The Shanghai Putuo District People’s Court recently issued 10 exemplary labour dispute cases, one of which, involving the termination of a senior executive, is worth close study by employers.
In 2015, Lu (full names have not been disclosed by the courts) joined a trading company as its general manager, his employment contract providing for a monthly salary of “RMB44,000 [USD6,208] plus variable sales commission”. In September 2020, the company resolved to establish a new shareholders’ meeting and board of directors, and engaged Yu, an outsider, as general manager.
In February 2021, the company notified Lu that, in view of a material change in the objective circumstances (i.e. the appointment of Yu as general manager), it was demoting him to the position of deputy general manager and adjusting his salary. Lu consented to the demotion but not to the decrease in salary. After a series of unsuccessful email communications, the company terminated Lu’s employment contract in March 2021. Subsequently, Lu applied for labour arbitration, demanding compensation from the company for illegal termination.
It was found in arbitration and by the courts of first instance and appeal that the company had lawfully terminated Lu and dismissed his claims.
The courts held that, while safeguarding the lawful rights and interests of workers, it was also necessary to respect the operational autonomy and employee management rights of employers. Pursuant to the resolutions of the shareholders’ meeting and the board of directors, the company established a new board of directors and appointed a new general manager.
Lu confirmed that the company discussed with him matters relating to amendment of his employment contract and that he could not continue to serve as the general manager in accordance with his employment contract. As the objective circumstances upon which the parties relied at the time of entry into the employment contract had materially changed, performance of the employment contract by the parties was no longer possible.
According to the emails exchanged between the parties, the company, after the material change in objective circumstances, held consultations with Lu on amending his employment contract, demoting him to the position of deputy general manager and reducing his wage to “RMB24,500 plus variable sales commission”.
Lu did not object to the demotion to deputy general manager, objecting only to his new salary. Accordingly, a finding that the parties failed to reach a consensus on the amendment of the employment contract was called for. Under such a circumstance, the termination of the employment relationship with Lu and payment to him of severance and salary in lieu of notice in accordance with the law by the company was in keeping with the law.
Affected by the external environment and revisions of business strategy, the third paragraph of article 40 of the Labour Contract Law is relatively commonly used by employers as the basis for termination of employment relationships. In practice, the applicability of the third paragraph of article 40 to terminate an employment contract comes down to two key points:
- Whether the condition that a material change in the objective circumstances has occurred is satisfied; and
- Whether the consultation procedure has been carried out.
With respect to material changes in objective circumstances, they are strictly limited to the following three types of circumstances in judicial practice in Beijing:
- force majeure resulting from a natural disaster such as an earthquake, fire, flood, etc.;
- a material change in an employer such as its relocation, transfer of its assets, cessation of production, change in production, change of corporate system, etc., arising due to a change in laws, regulations or policies; and
- a change in the scope of business of an employer operating within the framework of a concession.
In contrast, judicial practice in Shanghai is more flexible, and such circumstances as the closing down or consolidation of departments of an employer, a modification of its structure, etc., will also be comprehensively assessed in arriving at the specific determination.
Given the variation in judicial approaches in different regions, the authors would recommend that an employer that is considering application of the third paragraph of article 40 conduct a careful assessment and comprehensively consider the judicial approach in the place where it is located.
With respect to the determination of whether the consultation procedure was carried out in a reasonable manner, the court also pointed out that the legislative intent of the third paragraph of article 40 is to reach a consensus on continued performance of the employment contract through consultation, not termination of the employment relationship.
Accordingly, in general, when consulting with an employee on a change in his or her position, comprehensive consideration should be given to his or her previous rank and salary/wage level so as to ensure the reasonableness and non-discriminatory nature of the change in his or her position.
Business Law Digest is compiled with the assistance of Baker McKenzie. Readers should not act on this information without seeking professional legal advice. You can contact Baker McKenzie by e-mailing Howard Wu (Shanghai) at firstname.lastname@example.org