Corporate dissolution: is prior consent required before terminating labour contracts?

man-tears-employment-contractIn the face of China’s increasingly strong economic headwinds, some businesses are having to revise their strategies in order to ensure profitable growth.

This may involve reducing investments or moving the business to other parts of Asia or NAFTA while dissolving the business in China accordingly – 41 per cent of companies reported in the Chamber’s Business Confidence Survey 2016 that they are now re-evaluating their China operations and planning to cut costs, including through headcount. Peter Zeng, Senior Partner, and Mireia Paulo, Business Development Manager, A&Z Law Firm, anaylse the Chinese law to see if companies are obliged to obtain their employees’ prior consent before proceeding to close their operations.

Two cases, two different results

On the afternoon of 5th February, 2015, Citizen Precision Guangzhou Ltd, an important watch-parts factory of the world-famous Japanese wristwatch maker Citizen, suddenly announced its early liquidation and the termination of labour contracts with all employees. Citizen said that abrupt notice was given in the interests of employee safety – prior notice would, it said, have affected workers’ emotions and, consequently, production. However, the explanation was not deemed acceptable by its employees and the case consequently drew wider attention and led to a great deal of controversy.

By contrast, in the case of the announcement of the dissolution of Philips Consumer Luminaires Manufacturing Co Ltd (Philips), a subsidiary of Philips in Shenzhen, on 31st May, 2016, employees’ response was somewhat calmer – some stated that the company had begun to prepare the dissolution two months in advance. Among other things, the company’s management filed records with the local authorities and the street office, or sub-district office/agency,[1] in order to commence preliminary work for the dissolution. In other words, employees were already aware of Philips’ decision to some degree before the formal announcement was made.

So, while the two companies’ different approaches led to quite different outcomes, is it actually necessary to give prior notice to, or to obtain consent from, employees when a company decides to dissolve?

Interpreting the law

There is no need to give advance notice to, or get the consent of, employees if the labour contract is terminated because of the dissolution of the company.

According to paragraph 5 of Article 44 of the PRC Labour Contract Law, dissolution of a company is a legal premise for terminating labour contracts. Hence, as long as the company is dissolved in accordance with Chinese law, it retains the lawful right to terminate labour contracts with its employees. Moreover, in China there is no regulation that requires the company to give prior notice to, or obtain the consent of, its employees before labour contract termination. Therefore, in cases when a company’s board of shareholders has made a valid resolution of dissolution and obtained consent from the examination and approval authority for foreign investment,[2] the dissolution is deemed to be entirely legitimate.

Shanghai has witnessed several recent labour disputes due to company dissolution. By examining these cases it is evident that courts widely hold the belief that it is lawful for companies to terminate labour contracts in accordance with the valid resolution of a corporate closure. In case of any disputes arising therefrom, the court shall examine the formal essentials of such dissolution resolution. Taking a foreign-invested limited liability company as an example: first, the shareholders or the board of shareholders need to make a resolution with regard to dissolving the company. Then, the resolution shall be sanctioned by the examination and approval authority for foreign investment before the formal dissolution of the company. After receiving approval, the company can unilaterally terminate labour contracts without its employees’ consent.

There are some principle provisions on conducting democratic procedures, such as discussion and consultation with the employees, before passing a resolution for company dissolution. However, there is no decision on whether the dissolution resolution would become invalid if it never actually goes through a democratic procedure. So far, at least in the practices of foreign-invested enterprises (FIEs), it is very unlikely for such a resolution to be held invalid if the resolution has already been approved by the competent authority.

It is not explicitly stipulated in Article 4 of the PRC Labour Contract Law that it is necessary to go through a democratic procedure when a company plans to dissolve. However, there is a saving clause in this article, i.e. “…which have a direct impact on employees’ immediate rights and interests or other material matters”. Since company dissolution implies the termination of labour contracts, it is obviously vital to employees’ rights and interests. So in that sense, when a company plans to dissolve, it should comply with this particular article in the Labour Contract Law. In other words, it should follow the stipulated democratic procedures before making the resolution of dissolution. Similarly, paragraph 3 of Article 18 of the PRC Company Law also requires that: “When making a decision on company restructuring or any important issue related to its business operations, or formulating any important rule or regulation, a company shall take into account the opinions of its labour union, and the opinions and proposals of its employees through the employee representatives’ assembly or otherwise.”

ripped-contractYet, it should be noted that both the aforementioned articles are concerned with the resolution of company dissolution, not with the termination of labour contracts. Furthermore, it is not stipulated that a resolution would be rendered invalid if a democratic procedure is not followed.

For this reason, while in theory there is a risk that dissolution resolutions that do not follow democratic procedures might be deemed void, thus far there is no such legal precedent. In fact, there are very limited cases regarding employees’ objections to the termination of labour contracts when the company has been dissolved.

Should you be concerned?

Nevertheless, under the current management system for FIEs, as long as the examination and approval authority have already sanctioned the resolution of dissolution, the labour dispute arbitration and court are not likely to overrule such administrative action. Therefore, there is no need for FIEs to worry unnecessarily about this matter. Even if it is mandatory to follow democratic procedures before a formal dissolution, it is not actually stipulated that a company and its employees must reach consensus through consultation – in short, companies (with the exception of state-owned enterprises) still have the final say.

It is important to note that the Ministry of Commerce issued the Interim Measures for the Record-filing Administration for the Incorporation and Change of Foreign-invested Enterprises (Draft for Comments) on 3rd September, 2016. The Draft for Comments stipulates that FIEs that are not subject to special administration measures on access, as prescribed by the State, and do not need to go through formalities for examination and approval, but can complete formalities for incorporation and change simply by filing a record instead. This means that the aforementioned risk with regard to the validity of company dissolution resolution would be further reduced.

A&Z is a leading Chinese law firm, which employs over 55 experts consisting of attorneys, legal practitioners and business analysts across 11 jurisdictions. The Shanghai, Beijing, Dalian, Wuhan and Tokyo offices provide a full range of services covering Foreign Investment, Overseas Investment, Competition and Antitrust, Intellectual Property, M&A and Corporate Restructuring, Labour and Social Security, Dispute Resolution, Compliance and Corporate Social Responsibility, Finance and Capital Markets, Customs Logistics and Maritime Commerce, and Environment, Health and Safety (EHS).