China’s labor laws allow an employer and an employee to enter into a non-compete agreement or agree on a set of non-compete provisions (usually in the employment agreement or a confidentiality agreement) that prohibits the employee from competing with the employer for up to two years after the employment term.
Who can be subject to a non-compete?
China employee non-compete agreements are generally limited to senior management, senior technicians and other personnel who have a confidentiality obligation. “Senior management” usually means a person in a senior management position with access to the company’s confidential information. A “senior technician” usually means someone engaged in technology research and development, and who has fairly comprehensive access to the company’s technological information. Whether an employee falls under the category of “other personnel who have a confidentiality obligation” is determined on a case-by-case basis by considering all relevant facts, including the following:
- The employee’s compensation
- The employee’s job title
- The employee’s responsibilities
- The likelihood of the employee’s gaining access to and making use of the confidential information
- Whether the employee also signed a confidentiality agreement with the employer
- Whether the employee is suffering a financial hardship in his or her post-employment period and the extent of that hardship
The PRC Labor Contract Law limits the non-compete period to no more than two years. The two-year period starts to run from the time the employment contract ends or gets terminated. Some local rules set forth a permissible period longer than this two-year statutory maximum, but the Labor Contract Law must be followed here. As our regular readers know, we are always stressing the need to comply with the national, the provincial and the local laws and this is especially true with labor laws. See China Employment Law: Local and Not So Simple. It is important, however to distinguish between a situation where there is no national guidance or the national law is ambiguous or not detailed and a situation where there is a clear national law and the local rules clearly conflict with the applicable national law. In the latter case, the national law typically prevails. We virtually never say this, but it is almost always best to leave to your China lawyer the task of figuring out how to harmonize two or more laws.
In exchange for an employee’s promise to uphold a non-compete requirement, the employer is required to pay economic compensation to the employee. An employer’s failure to pay the non-compete compensation means the employee can stop abiding by the non-compete provisions.
Under the Judicial Interpretation IV of the Supreme People’s Court on Several Issues Concerning the Application of Law in Hearing Labor Dispute Cases (“Judicial Interpretation IV”), the amount set forth in an agreement between an employer and an employee regarding post-employment compensation for a non-compete provision will prevail. If the agreement is silent on the amount of post-employment compensation for the non-compete provision, the employer must pay the employee 30% of the employee’s average monthly salary in the twelve months before termination, or the local minimum wage, whichever is higher.
Notwithstanding the issuance of Judicial Interpretation IV, we are still finding local differences regarding the required amount for non-compete compensation.
One question is whether a non-compete compensation provision will be upheld if the agreed-upon amount is less than the local minimum wage. We have seen a trend among Chinese courts in major cities to strictly enforce contractual non-competes even when the agreed-upon non-compete compensation is extremely low. However, for avoidance of doubt and to avoid triggering the default rule, we advice our clients to specify non-compete compensation greater than the local minimum wage.
Contract damages provision
An employee non-compete agreement is one of the few instances where a China employer is legally allowed to impose a penalty on an employee. This is done via a specific contract damages provision. 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.
The standard is simple: the contract damages must be a good-faith estimate of the employer’s damages in advance. If a PRC court or other arbitral body considers your contract damages amount too high and thus too harsh on your employee (an argument virtually every employee will make), it will reduce this amount or perhaps even eliminate it entirely. For the difficulties inherent in coming up with an appropriate contract damages amount, check out China Contract Damages: More Art Than Science.
An employee cannot simply pay contract damages to get out of his or her non-compete obligations. The employer may demand its employee continue to perform his or her non-compete obligations (provided it is still within the non-compete period) even if the employee has paid contract damages for violating the non-compete agreement.
The standard here is quite simple: the geographic scope must be “reasonable.” In determining what constitutes a reasonable geographic scope for a non-compete, the Chinese courts will consider all facts, including the employer’s business scope, the employer’s size, the employer’s industry, and the employee’s position.
It usually makes sense to make your geographic scope as expansive as you deem appropriate because Chinese courts do not usually strike down a non-compete provision simply because its geographic scope is too broad. They will usually instead employ what is sometimes called the “blue-pencil doctrine” to reduce the geographic scope of the agreement, but leave it intact. On the flip side, it is nearly impossible to expand the scope of a non-compete in court. This means that you want your non-compete agreement to tilt towards the broad side, but not be so broad that a court throws up its hands and strikes the whole thing.
Once the non-compete period has begun, employers cannot terminate a non-compete agreement without being subjected to a penalty. Pursuant to Judicial Interpretation IV, employers that unilaterally terminate a non-compete agreement during the non-compete period must pay the employee three additional months of non-compete compensation for the early termination.
Keep in mind also that if you fail to make compensation payments for three months or longer, the employee has the right to unilaterally terminate the non-compete, provided the employee has performed his or her non-compete obligation and is not the cause for the employer’s failure to make payments. So if you want your non-compete agreement to remain in force, you should be sure to pay on it.