Is corporate merger ‘significant change of objective circumstances’?

By Qi Bin, Wilson Dong, Xin Bai Law Firm, Rui Bai Law Firm
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According to Article 40 of the Labour Contract Law, an employer may terminate an employee’s labour contract by giving a 30-day written notice to the employee or paying the employee an extra month’s salary in lieu of the notice under certain circumstances where “any significant change of the objective circumstances on which the conclusion of the labour contract is based renders the performance of the contract impossible, and the employer and the employee have attempted to negotiate, but failed to reach an agreement on how the labour contract may be modified.” (Article 40 (3) of the Labour Contract Law).

齐斌 QI BIN 信栢律师事务所合伙人 Partner Xin Bai Law Firm
QI BIN
Partner
Xin Bai Law Firm

In the past couple of years, understanding and interpreting “significant changes of objective circumstances” have been highlights of many local guidelines for arbitration and judicial proceedings involving labour disputes. Examples include the Explanations on Issues Concerning Application of Laws in the Hearing of Labour Dispute Cases jointly released by Beijing Higher People’s Court and Beijing Labour and Personnel Dispute Arbitration Committee, the Explanations on Challenges Concerning the Hearing of Labour Dispute Cases issued by Guangdong Higher People’s Court, the Minutes of the Symposium on Challenges in the Settlement of Labour and Personnel Disputes published by the Labour and Personnel Dispute Arbitration Committee of Jiangsu Province, as well as the Minutes of the Symposium on Issues Concerning Application of Laws (I) and the Minutes of the Symposium on Issues Concerning Application of Laws (II) of the First Civil Chamber of Chongqing Higher People’s Court. One of these issues or challenges relates to arguments over whether a corporate merger can be interpreted as a “significant change of objective circumstances”. For enterprises, it is important to gain a correct understanding of these regulations so as to avoid violations in terminating labour contracts. In this article, we will analyze this issue by looking at a real case.

Case overview

The general meetings of Company B and Company A approved a merger between the two, upon which Company A would be deregistered and Company B would still exist. As the merger was expected to lead to overlapping jobs, Company A, as the entity being acquired before the deregistration, decided to reallocate Brown, one of its employees, to a new position. It discussed the reallocation with Brown, but Brown declined three job offers from Company A. Subsequently, Company A terminated the employment of Brown, claiming there was a “significant change of objective circumstances”.

In this case, Company A argued that a “significant change of objective circumstances” prescribed by laws occurred when it was merged. Pursuant to Article 26 of the Explanations to Several Provisions of the Labour Law (the “Explanations”), a change of “objective circumstances” is defined as “any force majeure event or any other situation, which renders the performances of all or any provisions of the labour contract impossible, including relocation of an enterprise, or any transaction whereby the enterprise is merged or transfers its assets”. In practice, however, there has been argument that the relevant stipulations of the Explanations were superseded by Article 34 of the Labour Contract Law, which states that “in the event of merger or split-up of an employer, the existing labour contracts thereof shall remain in force and effect, and these labour contracts shall be binding upon the entity succeeding to the rights and obligations of the employer”. Pursuant to this provision, where an employer is merged, its existing labour contracts shall remain in force and effect; therefore, the fact that an enterprise is merged is not a “significant change of objective circumstances”.

董传羽 Wilson Dong 信栢律师事务所律师 Associate Xin Bai Law Firm
Wilson Dong
Associate
Xin Bai Law Firm

In the author’s opinion, the controversy discussed above can be clarified by giving consideration to the legislative purpose of the relevant stipulations. Article 40 (3) of the Labour Contract Law is designed to prescribe specific circumstances and reasons that entitle employers to terminate labour contracts of individual employees, whereas Article 34 of the Labour Contract Law provides for general principles on how all the existing labour contracts should be dealt with when the employer is being merged. The two stipulations are in addition to, but not exclusive of, each other. In some sense, Article 40 (3) may even be considered a special provision relating to Article 34 for scenarios involving mergers of employers.

Moreover, Article 40 (3) contains a qualifying condition that requires the change to “render the performance of the (existing) labour contract impossible”, in addition to an upfront procedural requirement that does not allow the employer to terminate the employment unless and until it fails to reach an agreement with the employee upon consultation with the employee on “how the labour contract may be modified”. Therefore, a “significant change of objective circumstances” is only one of the several prerequisites for terminating a labour contract. If an employer terminates a labour contract by citing “significant change of objective circumstances” only, it is highly likely that the termination by the employer may be deemed a violation of laws by the labour and personnel dispute arbitration committee or the court to which the dispute is submitted.

We may also consider whether a corporate merger is a “significant change of objective circumstances” by comparing it with a corporate reorganization. The author has acted as the counsel for a number of labour dispute cases for employers involving corporate reorganizations, all of which were deemed “significant change of objective circumstances” by labour and personnel dispute arbitration committees or courts. Now that corporate reorganizations, generally believed to involve smaller changes than mergers, are deemed “significant change of objective circumstances”, there is no reason to exclude mergers from this definition.

Back to the case, the fact that Company A was merged by Company B was not an immaterial change to Company A. According to Article 40 (3) of the Labour Contract Law, Company A was entitled to terminate its labour contract with Brown, who was holding a position cancelled because of the merger, but was unwilling to accept any of the new positions offered by the employer, and who failed to reach an agreement with the employer, despite mutual consultation.

Qi Bin is the PRC employment legal service leader and Wilson Dong is an associate at Xin Bai Law Firm. Rui Bai and Xin Bai are independent law firms and members of the PwC global network of firms

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