(By Lisa Li) The following is Part II of the topic on application of laws on non-competition clauses from perspective of Chinese employment law.
1.Termination of non-competition agreement
Article 4 of the Judicial Interpretation IV stipulates that if there are non-competition obligations and compensations agreed in the employment contract or confidentiality agreement, the employer’s failure to pay the compensations for three months will entitle the employee to request terminating the non-competition agreement. In accordance with the wording of these provisions, the employee has the right to request terminating the non-competition agreement, however the non-competition agreement shall not end automatically. However, local practice varies from place to place; even the same court rendered different judgments for similar cases according to the search conducted by the author.
Where there is an agreement on conditions triggering termination, such agreement may prevail under specific situations. For one appellant case of an employer claiming liquidated damages against an employee heard by Beijing No. 3 Intermediary People’s Court (please refer to the case: (2017) Jing 02 Min Zhong No. 9966), the court ruled that the agreement between the employer and the employee on release of non-competition obligations in case of failure to pay two months’ compensations, shall be effective. Moreover, as the employer confirmed that it had not paid compensations to the employee, the court ruled that the non-competition obligations of the employer were released.
Where there is an agreement on conditions triggering termination, such agreement may not be necessarily enforceable under specific situations. In a recent case of an employee claiming non-competition compensations against an employer heard by the same court, Beijing No. 3 Intermediary People’s Court (please refer to the case: (2018) Jing 03 Min Zhong No. 329), the non-competition clauses stipulated that the employer’s failure to pay non-competition compensations shall be deemed as release of the employee’s non-competition obligations; the employer delivered notice of releasing the non-competition obligations and sent SMS to the employee, for which the employee did not accept but allege that he had observed the non-competition obligations. The court ruled that the employer shall still pay three months’ compensations to the employee in order to terminate the non-competition agreement. In this case, the court did not confirm the effectiveness of the termination conditions but rendered the judgment directly based on the provisions of paying three months’ compensations to terminate the non-competition agreement by the employer as stipulated in the Judicial Interpretations IV.
From the two cases above, it may be concluded that arguments of employees that the agreement of an employer failing to pay the compensations constitutes termination conditions is valid may be accepted by the court; to the contrary, the same arguments from the employer by circumventing the Judicial Interpretation IV’s requirement of paying three months’ compensation as a condition for the employer to terminate the non-competition agreement may not be accepted by the court.
The author also noted that the Meeting Minutes of the Symposium on Issues of Application of Laws on Labour Disputes by Beijing Superior People’s Court and Beijing Municipal Labour Dispute Arbitration Committee mentions that if the employer explicitly expresses that it will not pay the compensations, the non-competition agreement shall not be enforceable against the employees.
There are also local provisions of Zhejiang Province that where, after the termination of employment, the employer fails to pay the compensations for three months and the employee conducts competing activities thereafter, it shall be deemed that the employee has implied terminating non-competition agreement by his/her behaviors and the employer’s claims of requesting the employee to bear liabilities for breach of non-competition agreement shall be rejected by the court (please refer to Zhejiang Superior People’s Court No. 1 Civil Trial Court and Zhejiang Labour and Personnel Dispute Arbitration Committee’s Clarifications and Replies to Several Issues on Trial of Labour Dispute Cases (III)).
Based on the above, it is not recommended to rely on the agreement of releasing the employee’s non-competition obligations on conditions of failing to pay compensations; the employers are advised to prudentially assess, prior to termination of employment, if it is necessary to require respective employees to follow Post-Contractual Non-Competition Obligations; if they are not necessary to be bound by such obligations following termination of employment, employers shall make sure to deliver the notice of releasing obligations prior to the termination day and properly keep the evidence of serving such notice. Otherwise, if the employee argues that s/he has performed non-competition obligations while the employer is not possible to prove that the employee did not perform the non-competition obligations, the employer shall still be liable for paying compensations. As for those employers who require the employees to follow such obligations, they shall make sure to pay the agreed compensations in full and in a timely manner.
2.Identifying a breach of non-competition obligations
If there is an explicit list of competitors included in the non-competition agreement, it will be relatively easy to convince the court that the employee is in breach of his/her non-competition obligations once the employer proves that the employee went to work/holds a position at the entity included in the foregoing list of competitors. However, in practice, it may not be so feasible to make an exhaustive list of competitors.
From the cases of Beijing and Shanghai the author searched, most of the courts followed the two-step approach to ascertain if the employee breached the obligations: (a) to check if the employee worked or held an office at another entity within the term of non-competition obligations; and (b) whether such entity deals in the same or similar business. In most of these cases, the courts compared the registered business scope of such entity with that of the employer. Overlapping of business scope seems to be a determinant factor for most of the courts to ascertain if it constitutes competing business.
It is worthy of noting that in one case heard by Beijing No. 1 Intermediary People’s Court (please refer to (2015) No. 1 Zhong Min Zhong Zi No. 4942), the court expressed different opinions on identifying whether it constitutes competing business – it held that overlapping of registered business scope shall not be regarded as a determinant factor to identify competing business as the actual scope of business activities of entities is usually inconsistent with the registered business scope; therefore it is inappropriate to enlarge the scope of non-competition obligations and the employer alleging breach shall prove that another entity is competing with the employer, e.g., they participated in the same bidding projects, for which the employer shall bear the burden of proof.
Based on the above, whether there is overlapping of registered business scope between the former employer and the new entity where the employee works or holds an office may generally constitute a determinant factor for courts to ascertain competing business. In addition, the actual scope of business activities by the new company may also be a factor to ascertain if it is competing business. If an employee under Post-Contractual Non-Competition Obligations is not sure whether the new employer is a competitor competing with the former employer, the employee may request the new company to assess if they engage in competing business. If not and if that is feasible, it is necessary for the employee to confirm with the former employer in this regard in order to prevent subsequent dispute over breaching non-competition obligations or payment of liquidated damages.
3.Payment of liquidated damages by employees in breach of non-competition obligations
The term of non-competition obligations covers the term of employment and the period for Post-Contractual Non-Competition Obligations. For several cases the author has seen, the court upheld the employers’ claim of liquidated damages against the employees by lowering the amount of liquidated damage to a reasonable extent.
4.Upholding of employer’s claim of returning compensations
As a consideration for employers to pay non-competition compensations, the employees shall comply with the non-competition obligations. Accordingly, in case of the employee failing to perform the agreed non-competition obligations, the employer is under no obligation to pay compensations for the period during which the non-competition obligations were breached. If the employer has paid compensations, the employer shall be entitled to request return of compensations on a pro-rata basis.
In a case heard by Beijing No.3 Intermediary People’s Court (please refer to (2015) No. 3 Zhong Min Zhong Zi No. 04017), the employer and the employee agreed on Post-Contractual Non-Competition Obligations and the employee enrolled in a university to study for a full-time master’s degree intended for directed education after termination of employment and claimed payment of non-competition compensations against the employer. In the case of first instance, the court ruled that the employee shall not be entitled to non-competition compensations for the period when the employee was studying for his master’s degree, as he was not possible to conclude any employment relationship with any entities as a result of the directed education which was the employee’s own choice to suffer from the loss of unemployment by continuing the full-time study for the master’s degree (the loss for unemployment was incurred because of the employee’s own choice instead of performing non-competition obligations), and therefore the employer shall be under no obligation to pay the compensations. In the case of second instance, the court, i.e., Beijing No. 3 Intermediary People’s Court, ruled that the employer was under no obligation to pay compensations based on the fact that the employee breached the non-competition obligations by working at competing entities.)
For several other cases of Beijing and Shanghai the author searched, all the courts involved ruled return of compensations by the employees, provided that they had been convinced that the employees breached the non-competition obligations.
Regarding if all compensations shall be refunded in case of employee’s breach of obligations, Zhejiang Province’s provisions may be referred to. The Reply and Clarifications of Zhejiang People’s Superior Court No. 1 Civil Trial Court and Zhejiang Provincial Employment and Personnel Dispute Arbitration Commission on Several Issues of Trial of Employment Dispute Cases III provides that in case of one lump sum payment already made by the employer, the compensations shall be returned on a pro-rata basis in accordance with the length of breaching period.
5.Amount of liquidated damages may be adjusted
The Notice of the PRC Supreme People’s Court on Issuing Meeting Minutes on National Civil Case Trial Work (Fa Ban [2011] 442) clarified that the claims of employees or employers for adjusting the amount of liquidated damages may be upheld if the liquidated damages agreed in the contracts are much higher or lower than that of the actual loss.
For plenty of cases of Beijing and Shanghai searched by the author, in which the employers sued the employees for extremely high amount of liquidated damages as agreed in the non-competition agreement, the courts referred to the judicial interpretations of PRC Contract Law and rendered judgement with a decreased amount of liquidated damages at their own discretion.
The author summarized the following factors referred to by the courts to lower the extremely high amount of liquidated damages agreed in the contract:
- Length of the employee’ working period at the employer;
- Status of performing the employment contract;
- Salary standards;
- Position of the employee;
- Extent of the employee’s subjective fault;
- Actual losses caused to the employer due to the breach;
- Whether the liquidated damages agreed are reasonable compared with the employee’s remuneration standards;
- Proportion of the employee’s compensations against the remuneration;
- Proportion of the compensations against the liquidated damages;
- Length of period for operating competing business and business cope thereof;
- Impact of the breach;
- Principle of fairness;
- Principle of good faith;
- Anticipatory benefits.
6.Competing company not liable for employee’s breach?
Non-competition obligations are contractual obligations instead of statutory obligations (the non-competition obligations of senior officers under corporate law are not discussed herein). Consequently, claims of requesting liquidated damages based on the non-competition agreement were usually upheld by the courts. However, claims of requesting the competing company to bear joint liabilities based on the non-competition agreement were rejected by the courts in the cases the author searched. From perspective of contractual nature of the non-competition obligations, the competing company is not a party to the non-competition agreement and there shall be no legal basis for the competing company to be jointly liable for the employee’s breach of obligations.
So will there be no legal risks for the competing company in case of its employees beaching their non-competition obligations towards the former employers? It is not necessarily the case. If the competing company is aware that the employer is/has been using the former employer’s confidential information but intentionally or negligently consent to or implied the employee to make use of such confidential information for the benefit of the competing company’s business, the former employer shall be entitled to launch infringement cases (by referring to cause of action such as trade secret infringement, unfair competition etc) claiming stopping infringement and compensating losses.
Therefore, companies are advised to require job applicants to disclose if there are any contractual agreements with other entities restricting their right to establish employment with them and request them to provide written commitment when recruiting senior management staff, senior technical staff and other employees which may be subject to confidentiality obligations.
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Lisa Li
E-mail: lisa.li@debund.com
Tel: +86 158 0196 9276 /+ 86 21 5213 4257
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