(By Lisa Li) In accordance with relevant laws of People’s Republic of China (“PRC), judicial interpretation by PRC Supreme People’s Court, judicial interpretation by local Superior People’s Courts and local regulations and based on the author’s research into and analysis of over two dozens of litigation cases from Shanghai and Beijing etc, the author elaborates on the application of laws on non-competition clauses from the perspective of Chinese employment law practice. The following is Part I of this topic on application of laws on non-competition clauses.[1]
1.Basic provisions on non-competition
The non-competition obligations under PRC Labour Contract Law (hereinafter referred to as “LCL”) mean the employees subject to confidentiality obligations (including senior management staff, senior technical staff and other employees subject to confidentiality obligations) shall, pursuant to their agreement with the employer, not be employed by any competing business, or independently / jointly conduct competing business activities which is the same as or similar to those of the employer within the agreed scope of geography and scope of activities during the employment and a subsequent term of not exceeding 2 years following the termination of employment. Obviously, term of non-competition obligations cover the term of employment and the agreed term following the termination of employment (the non-competition obligations for the latter period are referred to as “Post-Contractual Non-competition Obligations” below).
Following the implementation of LCL, there have been further interpretations on the application of laws on non-competition as set out in the PRC Supreme People’s Court’s Interpretation on Several Issues of Application of Laws on Trial of Labour Dispute IV (hereinafter referred to as “Judicial Interpretation IV”), including the payment standards of 30% of average monthly salary for the 12 months prior to the termination in the absence of an agreement on non-competition compensations, the employee’s right to claim termination of non-competition agreement due to the employer’s failure to pay non-competition compensations for three months, the employer’s right to unilaterally terminate the non-competition agreement by paying three additional monthly compensations during the post-contractual non-competition period, and so on.
2.Eligibility of employees subject to non-competition obligations
The LCL permits the employer and the employee to agree on non-competition obligations, aiming to protect the intellectual property and trade secret of the employer; however, the scope of employees subject to such obligations, the scope and term of non-competition obligations shall not be unlimited in order to achieve a balance between the employees’ employment related rights and interests and that of the employer.
The LCL limits the scope of employees subject to non-competition obligations to those senior management staff, senior technical staff and other employees subject to the confidentiality obligations. The LCL does not define who are senior management staff and senior technical staff. However the PRC Company Law’s provisions on senior management staff – managers, deputy managers and persons in charge of finance, board secretary of a listed company and other staff defined as senior management staff by the articles of association of the company – may be referred to. Companies may define the scope of senior technical staff and other staff subject to confidentiality obligations in their internal rules and regulations.
In practice, in case of a dispute over breach of non-competition obligations, certain cases searched by the author witnessed the argumentation of employees that they did not fall within the scope of employees subject to the non-competition obligations. In these cases, certain employees argued that they were not senior management staff and their scope of duties were not related to the employer’s trade secret, therefore they did not fall within the scope of employees subject to non-competition obligations. In one case heard by Shanghai Huangpu District People’s Court, the court expressed opinions on the scope of employees for non-competition obligations: the non-competition agreement shall be null and void if the employee did not obtain any trade secret of the employer – in this case, as the court considered that the employee must have known and obtained the trade secret of the employer during the employee’s conducting of business activities during employment term, the employee therefore was held eligible for the non-competition obligations (please refer to the case: (2014) Huangpu Min Yi (Min) Chu Zi No. 5596).
Consequently, it shall be deemed reasonable for employers to conclude non-competition agreement with employees who have access to the employer’s trade secret or intellectual property which requires to be kept confidential. The employers are advised to prudentially and reasonably define the trade secret, the scope of employees who may have access to the trade secret while enforcing appropriate confidentiality measures so as to reasonably determine the scope of employees subject to non-competition obligations. For those employees subject to non-competition obligations, where it is necessary to make them comply with the obligations following the termination of employment, the employer may conclude an agreement on the Post-Contractual Non-competition Obligations, for which they must pay compensations.
3.Geographic scope for non-competition obligations
The LCL allows the employer and the employee to agree on the geographic scope provided that it is not against the laws and regulations.
In one case heard by a court in Wuxi in 2014 (please refer to case: (2014) Xi Min Zhong Zi No. 1616), the employer located in Wuxi requested the employee to pay liquidated damages due to his breach of the non-competition obligations, the employee defended that the geographic scope was not clearly defined (both parties had agreed that the geographic areas of the competing business was not limited to Mainland China and Taiwan; the self-operating competing business was limited to the geographic scope where the employer was conducting businesses). The court ruled that the non-competition clause on the geographic area was reasonable without further explaining the reasons.
However, the Post-Contractual Non-Competition Obligations restrict the employee’s right to start new employment. From perspective of balancing the rights and interests of the employees and the employers, the employers are advised to consider their business characteristics, geographic areas of their businesses, the areas where competing businesses exist etc so as to determine the geographic areas of the non-competition obligations. As far as multinational corporations are concerned, they may define the geographic areas of domestic locations and certain overseas locations depending on the specific circumstances.
4.Whether non-competition compensations could be covered in salaries
The Reply from the PRC Supreme People’s Court to Queries from Journalists on the Judicial Interpretation IV clarifies that the non-competition compensations shall not be included in the salaries, which instead shall be provided to the employees on a monthly basis following the termination of employment.
In an appellant case heard by Beijing No.3 People’s Court in 2015 (please refer to (2015) No.3 Zhong Zi No. 06630), the employer and the employee had reached an agreement that the employer shall pay the employee a “confidential fee” as the compensation for the employee’s compliance with confidentiality and non-competition obligations after the termination of employment. The court pointed out that the non-competition compensations shall be compensations for the employee’s compliance with the Post-Contractual Non-Competition Obligations; consequently, the non-competition compensations in this case which had been paid together with the salary and which are allowed to be deducted according to the company’s internal rules, shall be regarded as not satisfying the basic characteristics of non-competition compensations. In another case heard by the same court (please refer to (2018) Jing 03 Min Zhong Zi No. 329), the court held that the compensation paid together with the salary did not satisfy the legal form of non-competition compensations, for which the employee had argued that it was in nature not non-competition compensations, and the employer shall still pay non-competition compensations to the employee.
Based on the above, employers are advised not to pay non-competition compensations together with the salaries and not to mix non-competition compensations with salaries. They shall make the payment after the termination of employment on a monthly basis.
5.Validity of the non-competition agreement without compensations
In accordance with the Judicial Interpretation IV, in case of lack of agreement on the amount of compensations or calculation method of compensations for non-competition obligations, the non-competition agreement’s validity shall not be impacted.
6.Validity of non-competition agreement not impacted by big gap between amount of compensations and that of liquidation damages
In several recent cases heard by Beijing’s courts that the author searched, the employees argued that the compensations agreed were less than the local minimum monthly salary while the amount of liquidated damages agreed was extremely high compared with that of non-competition compensations; in addition, the non-competition clauses were standard form clauses which exempted the liability of the employer, therefore it shall be null and void; alternatively, they argued that there was a very big gap between the compensations and the liquidated damages which was obviously unfair resulting in the possibility of rescinding or amending of the non-competition agreement.
For the above mentioned cases, the courts ruled that validity of the non-competition agreement shall not be impacted by the big gap between the compensations and the liquidated damages.
7.Amount of compensations to be paid in case of no prior agreement
In accordance with the Judicial Interpretation IV, in case of no prior agreement reached, the employees, if having performed their non-competition obligations, may request compensations at the rate of 30% of the average monthly salary during the 12 months prior to the termination, which shall also be not less than the local minimum monthly salary released by the local government.
In addition to the above national standards set by the PRC Supreme People’s Court, certain local areas set out local standards in case of no agreement reached on the compensation amount or calculation method thereof. Certain areas even set minimum standards regardless of whether the employer and the employee have agreed on compensations or not. The following is a non-exhaustive list of local standards (it is recommended to check the local applicable standards before employers determine the amount or calculation method of the compensations):
| Location | Standards of Non-Competition Compensations |
| Beijing | In case of no agreement, 20% – 60% of the employee’s salary for the last year prior to termination of employment may be referred to. |
| Shanghai | In case of no agreement, it shall be 20% – 50% of the employee’s previous normal salary. |
| Tianjin | It shall not be less than half of the employee’s salary standards and shall not be less than the local minimum salary standards. |
| Shenzhen | It shall be calculated based on a monthly basis and shall not be less than half of the employee’s average monthly salary for the 12 months prior to the termination. |
| Jiangsu | It shall be paid on a monthly basis and the monthly compensation shall be not less than 1/3 of the employee’s average monthly salary for the 12 months prior to the termination. |
| Suzhou | In case of no agreement, the monthly salary shall be not less than 1/3 of the employee’s average monthly salary for the 12 months prior to the termination. |
| Zhejiang | In case of no agreement or agreement on low amount of compensations, it may be paid at the rate of 30% of the average monthly salary for the 12 months prior to the termination; if such standard is less than the local minimum monthly salary, it shall be paid in an amount equal to such local minimum monthly salary. |
| Ningbo | The annual compensation shall be not less than 1/2 of the annual salary received by the employee for the year prior to the termination. |
8.Whether the compensations can be increased
The Judicial Interpretation IV only provides for the compensation standards for situations of lack of agreement. So does it in Shanghai and Beijing (for Beijing, it also sets out the minimum standards). However, certain local areas, such as Tianjin, Shenzhen, Jiangsu and Zhejiang, also set out the applicable minimum standards regardless of whether the employer and the employee have agreed on the compensation amount or calculation method. For the foregoing areas, the employee may request the court to increase the compensations to the local minimum standards if the compensations actually paid or agreed is lower than the local minimum standards.
Even for Shanghai where no minimum standards were set out for situations where both parties have agreed on the compensation amount or calculation method for the compensation which are less than local minimum salary, there are court cases in which the court ruled that the employer shall pay the compensations by referring to the currently applicable local minimum monthly salary (please refer to the case (2016) Hu 01 Min Zhong No. 13624).
Judging from several cases heard by Beijing’s courts where the compensation standards agreed were extremely low, the court considered that validity of non-competition agreement shall not be impacted but the employee shall be entitled to request increase of the compensation standards (please refer to Beijing No. 2 Intermediary People’s Court’s case: (2015) No.2 Zhong Min Zhong Zi No. 01824).
Based on the above, employers are advised to follow local standards when setting the non-competition compensation standards.
[1] Please note that this topic does not cover statutory non-competition obligations of senior management staff under the PRC Company Law, under which the senior management staff are statutorily required to follow non-competition obligations so as to protect the legitimate rights and interests of the company where they hold an office.
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