Dilemma of competition restriction while an employee is employed

By Felix Wu, Xin Bai Law Firm
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Article 23 (2) of the Employment Contract Law specifies that an employer can specify with a worker who bears a confidentiality obligation a non-compete clause and liquidated damages for breach of the non-complete provision in his or her employment contract or a non-disclosure agreement.

吴法全 Felix Wu 信栢律师事务所 高级律师 Senior Attorney Xin Bai Law Firm
Felix Wu
Senior Attorney
Xin Bai Law Firm

Article 24 further specifies the persons to whom such a competition restriction applies, and the terms, and the second paragraph of that article specifies that the non-compete term may not exceed two years after the termination or ending of the employment contract.

Dilemma faced by an employer. That the above-mentioned non-compete term commences to count upon termination or ending of the employment contract is the usual understanding and expectation of the public. However, in practice, a client that the author advised ran into a rather awkward situation; the company discovered that one of its employees in a sales position had concurrently been working for a company in the same industry for several years, and despite its having executed a non-compete agreement with that employee, it did not seem to have any way of sanctioning that employee or recovering its losses, other than dismissing that employee.

Articles 147 and 148 of the Company Law respectively specify that senior management personnel, such as directors, supervisors and managers, have a duty of loyalty and a duty of due diligence and care toward their company and that, while employed, they may not engage in competition against the company. The Partnership Law also set out similar restrictions on partners and management personnel. However, current laws do not expressly provide that ordinary workers are required to be loyal to their company while employed by it, and that they may not engage in acts of competition.

Reason for the dilemma. The Labour Law and the Employment Contract Law were issued against a background when manufacturing was the dominant industry, and it was unlikely that one worker could serve more than one employer. However, with socioeconomic development, the service industry has gradually risen to a dominating position in regions such as eastern China, where economic development has been relatively rapid, and many enterprises do not have the means or the necessity to carry out strict management of the attendance of employees as in the past, with an increasing number of enterprises adopting a flexible working hours system.

The emergence of such new technologies as big data and artificial intelligence has also caused companies to become more reliant on new technologies for management of the attendance of employees. The various reasons above have enabled certain workers to easily satisfy the attendance management requirements of a company while concurrently working for other companies.

Judicial response and analysis. In practice, there is a difference of opinion on how to handle this type of dispute. The judicial systems in certain regions are attempting to make up the gaps in current law. For example, the Jiangsu Provincial Labor and Personnel Affairs Dispute Arbitration Commissions states in a document that, “the compliance by a worker with a competition restriction while he or she is employed is a statutory obligation of workers, and where a worker breaches such non-compete provision by engaging in similar business with a third party while he or she is employed, and the employer pursues the worker’s liability for breach of contract, the same shall be upheld. If the parties have provided for liquidated damages, the worker shall pay liquidated damages to the employer as provided.”

The Zhejiang Provincial Higher People’s Court and the Zhejiang Provincial Labour and Personnel Affairs Dispute Court of Arbitration also state that, “the non-compete term includes, but is not limited to, the period after the termination or ending of an employment contract; where an employer has provided with a worker for a non-compete obligation during the worker’s period of employment, the same shall be deemed valid.”

The judicial opinion in Jiangsu and Zhejiang recognises that the non-compete obligation of a worker can be extended into the period of the existence of his or her employment contract. The legal basis for such an extension first lies in the fact that a competitive act by a worker during his or her period of employment poses a major challenge to the principle of good faith in civil law, and if it is not reined in, it ultimately has a negative impact on the public interest. Furthermore, the Employment Contract Law expressly specifies that, after the end of an employment relationship, an employer may impose a competition restriction on a worker and specify liquidated damages, and there is no doubt that an act of competition by a worker during his or her period of employment will have an even greater negative impact on his or her employer, so the law should naturally place restrictions thereon.

However, if employers are permitted to specify liquidated damages with workers at their own discretion, it could result in harm to the interests of workers. For this reason, there is another approach in practice that does not permit the extension of a competition restriction to the period before the termination or ending of an employment contract, but permits employers to recover, in accordance with other laws, losses against workers that engage in competitive acts during their period of employment. This opinion does not directly respond to or resolve the dilemma of a competition restriction during a worker’s period of employment, but avoids the suspicion of “creating law”. It has been adopted by courts in such places as Shanghai.

Some recommendations

Until the laws and regulations are revised and improved, the author recommends that when an employer executes a non-compete agreement with a worker, it specifies that the same applies during the worker’s period of employment, and expressly provides for liquidated damages for a breach of contract during his or her period of employment, or the specific amount of the loss incurred by the company as a result of the competition by the employee with a third party. In this way, although there is no guarantee of support from all courts, this will certainly affect judicial discretion when a dispute arises, and may even provide the judges with a solid footing for rendering a judgment or ruling that is favourable to the employer.

Furthermore, when establishing variable wage (bonus) jobs, an employer may consider transforming part of such remuneration into a “loyalty bonus”, with a fixed period, and decide on whether to pay the bonus based on a close look at the employee’s performance of his or her employment contract, and on the circumstances, in the hope of constraining the employee’s acts.

Felix Wu is a senior attorney at Xin Bai Law Firm

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