By Weiwei Gu / Sylvia Zhi
INTRODUCTION
In the field of labour laws, Art.23 of the Labour Contract Law of the People’s Republic of China (hereinafter referred to as “the Labour Contract Law”) provides for the potential inclusion of a confidentiality clause in a labour contract between an employer and its employee, or alternatively a confidentiality agreement in order to ensure that an employee will keep confidential matters such as trade secrets, or other matters in relation to intellectual property of the employer, confidential. Art.23 also provides that in the labour contract or confidentiality agreement, an employer can also include a competition restriction clause with the employee who bears confidentiality duty. And an employee should pay to the employer liquidated damages as agreed when he/she breaches competition restriction agreement. Accordingly, an employer and its employee can agree on liquidated damages for breaching competition restrictions. However, disputes exist in practice over whether an employer and its employee can agree on liquidated damages for the violation of confidentiality duty. Based on relevant laws and regulations, as well as the judicial practice in the area of Shanghai, this article will discuss whether liquidated damages can apply in the event of an employee breaching their confidentiality duty in the area of Shanghai.
1. Whether an employer and its employee can agree on liquidated damages for breaching competition restrictions
1.1. Dispute
Pursuant to Art.23 of the Labor Contract Law, “An employer and an employee may agree on keeping confidentiality of the employer’s commercial secrets and confidential matters in relation to intellectual property in a labour contract or confidentiality agreement. Where an employee is obliged to confidentiality duty, the employer may agree with the said employee in a labour contract or confidentiality agreement on a competition restrictive covenant and agree that upon the rescission or termination of the labour contract, the employer shall grant the employee economic damages on a monthly basis during the competition restrictive covenant period. Where the employee has violated the competition restrictive covenant, he/she shall pay liquidated damages to the employer pursuant to the agreement.” Art. 25 of the same Law stipulates that “Except for the circumstances stipulated in Article 22 and Article 23, an employer shall not agree with an employee on the bearing of liquidated damages by the employee.” As to the interpretation of these two provisions, there exists dispute in judicial practice over whether an employer and its employee can agree that the employee should pay liquidated damages to the employer for the breach of confidentiality duty.
One view regards that Art.23 of the Labor Contract Law only provides that an employer can agree with its employee on the liquidated damages under the circumstances where the competition restrictive covenant is breached, without mentioning whether an employer can agree on liquidated damages with its employee for the breach of confidentiality duty. In light of the language of “except for the circumstances stipulated in Article 22 and Article 23 of this Law” in Art.25 of the same Law, the Labor Contract Law provides that liquidated damages can be agreed only in connection with the service period and/or competition restriction. Therefore, an employer cannot agree on liquidated damages with its employee for the breach of confidentiality obligations.
According to the other view, the language used in Art.25 of the Labor Contract Law is “except in the circumstances stipulated in Article 22 and Article 23 of this Law”, while Clause 1 of Art.23 of the same Law, nevertheless, provides that an employer may stipulate the duty of confidentiality with the employee. Taking this into account together with Clause 2 of the same Article, it thus cannot be inferred that Art.23 excludes the circumstances where liquidation damages for breaching confidentiality duty can be agreed. An employer and its employee, therefore, can agree on liquidated damages for breaching confidentiality duty.
1.2. The preferred viewpoint in judicial practice
Given the relevant cases in the area of Shanghai that the author searched, the majority of courts in the area of Shanghai support the first view, holding that an employer and its employee cannot agree on liquidated damages for breaching confidentiality duty. Liquidated damages clause agreed between an employer and its employee in respect of such matter runs afoul of the mandatory laws, and shall be null and void, as analyzed in details below:
In the series of cases of labour contract disputes between Xiao Liu, Guangbi Zhai and others, and Shanghai Lingjiu Technology Ltd., Co. (Case No.: (2016)沪01民终10034号、（2016）沪01民终10027号), Shanghai No.1 Intermediate People’s Court and its lower court Shanghai Pudong New Area People’s Court clearly states that “With regards to the violation of competition restriction and confidentiality duty as agreed, The Labor Contract Law of our country stipulates different ways as to the undertaking of legal liabilities. Meanwhile, the Labor Contract Law provides that the liquidated damages undertaken by an employee with an employee as agreed is applicable only if agreement dealing with the violation of either service period or competition restriction is entered into. Therefore……the payment of liquidated damages for breaching the promise of keeping trade secrets confidential, as agreed in the labour contract and/or Agreement on Confidentiality, Competition Restriction and Invention, doesn’t comply with laws and regulations.” Thus, the Court ruled that the employer’s claim for liquidated damages to be paid by its employee, according to what was agreed between them, should not be supported.
In the case of labour dispute between Shanghai Zemakeming Machinery Equipment Ltd., Co., and Yan Zhang (Case No.: (2014)浦民一（民）初字第28458号), and the case of labour dispute between Shanghai Zhiman Investment Management Co., Ltd. and Jiaojie Tu (Case No.: (2016)沪0115民初34042号), Shanghai Pudong New Area People’s Court gave a more clear and specific determination on the viability of the liquidated damages clause as to the breaching of confidentiality duty, holding that such clause should be null and void for conflicting with the existing prohibitory laws.
In the case of labour contract dispute between Shanghai XXX International Trade Ltd., Co. and XXX Qi, Shanghai Baoshan District People’s Court (a lower court of Shanghai No.2 Intermediate People’s Court) (Case No.: (2013)宝民一（民）初字第2484号) also held that only if a service period or competition restriction exists can an employer and its employee agree on the bearing of liquidated damages by the employee. Besides, in the confidentiality agreement alone, an employer is not allowed, as a matter of law, to request its employee to pay liquidated damages without having already entered into a competition restriction clause.
In addition, with regards to the issue of whether an employee should pay liquidated damages to its employer for breaching of confidentiality duty during his/her employment, No.15 Survey and Reference by No.1 Civil Tribunal of Shanghai High People’s Court (2014) points out that “The Court tends to hold the opinion that based on Art.23 and Art.25 of the Labour Contract Law, an employee’s bearing of liquidated damages should be grounded on expressed laws……and so far, the existing laws only provide that an employee who breaches competition restrictive covenant after leaving the employer should pay liquidated damages to the employer as agreed. Given that the existing laws do not specifically require an employee to pay liquidated damages for breaching confidentiality duty, agreeing to have an employee to be bound by liquidated damages is thus not suggested in the absence of expressed laws……Therefore, the stipulation under a labour contract that the employee should pay liquidated damages to the employer if violating confidentiality duty during his/her employment should be null and void. And the employer’s claim for payment of liquidated damages by its employee for breaching liquidated damages during the employment should not be supported.”
To sum up, in judicial practice in the area of Shanghai, the preferred opinion is that an employer and its employee cannot agree on liquidated damages for breaching confidentiality duty, and any liquidated damages clause regarding such matter, as agreed between an employer and its employee, should be deemed as invalid for violating mandatory laws. Indeed, courts generally do not rule in favor of an employer’s claim for the payment of liquidated damages by its employee for breaching confidentiality duty.
2. Other Reliefs Available to Employers
2.1. An employer is entitled to claim for recovery of confidentiality fee, if it is agreed to be paid by the employer.
Art.23 of the Labour Contract Laws provides that an employer may agree on economic compensation with its employee in the non-competition clause. Furthermore, Art.6 of the Interpretations of the Supreme People's Court on Certain Issues concerning the Application of Laws in the Trial of Labor Dispute Cases (IV) provides that where an employer and an employee have agreed upon a non-competition clause in the labor contract or confidentiality agreement, but have not agreed upon the payment of financial compensation to the employee in the event of the rescission or termination of the labor contract, the relevant people’s court shall uphold the employee’s claim for monthly payment of financial compensation by the employer 30% of his/her average salary over the twelve-month period preceding the rescission or termination of the labor contract if the employee has fulfilled the obligations under the non-competition clause. Accordingly, in respects of the economic compensation for competition restriction, stipulated standard of compensation is provided by laws in the absence of agreement between both parties.
However, with regards to a confidentiality clause entered into by and between an employer and its employee, there is no law providing that an employer needs to pay a confidentiality fee to its employee, for the reasons that the duty of good faith should be observed in the performance of the labour contract between an employer and its employee, which entails the employee bearing the loyalty duty to its employer. Therefore, the employee is obliged to keep confidential the employer’s trade secrets and/or confidential information relating to intellectual property rights. Moreover, unlike observing the duty of competition restriction, observing confidentiality duty will not result in an employee losing the economic interests he/she should have enjoyed. Therefore, it is not required by law that an employer needs to pay its employee remuneration for performing confidentiality duty.
Nevertheless, in practice, it often occurs that an employer and its employee agree in the labour contract or confidentiality agreement, that the employer should pay a certain amount of confidentiality salaries/confidentiality fee in addition to the regular salary. With regards to such promise, the mutual consent by both sides of the labour contract is generally respected in practice and will thus be deemed valid. Under such circumstances, if the employee violates the confidentiality duty within the employment period, or after leaving (depending on the length of the confidential period), will the employer be entitled to ask the employee to return the paid confidentiality salary/confidential fee? In the author’s opinion, based on relevant cases in Shanghai, such a claim is likely to be supported by courts if the employer and its employee clearly agree in the labour contract or confidentiality agreement that the employee should return the confidentiality salary/confidentiality fee if he/she violates confidentiality duty.
In the case of a labour contract dispute between Yan Zhang and Zemakeming Machinery Equipment Ltd., Co. (cases No.: (2014)浦民一（民）初字第28458号), Shanghai Pudong New Area People’s Court ruled that the confidentiality salary agreed under Clause 7 of the confidentiality agreement entered into by, and between both parties, was not the labour remuneration which is normally defined as being obtained for the work performed by the employee; instead, it was the consideration additionally paid by the plaintiff (the employer) in exchange for the defendant’s (the employee’s) promise for not divulging trade secrets during the employment period. Given the nature of the confidentiality salary as discussed, the content of the promise under Clause 8 of the agreement that “In the case of violating the confidentiality duty during the employment, the employee should return the confidentiality salary already paid by the employer” is legal and valid, and hence should be accordingly performed by both parties. As a result, the defendant should return to the plaintiff the confidentiality salary that had been obtained. Shanghai No.2 Intermediate People’s Court held the same opinion in the case of competition restriction dispute between A You and Shanghai Sirui Polymer Technology Ltd., Co. (Case No.: (2011)沪二中民三（民）终字第1381号).
On the other hand, if the matter of returning the confidentiality fee is not agreed between an employer and its employee in the confidentiality agreement, the employer’s claim to have the paid confidentiality fee to be returned by its employee may not be supported by courts. For instance, in the case of labour dispute between Shanghai Hongjuan Trade Ltd., Co. and Huiping Shi (Case No.: (2014)浦民一（民）初字第44520号), Shanghai Pudong New Area People’s Court held that “as in either of the two confidentially agreements entered, the plaintiff and the defendant didn’t agree on the matter of returning the confidentiality fee or the circumstances where this matter should apply, the plaintiff’s claim that the defendant should return the confidentiality fee is ungrounded and therefore not supported by the Court.”
Therefore, the author would suggest that if an employer and its employee additionally agree on the payment of confidentiality salaries/confidentiality fee, they could also agree that in cases where the employee violates confidentiality duty, he/she should return to the employer the confidentiality salary/confidentiality fee that has been paid by the employer. In such cases, the employer will be entitled to claim for the recovery of such payment in the event where its employee violates the confidentiality duty.
2.2. An employer can seek relief through damages compensation
(1) Action for Breach of Contract
Art.90 of the Labour Contract Law provides that “Where an employee violates the provisions of this Law in rescission of labour contract or violates the provisions of a labour contract on confidentiality obligation or competition restrictive covenant and causes the employer to suffer damages, the employee shall bear compensation liability.” Besides, No.15 Survey and Reference by No.1 Civil Tribunal of Shanghai High People’s Court (2014) also points out that should an employee cause damages to the employer by violating his/her confidentiality duty during the employment, the employer can seek relief by claiming for compensation for its actual damages in accordance with Art.90 of the Labour Contract Law. In the aforementioned case of labour contract dispute between Shanghai Hongjuan Trade Ltd., Co. and Huiping Shi (Case No.: (2014)浦民一（民）初字第44520号), Shanghai Pudong New Area People’s Court ruled in favor of the plaintiff’s (the employer’s) claim that the defendant (the employee) should compensate for the loss of profits caused to the plaintiff by violating confidentiality duty. Accordingly, when an employee breaches confidentiality duty, the employer can claim for compensation for damages if it can prove the damages suffered.
(2) Action for Torts
In addition, an employer can claim for compensation from the employee by action for torts, and the calculation for compensation can be determined in accordance with relevant provisions under the Anti-Unfair Competition Law of the People's Republic of China (hereinafter referred to as “the Anti-Unfair Competition Law”).
Art.5 of the Compensation Measures as to the Violation of Relevant Provisions relating to Labour Contracts (No.223, issued by the Labour Department [1995]), states that where an employee violates the matter of confidentiality, as agreed in the labour contract, and thus causes economic damages to the employer, compensation should be paid to the employer in accordance with Art.20 of the Anti-Unfair Competition Law [1]. Accordingly, given that the new Anti-Unfair Competition Law became effective since January 1, 2018, when an employer proves that it suffered from damages as result of its employee’s violation of confidentiality duty, the amount of compensation the employer will be entitled to can be determined according to Art.17 of the new Anti-Unfair Competition Law.
Pursuant to Clause 3 of Art.17 of the new Anti-Unfair Competition Law, “The amount of compensation for a business operator whose legitimate rights and interests are damaged by activities of unfair competition shall be determined according to the actual loss suffered by the business operator as a result of the infringement, or be determined according to the profits gained by the infringer from the infringement if the actual loss is difficult to calculate. The amount of compensation shall also include the reasonable expenses incurred by the business operator for stopping the infringing acts.” And Clause 4 of this article further provides that “Where....it is difficult to determine the actual losses suffered by the obligee as a result of the infringement or the profits obtained by the infringer from the infringement, the competent people's court shall render a judgment on awarding compensation of up to RMB 3 million to the obligee depending on the severity of the infringing acts.”
It often occurs in practice that in cases of infringement of trade secrets, where an employer brings an action against both the employee who violates confidentiality duty and the business operator who have knowledge of and exploit the divulged trade secrets, courts will determine the amount of compensation in accordance with relevant provisions under the Anti-Unfair Competition Law. In the case between Jizhong Zhang and Shanghai Dingcai Plastic Technology Ltd., Co. (Case No.: (2007)沪高民三（知）终字第73号), the method adopted in determining the amount of compensation by Shanghai High People’s Court is substantially consistent with the new Anti-Unfair Competition Law, although it was the old Anti-Unfair Competition Law that was actually relied on by the Court, which offers a reference to the approaches to proof that can be adopted by employers in judicial practice. In this case, believing that the plaintiff didn’t prove the damages it suffered or the two defendants’ profits obtained from their tortious acts, the Court determined the amount of compensation at its discretion after taking into account factors such as the extent of the two defendants’ tortious acts and the actual value of the plaintiff’s trade secrets, etc. In addition, in the case of a trade secret infringement dispute among Shanghai XXX International Trade Ltd., Co., XXX Zhang and XXX Enterprise Development Co., Ltd. (Case No.: (2009)浦民三（知）初字第38号), the approach of determining the compensation for damages adopted by Shanghai Pudong New Area People’s Court is consistent with Shanghai High People’s Court.
In view of this, based on relevant provisions in the new Anti-Unfair Competition Law, in the aforementioned type of trade secret infringement lawsuits, for the purpose of determining the amount of compensation, the employer can first prove actual damages suffered by itself as a result of the act of tort; if it is hard to prove or calculate actual damages, the employer may prove the infringer’s gains derived from his/her tortious act. Meanwhile, the employer can also prove the reasonable expenses (including without limitation to attorney’s fees, litigation costs, etc.) incurred to prevent the tortious act. Even when an employer is unable to prove the actual damages or the infringer’s gains, courts may still determine that amount of compensation at their discretion after taking into consideration factors, including the extent of the tortious act, the actual value of plaintiffs’ trade secrets and the like.
2.3. An employer can claim for not only compensation, but also continuing performance of confidentiality promise.
In the aforementioned case between Jizhong Zhang and Shanghai Dingcai Plastic Technology Ltd., Co. (Case No.: (2007)沪高民三（知）终字第73号), the confidential period agreed between the employer and the employee lasts for ten years after the termination of their labour relation. As the employee violated his confidentiality duty within such period, the employer claimed for both compensation and the employee’s continuing performance of his confidentiality duty, which was supported by the Court. Hence, when asserting a claim for compensation against an employee who breaches his/her confidentiality duty, the employer can also request the employee to continue performing the confidentiality duty in the remaining confidential period.
3. Significance of the Confidentiality Clause/Agreement Entered by and between an Employer and its Employee
Given that liquidated damages cannot be agreed when an employer and its employee enter into a confidentiality clause/agreement, some people may doubt that since an employee has already owed confidentiality duty to the employer during his/her employment, and an employer is entitled to compensation for damages instead of liquidated damages in the case where its employee violates his/her confidentiality duty, what is the point of entering into such a confidentiality clause/agreement?
The author holds the opinion that in the aspects of agreeing on a longer confidential period, specifying the scope of confidential information, and identifying trade secrets, entering into confidentiality clause/agreement plays a significant role.
First of all, in terms of the confidential period, through entering into a confidentiality clause/agreement, an employer can not only agree on the confidentiality duty during the employment period with its employee, but also agree that the employee is still under such duty for a period of time even after the labour contract is rescinded or terminated. Consequently, the confidential period agreed can be longer than that derived from his/her loyalty duty to the employer.
Besides, entering into a confidentiality clause/agreement can specify the intension and extension of the trade secrets or confidential information relating to intellectual property rights which an employer intends to protect, thus avoiding potential disputes over whether certain information should be considered within the scope of confidential information.
Furthermore, entering into a confidentiality clause/agreement assumes a significant role in determining whether the information protected by an employer is within the scope of trade secrets in a case where an employer seeks for its employee’s undertaking of the compensation liability for infringing its trade secrets.
In cases where an employer claims that its employee should undertake the compensation liability for infringing trade secrets, courts tend to determine whether the contentious trade secret meets with relevant legal requirements [2]. Pursuant to Clause 3 of Art.9 of the Anti-Unfair Competition Law, trade secrets referred to in this Law means any technical or operational information which is not known to the public, has trade value, and for which the obligee thereof has adopted corresponding measures for confidential purpose. On the basis of the Interpretation of the Supreme People’s Court on Certain Issues regarding the Application of Laws in the Trial of Civil Cases Involving Unfair Competition and judicial practice, generally speaking, entering into a confidentiality agreement that is sufficient to prevent the divulging of confidential information in normal cases should be deemed that the obligee has adopted measures for confidential purpose.
As a result, though other factors should be taken into account as well when determining whether certain trade secrets in issue live up to the standard required by laws, the act of entering into confidentiality clause/agreement alone may directly satisfy the requirement that “the obligee has taken measures for confidential purpose”, which plays an important role in the determining of whether the information that has been divulged due to an employee’s breaching of his/her confidentiality duty should be deemed as trade secrets. It further helps in determining whether an employee commits conduct in violation of confidentiality duty and infringement of trade secrets.
In conclusion, for employers that desire to protect their trade secrets and confidential information relating to intellectual property rights, we suggest that a confidentiality clause be included into the labour contact, or a confidentiality agreement be otherwise entered into, for the purpose of preserving their rights and interests in a better way.
[1] Art.20 in the original Anti-unfair Competition Law is now amended as Art.27 according to the new Anti-unfair Competition Law, effective since January 1, 2018.
[2] Art.14 of the Interpretation of the Supreme People’s Court on Certain Issues regarding the Application of Laws in the Trial of Civil Cases Involving Unfair Competition provides that “Where a party alleges that another infringes its trade secret, the party shall bear the burden of proof as to the fact that the trade secret it has possessed is in conformity to the statutory requirements, that the other party’s information is identical or substantially identical to its trade secret, and that the other party has adopted unfair means. The evidence showing that the trade secret conforms to the statutory conditions shall include the carrier, specific content, and business value of the trade secret, and the specific confidentiality measures taken for the trade secret, etc.”
