By Amy Dai
The Interpretation (IV) of the Supreme People’s Court of Several Issues on the Application of Law in Trial of the Labor Dispute Cases (the “Interpretations (IV)”) became effective as of February 1, 2013. There are 15 clauses provided under the Interpretations (IV), among which 5 clauses are related to non-compete covenant. This article, based on the Interpretations (IV), is going to look into and analyze certain hot issues concerning the non-compete covenant in practice.
The non-compete mechanism is designed to protect the employer’s trade secrets, for which it is provided that: (A) on the one hand, within a certain period following the termination or expiration of a labor contract (and which period shall not exceed two years in accordance with the relevant PRC labor-related laws) (the “Non-compete Period”), an employee who bears confidentiality obligation (the “Quit Employee”) shall not (a) work for a person who (i) competes with his/her former employer and (ii) produces or trades in such products or engages in such business as his/her former employer does, or (b) establishes his own business to produce or trade in such products or engages in such business as his/her former employer does[Endnote 1]; and (B) on the other hand, the former employer shall provide the Quit Employee with certain amount of economic compensation (the “Non-compete Compensation”) for the employee’s observance of the non-compete covenant. Thus, under the non-compete mechanism, the Quit Employee shall enjoy and assume certain rights and obligations as to his/her former employer, and vice versa.
I. Where the Non-compete Compensation is not specifically provided under the non-compete agreement, shall the non-compete agreement be still valid?
In Practice. In order to protect their own trade secrets to the fullest extent, many employers, in practice, required the Quit Employees to enter into the non-compete agreements with such employers, respectively; while on the other hand, such employers are not willing to specify the exact amount of Non-compete Compensation for the cost-effective purpose. The arising issue is that whether or note the non-compete agreement is valid under such circumstance. Before promulgation of the Interpretations (IV), judicial authorities of different places held different views. For example, (i) the competent authorities in Shanghai and Beijing opined that the non-compete agreement shall be valid regardless of whether or not the exact amount of Non-compete Compensation is specified thereunder; while (ii) the competent authorities in Guangdong province held that the non-compete clauses shall have no binding effect as to the Quit Employee (in the case that the exact amount of Non-compete Compensation is not specified thereunder); and (iii) the competent authorities in Jiangsu province adopted the concept of “relatively invalid”, which means that (if the exact amount of Non-compete Compensation is not specified thereunder) the non-compete agreement shall have no binding effect as to the Quit Employee, but once the Quit Employee observes the non-compete covenant, such Quit Employee shall have the right to require the former employer to pay the Non-compete Compensation.
New Rules. It is clearly prescribed in the Interpretations (IV) that the Non-compete Compensation provision is not a requisite for the validity of the non-compete agreement, namely the lack of Non-compete Compensation provision would not certainly affect the validity of the non-compete agreement[Endnote 2].
Analysis. The reason why Interpretations (IV) prescribed as such is that it would be unfair to the Quit Employee if the whole non-compete agreement is held invalid for the lack of Non-compete Compensation provisions while the Quit Employee has observed his/her non-compete covenant. On the other hand, once a non-compete agreement was entered into by and between the Quit Employee and his/her former employer, the Quit Employee shall have the obligation to perform the non-compete covenant regardless of whether or not the Non-compete Compensation was provided. In other words, the Quit Employee cannot claim that he/she is not subject to the non-compete agreement merely due to the lack of Non-compete Compensation provision.
Attention/Suggestion. Both the employer and employee should be cautious on non-compete agreement, once it has been signed, neither party could claim invalidation merely due to the lack of Non-compete Compensation provision. Furthermore, both parties should do their best to specify the amount of Non-compete Compensation; otherwise, a mandatory amount of Non-compete Compensation per month shall be imposed, which amount shall be equal to 30% of the employee’s average salary over the twelve-month period preceding the termination or expiration of the labor contract[Endnote 3]. If a specific amount of the Non-compete Compensation is provided thereunder, such specific amount shall prevail, but if such amount is far too low, it may be subject to adjustment made by the competent courts or arbitration tribunals.
II. Could Non-compete Compensation be included in the paid salaries?
In practice. Under many existing non-compete agreements, the Non-compete Compensation is provided as follows: “the salaries paid to the employee has taken into account the Non-compete Compensation”. Then, is such clause viable?
New rules. “Non-compete Compensation cannot be included in Quit Employee’s paid salaries, and it should be paid to the employee on a monthly basis during the Non-compete Period.”[Endnote 4] The Labor Contract Law has already provided the foregoing, and the Interpretations (IV) reaffirmed it this time.
Attention/Suggestion. Where an employer requires the Quit Employee to perform the non-compete obligation by claiming that the Non-compete Compensation has been included in the Quit Employee’s paid salaries, such request could be hardly upheld by the competent court. Therefore, if the employing unit ascertains which employees need to perform the non-compete obligation after termination or expiration of the labor contract, it would be advisable for the employer to pay the Non-compete Compensation on a monthly basis (during the Non-compete Period) rather than pay it as a part of salary.
III. Whether the validity of the non-compete covenant will be affected by the employer’s failure to pay the Non-compete Compensation?
In Practice. Before promulgation of the Interpretations (IV), many people held the views that the non-compete agreement would be invalid if the employer fails to pay the employee the Non-compete Compensation during the Non-compete Period.
New Rules. According to Article 7 and Article 8 of the Interpretations (IV), where an employer and an employee have agreed upon both non-compete clauses and Non-compete Compensation matters, unless otherwise agreed upon, the employee shall perform the non-compete obligation during the Non-compete Period. Non-compete obligation is deemed as “simultaneous obligation”, which means one party can terminate the contract if the other party fundamentally breaches the contract pursuant to the PRC Contract Law. Therefore, if the employer has not paid any Non-compete Compensation for three months due to its own reasons, the Quit Employee shall be entitled to terminate the non-compete agreement and require the employer to pay the Non-compete Compensation for the period he/she has fulfilled the non-compete obligation. Notably, the Quit Employee could exercise such termination right only when the failure of compensation payment is “due to the employer’s own reasons”. Where the employer has no fault (for example, the Quit Employee viciously rejects the Non-compete Compensation paid by the employer), the Quit Employee shall have no right to terminate the non-compete agreement and shall be bound by the competition restriction therein. On the contrary, if the Quit Employee breaches the non-compete covenant, the employer may require the Quit Employee to pay the penalty and further require him/her to continue to perform the obligations under the non-compete covenant.
Attention/Suggestion. If an employer cannot determine the list of employees who should bear non-compete obligation, the employer could still enter into the non-compete covenants with employees as many as practicable. However, the execution of the contract shall be designed as not a requisite for the effectiveness of such non-compete covenants. Instead, it shall be explicitly stipulated in the non-compete covenant that the contract only comes into effect upon “receipt of the performing non-compete covenant obligation notice from the employer”, thus the employer has the opportunity to choose whether or not to effect the non-compete covenant. Additionally, it might become more difficult and problematic for competing employers to hire the Quit Employee, because the former employer can require the Quit Employee to perform the non-compete obligation even if he/she has paid the penalty (for the breach of non-compete covenant).
IV. The right to terminate the non-compete agreement
The third issue discussed above has mentioned that the Quit Employee has the right to terminate the non-compete agreement under certain circumstances. According to the Interpretations (IV), the employer also enjoys the right to terminate the non-compete agreement.
In Practice. In the case that the non-compete agreement has been executed by the employer and the Quit Employee, during the Non-compete Period, if the employer no longer requires the employee to perform the non-compete obligation due to various reasons, the employer shall have the right to terminate the non-compete agreement by paying a certain amount of Non-compete Compensation.
New Rules. According to Article 9 of the Interpretations (IV), the people’s court shall uphold the request of an employer for terminating the non-compete agreement during the Non-compete Period. Meanwhile, the people’s court will also uphold the request of the Quit Employee for payment of an extra three-month Non-compete Compensation upon the termination or expiration of non-compete agreement.
Attention/Suggestion. As parties of the non-compete covenant, both the employer and the Quit Employee have right to terminate the non-compete agreement. The Quit Employee’s termination right is based on the employer’s failure to perform the payment obligation, while the employer may terminate the non-compete agreement at any time by paying extra Non-compete Compensation.
V. Whether the termination of the labor contract will affect the validity of the non-compete agreement?
In Practice. In practice, some employer signed the non-compete agreement with the employee but terminated the labor contract (not the non-compete agreement) illegally thereafter. Under such circumstances, shall the Quit Employee still need to undertake the non-compete obligation?
New Rules. According to Article 7 of Interpretations (IV), if an employer and an employee have agreed upon the non-compete clauses and Non-compete Compensation matters in the labor contract or confidentiality agreement, both parties shall, in the event of termination of the labor contract, perform the non-compete obligation, unless otherwise agreed. The separation of the validity of the non-compete covenant and the termination of the labor contract under the Interpretations (IV) is propitious to handle the relationship between them properly.
Analysis. The termination of the labor contract shall be subject to the statutory provisions while the non-compete covenant is subject to both parties’ discretionary agreements. The legislative purpose of the non-compete covenant is to protect the employer’s trade secrets. The Quit Employee therein undertakes passive obligations that shall not be changed as a result of the termination of the labor contract. In other words, the non-compete covenant shall be a relatively independent agreement and have no causality with the termination of the labor contract. If the employer terminates the labor contract illegally, the Quit Employee may claim his/her rights against the employer pursuant to the Labor Contract Law, the Labor Law or other relevant laws and regulations. However, the validity of the non-compete agreement shall not be affected by the termination of the labor contract. “Such provisions are also beneficial to the protection of employer’s trade secrets. Otherwise, the fairness, order and competitiveness of the market will be influenced if the Quit Employee engages in the business which is competitive with his/her former employer”.[Endnote 5]
Attention/Suggestion. Neither the employer nor the Quit Employee can refuse to undertake the obligations under the non-compete agreement on the grounds that the labor contract is terminated or terminated illegally. Instead, both of them shall claim their rights according to the relevant laws and regulations.
VI. Conclusion
Labor relation is one of the most important social relations in modern economic society. The Interpretations (IV) is issued under the background of high rate of labor disputes in recent years. With regard to the legal relationship under the non-compete covenant, the Interpretations (IV) attempts to protect the employees more favorably on the one hand and protect the trade secrets of enterprises on the other hand, thereby balancing the benefits of both parties. Based on the fully understanding of the Interpretations (IV), the employer and the employee shall be cautious with the non-compete covenant.
Ms. Amy Dai is a Shanghai-based counsel with Global Law Office who specializes in foreign direct investment and M&A. (E-mail: amydai@glo.com.cn)
Endnote 1: Please refer to Article 23 and Article 24 in the Labor Contract Law of the People’s Republic of China (2008) (“Labor Contract Law”).
Endnote 2: Article 6 of the Interpretation(IV) prescribes that: “Where an employer and an employee have agreed upon a non-compete clause in the labor contract or confidentiality agreement, but have not agreed upon the payment of Non-compete Compensation to the employee in the event of the termination or expiration of the labor contract, the relevant people's court shall uphold the employee's request for monthly payment of Non-compete Compensation by the employer in an amount equal to 30% of his/her average salary over the twelve-month period preceding the termination or expiration of the labor contract if the employee has fulfilled the obligations under the non-compete clause. If the amount of 30% of the average monthly salary as prescribed in the preceding paragraph is lower than the minimum wage standard applicable in the place where the labor contract is performed, the said minimum wage standard shall prevail.”
Endnote 3: Before the promulgation of the Interpretations (IV), judicial authorities of different places held different views. For example, (i) the competent authorities in Shanghai held that, pursuant to the Shanghai High Court on Several Issues the Application of the Labor Contract Law the non-compete covenant shall be valid even if the Non-compete Compensation is not stipulated thereunder and the amount of Non-compete Compensation shall be 20%-30% of the salary; (ii) the competent authorities in Beijing held that, pursuant to the Minutes of the Seminar of Beijing High Court on the Several Issues on the Application of Law in Trial of the Labor Dispute Cases, the Non-compete Compensation shall be 20%-30% of the annual salary.
Endnote 4: Abstract from the Handling Labor Dispute Cases Correctly To Build Harmonious Labor Relationship According To Law-- Answer To Reporters' Request Of The Person In Charge Of Court of Civil Jurisdiction No. 1, The Supreme People's Court (“Answer to Reporters' Request”).
Endnote 5: Abstracted from Answer to Reporters' Request.
