employers should realize that when there is no definite explanation of "objective circumstances", the word "objective" could be interpreted according to its strictest definition under the text of law. Therefore, employers should make a prudent judgment and determination of "material change of objective circumstance"; so as to avoid damages of the interests of their employees and to avoid the legal risk that may be imposed on themselves.

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.

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