Key issues in non-competition agreements

By Shen Jin and Li Ming, AnJie Law Firm

Q: What are the subjects and terms of a non-compete obligation? Can an employer enter into non-compete agreements with every one of its workers?

Shen Jin
AnJie Law Firm

A: Pursuant to article 24 of the Employment Contract Law: “persons subject to non-competition shall be limited to the employer’s senior management personnel, senior technical personnel, and other persons with a non-disclosure obligation. The scope, territory and term of non-competition shall be agreed upon by the employer and the worker, and the provisions on such non-competition may not violate laws or regulations.

“Once an employment contract is terminated or ends, the term of non-competition that prohibits a person mentioned in the preceding paragraph from serving with a competitor that produces or deals in the same type of product, or engages in the same type of business as the employer, or prohibits him or her from opening his or her own business to produce or deal in the same type of product, or engage in the same type of business, may not exceed two years.”

From this it can be seen that an employer may not specify non-competition however it wishes. The objectives of a non-compete agreement are to protect the enterprise’s trade secrets and competitive advantage, but such agreements also reduce the degree of flexibility of the manpower market. The law places appropriate restrictions to minimize the adverse aspects of non-compete agreements.

In practice, some employers will incorporate non-compete clauses directly into employment contracts, which might expose such employers to certain risks. This could involve a subject that is unqualified, resulting in invalid non-compete clauses, or result in an employee, for whom a non-compete obligation is not required, demanding economic compensation for non-competition after he or she leaves the enterprise, thereby increasing the employer’s costs.

If an enterprise opts for the signing of such clauses by all of its employees, the conduct of a review of the necessity of the performance of the non-compete obligations when an employee leaves the enterprise is of utmost importance.

Q: What is the difference between a non-compete and a non-disclosure obligation?

Li Ming
AnJie Law Firm

A: The scope of application of a non-disclosure agreement is broad, as it may be applied to all workers. In contrast, a non-compete agreement applies to senior management personnel, senior technical personnel, and other persons with a non-disclosure obligation.

A non-disclosure agreement protects only the enterprise’s trade secrets, whereas a non-compete agreement, in addition to protecting trade secrets, also protects confidential matters relating to the enterprise’s trade secrets.

The obligation of a worker under a non-disclosure agreement is to protect the employer’s trade secrets to which he or she is privy in the course of his or her duties, in a passive manner by not spreading or disclosing the same. In contrast, under a non-compete agreement, a worker may not directly or indirectly participate in a competing enterprise.

Regarding the term of the obligations, in contrast to a maximum term of two years for non-compete obligations, there are no express requirements on the maximum length of the term of non-disclosure obligations, generally being until the trade secrets in question enter the public domain or no longer provide a competitive advantage.

A non-disclosure obligation is an obligation that is concomitant with a worker’s performance of his or her employment contract, and accordingly there is no need to pay economic compensation in connection with the performance of such a non-disclosure obligation. In contrast, a provision on compensation is a must in a non-compete agreement, and failure by the employer to pay such economic compensation gives the worker the right to terminate the agreement.

Q: Does the failure to specify compensation for non-competition, or the rate of such compensation, affect the validity of a non-compete agreement?

A: In the adjudication practice of the majority of regions at present, the failure to provide for economic compensation or the provision of relatively low compensation in a non-compete agreement does not affect such agreement’s validity.

However, if either of the above-mentioned circumstances holds, as the payment of economic compensation by the employer is the consideration for the performance by the worker of his or her non-compete obligations, the worker has the right, once he or she has performed his or her non-compete obligations, to demand that the employer pay him or her economic compensation at the rate of 30% of his or her average wage during the 12 months prior to the termination or ending of his or her employment contract, or make up any discrepancy.

Q: Under what circumstances may such an agreement be terminated? Is an enterprise free to do so at its own discretion? Can a worker request termination?

A: First, as a type of civil agreement, a non-compete agreement may be terminated by the parties if they reach a consensus through consultations. Second, given that the purpose of setting up a non-compete agreement is to protect the employer’s trade secrets and competitive advantage, and prevent the worker from taking such information or technology to another enterprise, relevant laws bestow upon employers the right to unilaterally terminate non-compete agreements. Accordingly, if an employer deems that there is no need to continue blocking the worker from competing, it has the right to unilaterally terminate the agreement.

It should be noted that if the employer exercises its right of termination before the employee enters the non-competition term (e.g., before officially leaving the enterprise), it is not required to pay economic compensation. However, if the employee has entered the non-competition term, the employer is required to pay an additional three months of non-competition economic compensation if it unilaterally terminates the non-compete agreement.

Under certain conditions, a worker also has a right of unilateral termination. If, during the performance of his or her non-compete obligations, the employer fails to pay the economic compensation for three months, the worker has the right to exercise his or her right of termination. An employer should be aware that failure to pay the economic compensation for three months does not automatically result in termination of the non-compete obligation if the worker opts not to exercise his or her right of termination and continues performing his or her non-compete obligations, in which case the employer is required to continue paying the compensation. Furthermore, certain regions have specially provided for a waiting period for the right of termination.

Shen Jin is a partner and Li Ming is an associate at AnJie Law Firm

Share-based payment

AnJie Law Firm
19/F Tower D1, Liangmaqiao Diplomatic Office Building
19 Dongfang East Road, Chaoyang District
Beijing 100600, China
Tel: +86 10 8567 5988
Fax: +86 10 8567 5999