Termination of employment contracts due to “significant changes in objective circumstances”

Under the legislative framework of Chinese labour law, which prioritises the protection of employees’ rights, employers seeking greater autonomy in terminating employment contracts often rely on provisions in the Labour Contract Law. These include article 39, which addresses “termination due to employee misconduct”, and article 40, which covers “non-fault dismissals”. Among these, the provision for termination due to “significant changes in objective circumstances” under article 40 is frequently invoked. This is because it places less emphasis on employee fault and allows for interpretative flexibility. However, its application remains contentious and subject to strict procedural requirements, often leading to disputes over unlawful termination.

This article analyses the legal framework surrounding the concept of “objective circumstances”, exploring its definitional boundaries and the compliance requirements for negotiation procedures. It aims to provide systematic recommendations for employers to establish lawful and reasonable mechanisms for terminating employment contracts. To terminate an employment contract on the grounds of “significant changes in objective circumstances”, two conditions must be met: the objective circumstances must render the contract’s performance impossible; and the employer and employee must fail to reach an agreement after consultation.

Employers must carefully define the reasonable scope of “objective circumstances” and focus on collecting relevant evidence to substantiate their objectivity and significance. The definition of “objective circumstances” is a critical and challenging aspect of legal application. Relatively clear legal guidance can be traced to article 26 of the former Ministry of Labour’s Notes on Certain Provisions of the Labour Law. According to this provision, “objective circumstances” refer to force majeure or other situations that render the full or partial performance of an employment contract impossible, such as corporate relocation, mergers, or asset transfers. These examples highlight the legislative intent to emphasise the “objectivity” of the circumstances and the “significance” of their impact, meaning the changes must arise from non-subjective factors and create substantial obstacles to contract performance.

However, in practice, there is ongoing debate in both academic and practical fields regarding whether corporate decisions, such as organisational restructuring or business downsizing, fall within the scope of “objective circumstances”. For instance, in the Yangtze River Delta region, Shanghai courts, considering the local business environment, adopt a relatively open stance, recognising internal organisational adjustments as “objective circumstances” to some extent. This approach provides necessary flexibility for corporate management in a dynamic market economy. Conversely, some courts in Jiangsu hold that internal business decisions should not be deemed “significant changes in objective circumstances”. Certain scholars argue that shifting business risks onto employees violates the labour law’s principle of preferential protection for workers and risks enabling employers to abuse termination rights.

These differing interpretations reflect the judicial balancing act between protecting employee rights and preserving corporate autonomy, as well as the nuanced considerations across jurisdictions. Therefore, employers should adopt a cautious approach when invoking “objective circumstances” and focus on preserving evidence that demonstrates objectivity and significance, such as government-issued documents.

The negotiation process is a mandatory prerequisite for terminating an employment contract, and employers must prioritise and standardise the content and format of such negotiations. Negotiations with employees must be based on the premise of “significant changes in objective circumstances” and serve as a statutory precondition for contract termination. Employers and employees should engage in substantive negotiations with the aim of maintaining the employment relationship. Employers are required to provide employees with specific proposals for changes or job adjustments during negotiations, including details such as job responsibilities, salary levels, and work locations, avoiding mere formal notifications. Given the unique nature of labour disputes, the content of negotiations must be reasonable and lawful, avoiding any implication of disguised malicious pay cuts, demotions, or dismissals.

It is important to note that negotiating changes does not equate to negotiating termination. Employers should not issue termination notices simply because employees reject offers, such as “N+1” compensation or amounts exceeding statutory standards. Even in regions like Shanghai, where courts adopt a more flexible approach to “objective circumstances,” evidence of negotiations is scrutinised rigorously. In one ruling, the court clearly stated that article 40(3) of the Labour Contract Law is not intended to encompass the negotiation of employment contract termination as part of modifying its terms. Terminating a contract directly on the grounds of “significant changes in objective circumstances” without any negotiation violates the provision. When “objective circumstances” render the performance of an employment contract impossible, employers must strictly adhere to standardised negotiation procedures and ensure the content of negotiations is reasonable.

Terminating an employment contract on the grounds of “significant changes in objective circumstances” represents a key point of contention between employers’ autonomy in labour management and the protection of employees’ rights. To mitigate the risk of unlawful termination, employers must strictly adhere to the dual standards of “objectivity” and “significance”, avoiding the simplistic classification of internal business decisions as “objective circumstances”. Additionally, employers must ensure the substantive implementation of the negotiation process and focus on systematic evidence management. From the occurrence of the change to the conclusion of negotiations, a comprehensive evidence chain should be established, encompassing factual evidence, procedural evidence, and materials supporting the reasonableness of the actions. This approach is essential for effectively addressing potential labour disputes.

Wu Kun is a partner and Sun Linjiaying is an associate at Blossom & Credit Law Firm