Earlier this year, China’s Supreme People’s Court of China promulgated various interpretations of various employment law issues.  These interpretations were intended to clarify and for the most part, they did.  In particular, what was once unclear about non-competes signed by China employees has now become much clearer.  I am not going to compare the old rules on China non-competes with the new rules, in large part because many of the old “rules” were less than clear.  This post is instead intended to set out what the new rules are so that you as a China employer can act accordingly.

Perhaps most importantly, the Supreme People’s Court has made clear the required compensation for a non-compete to be valid and to remain in effect.  If an employee agrees to a non-compete provision, but the labor contract or confidentiality agreement (signed by the employee) does not mention the compensation the employee must receive as consideration for not competing, and the employee has in fact not competed, the court can award the employee up to 30 percent of his or her average monthly salary. If a 30 percent award of the average monthly salary is less than the minimum salary standard in the city, the minimum salary must be paid instead. The Court also made clear that the employee is entitled to such compensation no matter what the reason is for the employee having not competed.  In other words, even if the employee’s not competing arises from the employee’s inability to find new employment, the employee is still entitled to compensation for not having competed.

The Court also clarified what it takes to terminate (or not) an employee non-compete:

  • An employer may terminate a non-compete agreement and thereby cease having to pay for that non-compete, so long as it pays the employee at least three additional months’ compensation for the non-compete.  In other words, three months notice is essentially required to terminate the compensation requirement
  • An employee may terminate a non-compete if he or she has not been paid for three the required non-compete compensation for at three months by requesting termination of the non-compete agreement. Note though that this non-payment has to be the fault of the employer; the employee cannot deliberately avoid payment in an effort to cancel a non-compete.

Certain aspects of non-compete agreements in China have not changed and remain important, including the following:

  • 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.
  • 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 non-compete 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.

Just as is true of any contract that you will eventually seek to/need to enforce in China, your non-compete/trade secret/employee contract should be written in Chinese as the official language.

Many American companies (at least outside California where employee non competes are generally considered invalid) love non competes and they use them as a matter of course with most (sometimes all) of their employees.  Generally a non-compete agreement or a non-compete provision in an employee contract provides that the employee cannot work for one of the employer’s competitors and/or engage in the same business as the employer.

The well crafted non compete provision is usually limited to a certain period of time following the employee’s termination and also usually limited geographically. Just by way of example: if you own a small sushi restaurant in Peoria, Illinois, a well-crafted non-compete with your sushi chef might prohibit him or her from working as a chef at another sushi restaurant within a 25 mile radius. The poorly crafted non-compete provision might prohibit him or her from doing anything in the food business anywhere in the world for the next five years.

For obvious reasons, courts are loathe to enforce over-broad non-compete agreements simply because they do not think it fair or right to preclude someone from making a living at their profession or craft, especially when doing so poses no real threat to anyone.  China’s laws on non-competes are not so different on this point, but they are quite different on others.

China’s Labor Contract Law specifically permits employers to include non-compete provisions in labor contracts or confidentiality agreements with their employees. But these sorts of provisions are valid only if all of the following are the case:

  •   The employee is senior management or a senior technical person. China’s courts take this requirement very seriously and few employees will qualify.
  •   The period of the non-compete and its geographic scope must be reasonable and the non-compete period must be for less than two years.
  •   The employer must pay the employee during the non-compete period or the non-compete provision ceases to be valid.

Note again that for the non-compete agreement to remain valid after the employee has left the company, the employee must continue receiving compensation from the company.  In other words, the employee must get paid for not competing.

How much must the employer pay the employee during the non-compete period?  We used to advise our clients to put in the contract this amount and to make it between 30 and 50% of the employee’s salary, depending mostly on the locale.  China’s Supreme Court recently issued some national level guidance on these payments and it appears that the terminated employee’s monthly compensation should be 30% of the employee’s average monthly salary over the previous year, or the local statutory minimum wage, whichever is higher.  This 30% should be deemed the minimum; employees may be able to negotiate a higher amount when signing their employee contracts.

We used to tell our clients that they “might as well” put in a non compete clause into their contracts with their high level employees since they would always be free to back out of any payment post termination if they wished.  I now have my doubts as to that advice going forward as the Supreme Court has said that though employers are free to terminate a non-compete clause at any time, they must pay three months compensation to do so. We will now be advising our clients to think a little longer and a little harder before just throwing in non-compete provisions.

What are you seeing out there with non-compete provisions in employee contracts?

This is the final part of a series arising from a speech I gave last month at a biotechnology conference in Washington DC.

In How To Protect Your IP From China. Part 1, I mostly looked at the risks China poses to intellectual property and very generally on how companies can determine how those risks should influence their actions.

In How To Protect Your IP From China. Part 2, I mostly focused on what I, as a lawyer, look at in trying to protect my clients’ IP from China and what you, the company, should be looking at and doing to protect your own IP.

In How To Protect Your IP From China. Part 3, I looked at the negotiating tactics Chinese companies so often employ in an effort to take advantage of your intellectual property.

In How To Protect Your IP From China. Part 4, I wrote on the basics of what goes into Chinese contracts, particularly those related to protecting your intellectual property.

In this part 5, I discuss some of the most common situations companies face where they must focus on protecting their IP.

  • Employees

Confidentiality agreements. In China, unlike in the United States, it is the norm to have a written employment contract with all employees. This is because not having a written agreement can lead to having to pay a year or more in salary to anyone you terminate.  You should use the written contract to your advantage by putting in a confidentiality provision that sets out your company information that must be kept confidential. Confidentiality agreements can protect company information that may not rise to the level of a trade secret, but they cannot be so broad as to protect everything.  China actually has very sophisticated trade secret laws — they come the US’s Uniform Trade Secrets Act — and the courts there are not bad at all in ruling favorably in favor of employers on confidentiality and trade secret cases.  But for you to be able to prevail, just as in the United States, the information you are seeking to keep confidential must have commercial value and you must make a reasonable effort to keep it away from the public.

Non Compete Agreements – These generally work in China only with very high level employees.  Very high level. And even then, they are enforceable only if they are: (1) not too long in duration and no longer than two years; (2) not too large in terms of geographic scope: and (3) do not restrain too much the employee’s opportunity to pursue his or her occupation.  Now here’s the real kicker on these:  you must pay your employee for the non-compete after his or her termination.  Limited to two years.  Typically, you must pay 20 to 50% of the employee’s salary, with the amount depending on the location in China.

Nonsolicitation agreements. Nonsolicitation agreements prevent employees from soliciting customers, former co-workers and/or agents upon separation from the company. These are usually enforced by China’s courts so long as they only prevent solicitation of the employer’s customers or accounts that existed at the time the employee left and so long as they are limited in duration and in geographic area.

It can be critical — especially for your employees doing R&D — that your employee contracts set forth who owns any intellectual property your employees help develop. You want a provision in your contract making clear that all IP developed by your employees belongs to the company and you want that because in China you run the real risk of your employees claiming ownership of what they developed. We also like to see a provision in the employee manual saying that any IP developed by company employees belongs to the company.

Contracts with your Chinese Distributers, Manufacturers, Joint Venture Partners, and Licensees should include the same sort of provisions relating to non-compete, non-solicition, and non-disclosure and they also should be clear about who owns what with respect to any IP.

 

  • Licensing Contracts

Three things you should be thinking about if you are licensing your IP to a Chinese company.

  1. Be careful about getting paid based on sales, unless you have some really good way of knowing what the sales really are.
  2. Get what you need to do the deal before you relinquish the technology.  Figure that the Chinese company will stop paying you after it has secured your technology.
  3. Register your licensing agreement with the proper governmental agency.  If you don’t, you run the risk of not being able to sue on it.
  • IP Registrations 

Just as in the US, you should register your IP in China to protect it.  There is no way can I go into great detail on what you can and should do to protect your IP in China through registration, but what I can tell you is that it almost always makes sense to do something.  Earlier I talked about how bad China is on IP and that is true, but if you have not done the proper registrations, you pretty much have zero chance of protecting your IP.  If you have done the proper registration, your chances are considerably better.

China’s IP registration and protection system is in many ways not all that different from that in the US.  Just as is the case here, China has patents, trademarks and copyrights.

Patents. China has invention patents, utility patents and design patents.  Invention patents are thoroughly reviewed before they are granted and so they can take quite a while.  Because of this, many companies will secure a quicker utility or design patent while waiting until their invention patent comes through.  Couple things you need to know about patents in China. First, if you do not file for your patent in China within a year of filing for it in the United States, you will be too late. China is a signatory of the Patent Cooperation Treaty and the Paris Convention, but Chinese patent lawyers tell me that it is better to file your patent in China.

China has had compulsory licensing of patents since 2001, but earlier this year the Chinese government came out with detailed criteria for the granting of compulsory licenses and that threw many into a panic, believing that the government was instituting compulsory licensing for the first time. These new rules really did not change much of anything and as far as I know, China has not in the last ten years required any company to compulsorily license its IP.

Trademarks are unique names, symbols, or logos. Can include colors. We trademarked a particular color of screws for a client. Don’t underrate trademarks in China. These work in China. China is a first to file country, not a first to use country, so generally, whoever files first for a trademark gets it. Trademarks cannot be place names. This is a bigger problem than you might initially think.  Another problem is that the people at China’s trademark office usually view acronyms as images and so if your company name is something like EVO and someone else has already registered the company name ECO, there is a very good chance your EVO name will be rejected as conflicting with ECO, because to someone who cannot read English, the two names look too much alike.  What this means is that if you have a two or three letter company or brand name, you had better try to register it now because it will only get tougher.  We used to get these approved all the time, but in the last year, we are succeeding only around 50 percent of the time.

Copyrights.  A lot cheaper and easier to obtain than patents and they last a lot longer. Very similar to the US. You do not need to file for a copyright in China to have a China copyright, as they arise automatically upon creation of a work created or first published in China, but you do need to have a registered copyright to sue on it and that’s the catch. In China, it takes so long to secure the registration of a copyright that if you are going to want to protect your copyright in China, you should file for it right away, because if you wait until you have a problem to file for the copyright, you may have a one-year lag before you can do much about it. Just like in the US, you don’t have to reveal all of your material in the copyright filing.  This is particularly important for something like computer code.

Stopping IP Theft.  If you have registered IP, and someone in China tries to use it without authorization, you can seek an administrative remedy by trying to get the Chinese government to do something about it or you can sue for damages. You also can try to get Chinese customs to stop any violating goods from leaving the country and, if you have your IP registered here, you can try to get US customs to stop it from entering into the US.

 

One of the most common calls my law firm receives is the one from someone saying that they want to “start a business in China.” The first thing we do with that sort of caller is to seek to ascertain whether a China business is actually necessary.  Forming and then operating a business entity in China is not fast, is not easy, and is not cheap. I usually convey this by asking the caller if they find it easy running a business in the United States (or Europe), what with having to figure out and pay taxes, rent, wages, vendors, etc.  I then point out that having a business in China means they will have to do the same thing over there. So whenever possible, we seek to determine whether there is some way the caller can conduct business with China, achieve its goals with respect to what it is seeking to do with China, while not having a business in China at all.  For potential alternatives to forming a China business, check out the following:

But if forming a China business does make sense, the next issue is what kind of business makes sense. On this, you typically have three choices: a Wholly Foreign Owned Entity (WFOE), a Joint Venture (JV), or a Representative Office.  These days, the overwhelming majority of foreign companies seeking to do business in China go in as a WFOE, but there are definitely still instances when a Joint Venture or a Representative Office makes sense.  For more on the differences between these three sorts of entities and on what it takes to form each of them, check out the following:

If you are going to have a China business entity, you are going to have employees (indirectly in the case of a Rep Office). That means you are going to need written employee contracts (it virtually always makes sense to have these in both Chinese and in English) and a written employee manual/employee handbook (again, in English and in Chinese).  You probably will want your employee agreements to speak to issues like trade secrets and non-competes (which are limited in China) and overtime.  For more on employee contracts and employee handbooks, check out the following:

The last thing you need to focus on if you are going to be doing business with China, particularly if you are going to be doing business in China, is protecting your intellectual property. In nine out of ten cases, this means registering your trade name and your other important trademarks in China. On some occasions, this also means registering your patents or copyrights in China as well. For more on registering your trademarks in China and protecting your IP there, check out the following:

The above are the four main issues confronting foreign companies seeking to do business in China. 1) Determine if a China company is necessary.  2) If a China entity is necessary, form the right one. 3) If you are going to have a Chinese company, you should have the proper employment contracts and employee manual.  4) If you are going to be doing business in China, you are going to need to take certain steps to protect your IP.

That was easy, wasn’t it?

Co-blogger Steve Dickinson wrote an email to a client the other day that nicely sets forth much of what is involved with China employment agreements and with China employee manuals.  Steve sent this email after having completed the first draft of the client’s employment contracts and its employee manual, both of which documents are absolutely essential for any company with an employee (foreign or domestic) in China.

Here is that e-mail:

We revised these documents to as closely as possible accord with the type of employment you will have in your China WFOE. Please review these documents and get back to us with your questions and comments.

Please note that the rules and regulations document is a virtual handbook on Chinese labor law. Most of the content in this is not optional; the terms are required by Chinese law. Review of the rules and regulations first will resolve many of your questions about other matters.

Please also note the following:

The labor contract requires you to set the term of the employment relationship and the term of the probation period. At the end of the probation period, you can terminate the employee with no further issues. At the end of the first term, you can terminate the employee and pay severance or you can retain the employee.

Under the current interpretation of the law in China, once the second term starts, you are required to retain the employee up to mandatory retirement age. Termination during that period requires good cause. We therefore recommend an initial period that is as long as possible to allow you the longest probationary period possible.

The probationary period should be treated seriously and no employee should be taken beyond the probation period unless you are clear that he or she will work out. We generally recommend a term of three years and a probation period of six months. Most of our foreign clients choose to do an initial term of one year. Most end up regretting  that decision.

The rules and regulations are the basis for the relationship between you and your employees. You can only terminate an employee for cause, and cause must be a violation of a written regulation. That is why the rules and regulations are so detailed and generally so negative in tone. If you have anything else you want included in the rules and regulations, please advise me now.

Since your employees will be dealing with your proprietary information, we have included an IP agreement for them to sign. Note that there is really no way to control their behavior through a non-compete agreement because they are not senior enough to be covered by such an agreement. Because you are going to essentially be limited to the terms of the IP agreement, you should review it carefully and let me know if you have additional concerns.

The sign off agreement is used to ensure that the employee agrees that he or she received all required documents.

Again, if you have any questions, please do not hesitate to ask. Our goal is always to provide you with documents that both comply and work with China’s laws, while at the same time maximizing your business objectives.

What do you think?