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Mergers and acquisitions (M&A) have become a key strategic choice for many companies seeking growth. Through M&A, businesses can expand their scale, reduce costs and integrate resources to enhance competitiveness and profitability in a challenging market.

In this process, addressing employee placement is critical. Properly managing labour contracts is essential to ensuring smooth completion of M&A transactions and sustained development of operations, warranting focused attention from companies.

Contract continuation

In equity acquisitions, the acquirer gains control of the target company by purchasing its shares, becoming a shareholder. Under article 33 of the Labour Contract Law, existing employment contracts between the target company and its employees remain valid.

The acquirer is not required to terminate or amend these contracts. This ensures the acquirer assumes the rights and obligations stipulated in the original contracts, and does not allow the acquirer to unilaterally alter terms such as wage standards and calculation of seniority.

Contract novation

In the case of business re-engineering or organisational restructuring, employees of the target company may have to be entirely separated from the target company or redistributed across affiliated entities.

As this involves a change in the employer entity, the original labour contracts fail to remain valid and need amending. Importantly, any such amendments are subject to mutual agreement, as the acquirer is not entitled to unilaterally alter the contracts.

Previous cases reveal that employees tend to prioritise concerns over contract terms, seniority and the financial stability of the new company. To facilitate smooth negotiations, the acquirer should provide clear explanations, offering sincere and reassuring contract amendments to efficiently secure employee agreement.

Contract cancellation

Should the acquirer fail to reach consensus with the target company¡¯s employees on amending the labour contracts, or be unwilling to retain employees due to strategic considerations, it shall proceed with cancelling the original labour contracts.

In circumstances where employees are deemed unfit for the role, or are at or about to reach retirement age, contract cancellation is also the only solution.

Entity. As cancellation involves the original labour contracts, and the employer entity has not yet changed, the cancellation must be carried out by the original employer; that is, the target company.

Grounds. The Labour Contract Law imposes strict restrictions on the unilateral termination rights of employers. Employers can only choose to unilaterally terminate labour contracts on the grounds of employee misconduct, no-fault dismissal or economic layoff, depending on the circumstances. Any other grounds for termination will be deemed unlawful.

(1) Misconduct-based dismissal arises from severe violations or gross negligence by employees. Employers must avoid retroactively addressing past infractions solely to reduce termination costs, as delays in handling such misconduct may render the dismissal unlawful.

(2) No-fault dismissal occurs when an employee is incompetent at his/her role, unable to resume work after medical leave, or when significant external changes necessitate contract cancellation. The target company must provide evidence that the strategic adjustment stems from critical external factors, such as survival threats without the M&A. Otherwise, the M&A may be deemed a subjective business decision rather than an ¡°objective circumstance¡±.

(3) Economic layoffs apply to large-scale redundancies. They require employers to comply with substantive and procedural conditions, as well as the principle of priority retention. In practice, due to high standards, lengthy process and typical outcome of paying severance, employers often opt for contract cancellation through mutual agreement, which carries significantly lower legal risks compared to economic layoffs.

Contract termination

In certain circumstances, the acquirer and target company may agree to dissolve the target company post-acquisition. In such cases, if the acquirer does not assume existing labour contracts or reach agreement with the employees on contract amendment, the statutory ground of ¡°early dissolution by company decision¡± can be invoked for termination.

However, it is crucial to promptly liquidate and deregister the company after the dissolution decision, as delays may render the termination grounds unlawful.

During the M&A, the target company may terminate labour contracts for employees whose contracts expire, or who have reached retirement age and begun receiving pension benefits.

Importantly, careful review should be conducted in the statutory termination conditions to avoid unlawful termination in cases that require open-term contracts, or where employees have reached retirement age but are not yet receiving pension benefits.

Key takeaways

A well-structured placement plan should prioritise protecting the employees¡¯ legal rights, consider their specific circumstances, and offer multiple constructive options. Special attention should also be given to handling contracts for vulnerable groups such as women in pregnancy, maternity or lactation period, employees with work-related injuries, and those on medical leave.

M&A involves complex legal issues, requiring companies to collaborate with professional lawyers for thorough evaluation and ongoing oversight to minimise employment risks and potential negative public opinion from collective disputes.

Xie Yanping is a partner at Zhilin Law Firm.