In previous posts, I talked about various legal issues surrounding China employee non-compete agreements/provisions. This post briefly explains how a non-compete contract damages provision works.
Generally speaking, an employer in China is not allowed to impose a penalty on one of its employees, not even by agreement. An employee non-compete agreement is one of the few exceptions to this rule. Although such an employee penalty is permitted by law, we usually advise our clients to avoid using the term “penalty” and instead use a specific contract damages (“违约金”) provision instead. By agreeing to such a provision, an employee agrees to pay a specific damage amount if he or she fails to comply with the non-compete provision.
In practice, the PRC courts will reduce the contract damage amount, if they think it is too harsh on the employee. For instance, in a Shanghai case involving an employee who clearly violated his non-compete obligations, the court nonetheless held that the contract damage provision to which he had agreed was too high to be enforced. That provision called for the employee to have to pay contract damages of five times the amount he could receive in non-compete compensation. The court reduced the amount of the contract damages, but did not throw out the concept of payment entirely.
The good news for China employers is that just as is true generally of contract damages provisions, the amount listed is not a ceiling. In other words, an employer is free to argue to a court that its employee be required to pay an amount even higher than that listed in the contract damages provision if it has some basis for asserting that its actual amount of damages exceeds the previously agreed to contract damages.
Also good for the employer is that pursuant to the Interpretation (IV) of the Supreme People’s Court on Several Issues Regarding the Application of Laws for the Trial of Labor Dispute Cases (最高人民法院关于审理劳动争议案件适用法律若干问题的解释(四)), an employer has the right to require its employee to continue to perform his or her non-compete obligations (provided it is still within the non-compete period) even though the employee has paid contract damages for violating the non-compete agreement. In other words, the employee cannot simply pay contract damages to get out of his or her non-compete obligations.
So even though there is some risk that an arbitrator/judge may end up adjusting the contract damages amount you set forth in your China employment contracts, (just as is true for China commercial contracts) contract damages often make sense in employee non-compete agreements, especially if you choose an amount that is neither too high nor too low, but just right.
For more on China employee non-competes, see China Non-Competes, China Non-Competes. Oh, Oh, The Price You’ll Pay, and How To Terminate A China Employee Non-Compete Agreement. Very Carefully. For more on China contract damages (a/k/a liquidated damages) provisions, check out How To Write A China Contract. Liquidated Damages and The Effective China Contract: Liquidated Damages.