China Employee Non-Compete Agreements: It’s Complicated.

eating dog in China

Chinese employment law presents many challenges to foreign employers. One issue that often causes 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 their Chinese employees to enter into non-compete agreements. This blanket use of employee non-compete agreements in China was never a good policy because China’s labor arbitration board and its courts have always viewed non-competes as infringing on employees’ basic rights This is not unlike how most countries 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 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 reduce their utility for employers. My law firm’s international employment lawyers find that foreign companies with Chinese employees often ignore the new non-compete rules and continue trying 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, which set out the following basic rules:

  • 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.
  • Employee competition restrictions 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.

Our employment lawyers have seen many cases where employment agreements contain provisions that violate the requirements of the LCL. By far the most common issue is failing 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 and failing or delaying payment voids the entire non-competition provision. The vast majority of employee non-competition claims are rejected for failure to make payment. This payment requirement applies even if the employee has found employment elsewhere and does not “need” the compensation for not competing.

China employers need to face the fact that non-competition agreements usually have limited utility under Chinese law and oftentimes the better approach is to use 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.

A lack of a trade secrecy violation is the most common reason we see for trade secret claims failing in China. For example, a common claim is that sales personnel are making use of their former’ employer’s client list. However, client lists that are easily accessible to nearly all employees are not a trade secret. In other cases, the employee in fact had no access to trade secrets applicable to the claim.

What are you seeing out there?

8 responses to “China Employee Non-Compete Agreements: It’s Complicated.”

  1. Steve
    Excellent and very useful post. Just finishing our new Employee Manual so your comments are timely. I had always felt that excessive restrictive convenants on staff were inappropriate restraint of trade that would fall over in most jurisdictions. As such, I’d restricted our Employee Manual focus to trade secrets, databases, customer lists and other internal information.
    I’d prefer to make our company an employer of choice, rather than threatening employees with sanctions should they choose to leave and work for a competitor.
    Your post suggests this approach is correct and that even if we had proceeded to include clauses on subsequent employment, it would not be valid.

  2. What if you have a non-compete clause and at the end of the work term, either by dismissal or voluntary resignation, the employer decides not to enforce the non-compete, can the employee make a claim for the non-compete.
    Also, if you do decide to enforce the non-compete, can you just make a one off lump-sum payment for the full amount owed for the non-compete period, rather than paying monthly?
    Any advise?

  3. Anon,
    1. The answer to your first question might very well depend on the language of the non-compete.
    2. If I were to do this, I would secure a signed release from the employee with respect to what is being done.

  4. I guess it shouldn’t need pointing out that this is an area where China is more reasonable and more in-tune with global norms than the United States is. NCA’s and NDA’s are most often simply used as a way of restricting an employee’s freedom of action and locking them into the company, rather than to actually prevent unfair competition or protect confidential information/trade secrets. The right to work is a human right, and at least in this small area, China is a better defender of those rights than the US is.

  5. One should point out that NCA’s in the United States are a matter of state law. Some states (notably California) ban them outright, and it’s been argued that the success of Silicon Valley is because California bans NCA’s.

  6. I have some question about the non-competition clause. For example, Labour contract signed on January 10, 2008, has clause that prohibits employer from working for competitor for 3 Y. this clause still valid or not?

  7. Great post! I was wondering what the typical outcome of non-compete cases are for employees that are found guilty in court for violating a non-compete. Of course it depends on the extent, but I was wondering what the arbitration process is and some example results of cases that have been tried.

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