Employee Non-Compete Agreements In China. It's Complicated.

By Steve Dickinson

Chinese employment law presents many challenges to U.S. employers. One issue that causes much confusion is the proper use of non-compete agreements with Chinese employees. Before China adopted its Labor Contract Law (“LCL”) in 2008, it was common for foreign employers to require all of their Chinese employees to enter into non-compete agreements. This blanket use of non-compete agreements was never a good policy under Chinese law. This is because the Chinese labor arbitration board and the courts view non-competes with great suspicion as an infringement on the basic employment right of the employee. This is not unlike how US courts view these agreements.

Consistent with this basic hostility towards employee non-competition agreements, the LCL provides for clear provisions on such agreements. On the positive side, the LCL makes it clear that “reasonable” non-competition agreements are enforceable. On the other hand, the LCL provides a set of rules for non-compete agreements that significantly reduces their utility for employers. We find that many employers ignore the new rules and continue to operate under the old system. This has two bad results. First, the employer believes it is protected when it is not. Second, the inclusion of a provision that openly violates the terms of the LCL weakens other provisions that arguably comply with the law. The only rational course of action is to proceed in careful compliance with the law.

Non-competition agreements are authorized by Articles 23 and 24 of the LCL. The basic rules are as follows:

* An employment agreement may include provisions intended to protect the trade secrets of the employer. A non-competition agreement may be included in support of such protections.

* The employer must pay reasonable compensation on a monthly basis to the employee during the term of the non-competition period. There is no definition of “reasonable compensation.” Commentaries suggest employees should be compensated in a manner equivalent to their salary with the company. Others suggest that compensation is only required at the level of the current minimum wage in the relevant jurisdiction.

* Non-competition agreements are limited to executives, technical personnel and other personnel who have access to trade secrets. Cases have held that senior sales staff are included in this category. On the other hand, blanket agreements that apply to all employees are invalid.

* The terms of the restriction must be “reasonable” in length of restriction, business scope and geographic area. A term in excess of two years is prohibited. The scope requirement is strictly interpreted. It is not sufficient that the employee is working in the same general area as the former employer. Competition must be specific and direct.

* If the employee violates the terms of the non-compete agreement, the employee can be held liable for a payment of contract damages to the employer. The amount of contract damages must be reasonable. Excessive damages that are clearly punitive will be rejected.

We have seen many cases where employment agreements contain provisions that violate the requirements of the LCL. By far the most common issue is failure to pay compensation to the employee during the non-competition period. Many foreign employers strongly object to the notion of paying an employee to abide by the terms of a non-compete agreement. This is especially true when an employee voluntarily resigns and then goes to work for a potential competitor. However, the law is very strict on this issue. Reasonable compensation must be paid on a monthly basis. Failure to pay or a delay in payment voids the entire noncompetition provision. The vast majority of employee non-competition claims are rejected for failure to make payment. The requirement applies even if the employee has found employment elsewhere and does not “need” the compensation for not competing.

Employers simply need to face the fact that non-competition agreements have very limited utility under Chinese law. The better approach is to deal with the whole issue under the terms of a trade secrecy agreement. Employees are bound by the terms of any trade secrecy agreement they execute. Employees who will truly be exposed to trade secrets should be required to execute a non-disclosure and non-use agreement. Such an agreement will make the use of trade secrets in their new employment a contractual violation subject to action by litigation. The main issue is that the employer must prove that the employee is actually making use of trade secrets in the new position.

The most common reason such claims fail is that there is in fact no trade secrecy violation. For example, a common claim is that sales personnel are making use of the client list of the former employer. However, client lists that are kept in an open Rolodex or in an open file or in an open access computer file are not secrets. In other cases, the employee in fact had no access to trade secrets applicable to the claim. For example, a common claim is made against sales personnel, but the trade secret is highly technical information concerning the product. In this case, sales personnel can successfully argue that though the product is the same, they had no access to or ability to use highly technical information related to the product.