Tips for employers on non-compete compensation

Under PRC law, an employer needs to pay compensation to an employee for his or her fulfilment of non-compete obligations (non-compete compensation). In practice, due to defects in the form and standard of non-compete compensation paid by the employer to the employee, the employer may face disputes and potential adverse consequences. The authors have summarized five things that employers must know.

Q: When should non-compete compensation be paid? A: According to the Labour Contract Law, the employer must pay financial compensation to the employee within the non-compete term, on a monthly basis. In practice, some companies choose to pay non-compete compensation, or a “confidentiality payment” to employees within the term of employment, on a monthly basis. This is against the above provision and PRC courts and labour arbitration commissions generally hold the view that non-compete compensation has not been paid.

Q: Is there a standard in relation to the amount and percentage for non-compete compensation? A: Local regulations and rules, as well as judicial guidance, in relation to such a standard vary.

(1) Explicit minimum non-compete compensation: the employer and employee can agree on an amount which is above the explicit minimum payment. For example, in Shenzhen the explicit minimum payment is “one-half of the average monthly salary over the previous 12 months before the employee leaves the enterprise”.

(2) Courts and arbitration commissions can determine a reasonable standard within a specified range, if the employer and employee fail to agree on the amount. For example, in Beijing, if the employer and employee fail to agree on the amount, non-compete compensation can be paid in the range of “20-60% of the salary of the employee in the preceding year before the termination of employment”; in Shanghai, “the employer shall pay the compensation according to 20-50% of the employee’s previous regular salary”.

(3) The employer and employee can agree on the standard of non-compete compensation, failing which the payment must be no less than the local standard. For example, in Zhejiang, if the employer and employee fail to agree on the amount, the annual amount must be calculated as “two-thirds of the total remuneration received by the relevant person from the enterprise in the preceding year before the (employment) contract is terminated”.

(4) In addition, according to article 6 of the No. 4 Interpretation of Relevant Issues for the Application of Law in Hearing Labour Dispute Cases of the Supreme Court, “where the employer and employee have agreed upon a non-compete clause in the labour 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 labour contract, the relevant people’s court should uphold the employee’s request for monthly payment of financial compensation by the employer according to 30% of his or her average salary over the 12-month period preceding the rescission or termination of the labour contract, if the employee has fulfilled his or her obligations under the non-compete clause”. Please note, however, that the above standard only applies to the scenario where the employer and employee have agreed on non-compete obligations and such non-complete obligations have been performed by the employee.

Q: Will non-compete compensation affect the validity of a non-compete agreement? A: Some employers have signed a non-compete agreement with their employees but the parties have not reached an agreement on the amount or method of calculation of non-compete compensation. Under this circumstance, the validity of the non-compete agreement is not clear under PRC law, and is debated in practice.

According to article 6 of the interpretation, lack of agreement on non-compete compensation does not necessarily invalidate the non-compete agreement. If the employee has performed the non-compete obligations, the employee can still request the employer to pay non-compete compensation on the basis of “30% of his or her average salary over the 12 months preceding the rescission or termination of the labour contract”.

However, article 7 of the interpretation also provides that “where the employer and employee have agreed upon both a non-compete clause and financial compensation matters in the labour contract or confidentiality agreement, unless otherwise agreed upon, the relevant people’s court should, in the event of rescission of the labour contract, uphold the employer’s request for performance of the obligations under the non-compete clause by the employee, or the employee’s request for payment of financial compensation by the employer after he or she has fulfilled the obligations under the non-compete clause.” This provision seems to treat the provision of “financial compensation” as a precondition for the employer to request the employee to perform the non-compete obligations.

To avoid the risk of invalidity of the non-compete agreement, employers should explicitly specify the non-compete compensation in their non-compete agreement with their employees.

Q: Can the non-compete agreement be terminated if non-compete compensation is not paid? A: Article 8 of the interpretation provides: “Where the employer and employee have agreed upon both a non-compete clause and financial compensation matters in the labour contract or confidentiality agreement, the relevant people’s court shall uphold the employee’s request for terminating the agreements under the non-compete clause, if after the rescission or termination of the labour contract the employer has not paid any financial compensation for three months, due to its own reasons.” Accordingly, if the company fails to pay non-compete compensation for three months, the employee has the right to request to terminate the non-compete agreement.

Q: Can liquidated damages be provided against the employee’s breach of the non-compete agreement? And what is the relationship between the liquidated damages and non-compete compensation? A: Under PRC law there are no restrictions on the liquidated damages for the breach of non-compete obligations by the employee. The employer and employee can agree on the amount of the liquidated damages. However, in practice arbitration commissions and courts normally consider the reasonableness of the liquidated damages, which can be adjusted if they are considered too high. Among other things, non-compete compensation that has actually been paid by the employer will be an important factor in deciding if the liquidated damages are reasonable or not.

Liu Zhenghe and Samuel Yang are partners at AnJie Law Firm