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) 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 Purpose and Use of Non-Compete Agreements
A Non-Compete Agreement is a contract where one party agrees not to compete with the other. These agreements reduce the likelihood of someone using information you provide them to compete against you. Non-compete agreements are common between Western companies and their more important employees, and it is common for those Western companies to want similar such agreements with their China-based employees.
Key Elements of a Well-Crafted China Non-Compete Agreement
The well-crafted China non-compete agreement/provision is usually limited to a certain time period following the employee’s termination and usually limited geographically. Just by way of an example: if you own a small sushi restaurant in Peoria, Illinois, a well-crafted non-compete with your sushi chef might prohibit that person from working as a chef at another sushi restaurant within a 25-mile radius for a year. The poorly crafted non-compete provision might prohibit them from doing anything in the food business anywhere in the world for the next five years.
For obvious reasons, courts are loathe to enforce overly broad non-compete agreements because it is neither fair nor 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 Laws on Non-Compete Agreements
China’s Labor Contract Law specifically permits employers to include non-compete provisions in their employees’s employment contracts, but these provisions are valid only if the following are all true:
Only some China employees can be bound by non-compete agreements. Employee non-compete agreements are generally limited to senior management, senior technicians, and other personnel who have confidentiality obligations. Senior management usually means a management level person who has access to company confidential information. Senior technician usually means someone who engages in technology research and development and who has access to company technology information. Whether an employee is deemed 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 getting access to and using confidential information
- Whether the employee has signed a confidentiality agreement with its employer
The duration of the non-compete is for two years or less. China’s employment laws generally limit employee non-compete periods to a maximum of two years from the date on which the employment contract ends or gets terminated.
You compensate your employee for not competing. Chinese law requires employers compensate their employees for agreeing not to compete during the entire post-employment non-compete period and failing to pay this required compensation will free up the employee to compete. Therefore, it’s best to have a non-compete compensation provision that specifies how much you will pay or how the amount of the compensation will be calculated. If there is no written agreement regarding the amount of an employee’s compensation for not competing, 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. However, as is true with just about everything involving Chinese employment law, there are local differences regarding the required amount for non-compete compensation. See China Employment Contracts: Localization is Key.
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.
Determining Non-Compete Compensation
How much must the employer pay the employee during the non-compete period? We used to advise our clients to put this amount in the contract and to make it between 30 and 50% of the employee’s salary, depending mostly on the locale. But China’s Supreme Court issued some national level guidance on these payments and a terminated employee’s monthly compensation typically should be at least 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 they “might as well” put a non- compete clause in their employment contracts with their high-level employees since they would be free to back out of any payment post-termination if they wished. However, since China’s Supreme Court has held that employers are free to terminate a non-compete clause but in doing so, they must pay three months compensation, we now usually advise our clients to think longer and harder before just throwing in non-compete provisions.
Precedence of Agreements and Local Variations
Pursuant to 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”), if there is an agreement between an employer and an employee regarding post-employment compensation for a non-compete provision, their agreement prevails. If the agreement is silent on the amount of post-employment compensation for the non-compete provision, the employer must pay the employee compensation at 30% of the employee’s average monthly salary in the 12 months before termination, or the local minimum wage, whichever is higher.
Before Judicial Interpretation IV, there was no statutory guidance (other than Labor Contract Law which does not say much) on the standard of non-compete compensation and locales dealt with this issue by coming up with their own rules. For example, Shanghai used to hold that if there was no agreement on the amount of post-employment compensation, the employer had to pay the employee 20% to 50% of the employee’s last monthly salary. In Jiangsu, the rule was different: the annual non-compete compensation had to be at least one third of the annual salary the employee received from the employer over the 12 months before leaving employment. Though Judicial Interpretation IV is supposed to supersede all the local rules, it is nonetheless advisable to check with the relevant authorities to figure out exactly what their standard as we still occasionally find local differences.
Enforceability of Non-Compete Agreements in Chinese Courts
A literal reading of Judicial Interpretation IV would mean that even if the amount of compensation agreed to in a non-compete agreement between an employer and an employee is less than the local minimum wage, it is nevertheless valid and enforceable, because the 30% rule applies only when the non-compete agreement does not specify the compensation. But ex-employees could also argue that any amount less than the minimum wage is unfair and against public policy and thus should not be enforced. Some municipalities faced with this argument, including Shanghai have upheld the “freedom to contract” and ruled against the poorly paid ex-employee.
Non-Compete Agreements in Practice
China employee non-compete agreements are legally complicated and foreign companies constantly get burned by them. For example, if you as an employer agree to a non-compete for, say two years (the maximum non-compete period you can impose under Chinese law), you must pay your ex-employee for two years after he or she leaves, and this is true even if you no longer care about the employee competing with you; otherwise you are in breach of your contract with what has now become your ex-employee. In our experience, about half the time foreign employers are better off not using a post-employment non-compete at all. The trick is figuring out which half your company falls in.
Drafting Clear Non-Compete Provisions
Another key to China employee non-competition agreements is to draft the non-compete provisions (in Chinese, of course) in a clear and easy-to-understand manner so that your employee cannot claim confusion and so that the specified non-compete compensation will not trigger a default compensation rate.
Enforceability of Non-Compete Agreements in Chinese Courts
Our China employment lawyers have over the last few years been seeing a trend where the courts in China’s major business cities strictly enforce contractual non-competes even when the non-compete compensation in the employment contract is very low. However, we advise our clients to provide for non-compete compensation at least greater than the local minimum wage to minimize the likelihood of their having to defend their non-compete compensations before a Chinese court.
China Allows for Contractual Penalties Against Employees that Breach their Non-Compete Agreements. Employee non-compete agreements are one of the few instances where China employers are allowed to impose a penalty on their employees. This can be done with a contract damages provision requiring the employee pay a specific damage amount for failing to comply with the non-compete provision. But for non-compete contract damages to be effective, they must be reasonable. If a Chinese court or arbitral body determines your contract damages are too high, it will reduce this amount or maybe even eliminate it entirely. For the difficulties inherent in coming up with an appropriate contract damages amount, see On the Importance of Contract Damages in China Contracts.
Permissible Geographic scope of China Employee Non-Competes. The geographic scope of your employee non-compete must also be “reasonable.” The Chinese courts and arbitral bodies consider all sorts of facts in determining whether the geographic scope of an employee non-compete is reasonable, including the employee’s position, the employer’s business scope and size and industry.
Chinese courts do not usually strike down non-compete provisions solely because its geographic scope is too great; they instead will usually simply reduce its geographic scope. Because it is nearly impossible to expand the scope of an employee non-compete in court, we usually advise our clients to make their non-compete agreements geographically broad, but not so broad that the court will throw up its hands and strike the whole thing.
Employers May Not Terminate an Employee Non-Compete Agreement Early. China employers are not allowed to unilaterally terminate a non-compete agreement without being subjected to a penalty and employers that do so during the non-compete period must pay the employee three additional months of non-compete compensation for the early termination.
Employers Must Pay the Required Non-Compete Compensation. A China employee may unilaterally terminate a non-compete if its employer has failed to make its required non-compete compensation payments for three months or longer, so long as the employee performed his or her non-compete obligations. In other words, if you want your non-compete agreement to remain in force you must pay for it.