Focus on enforcement and remedy of non-compete issues in China (Part II)

In China, one of the key criteria for imposing a non-compete obligation on an employee is that the obligation must be related to the protection of confidential information of an employer. Accordingly, in practice, judges look at various issues when determining whether a non-compete agreement is valid and enforceable and they try to reach a balance between the need for protection of an employer’s confidential information and an employee’s right to move freely and take up alternative employment. This article looks specifically at the remedies available to employers when enforcing non-compete agreements.

First of all, non-compete restrictions are not just a post-termination obligation. Employees must not compete with their employer during their employment (without any additional payment other than their normal salary or contractual remuneration being required) – this means having a duty of loyalty and acting in the best interests of the employer. In addition, if employees work for other employers simultaneously, an employer can require that the employee cease working for the other employer. If the employee breaches the obligation not to compete, or if he/she refuses or fails to cease any additional employment relationship when requested to do so, the requesting employer has the right to terminate the employment relationship without further notice or severance and also to claim compensation from the employee for any loss caused to the company. Please note that given the sensitivities and strict interpretation regarding legal cause for termination, the employer should also have in place clear internal rules to specifically prohibit employees from engaging in any activity that competes with the business of the company, no matter whether this is paid or not.

For post-employment non-compete obligations, it is important to be aware that, except in cases where certain specific intellectual property rights are involved, it is generally not possible to obtain injunctive relief in relation to labor disputes in China (even if a judgment for specific performance is obtained - see below). According to the Judicial Interpretation IV, a former employer is entitled to the following possible remedies under PRC law when enforcing a non-compete agreement:

  • The former employer may ask the employee to pay back the non-compete compensation that has been made to him/her and additionally also claim for any losses or the damage caused to the former employer.
  • If the relevant non-compete provision contains a liquidated damages provision, the former employer may also ask the employee to pay the specified liquidated damages and also ask the employee to comply with the non-complete obligation (ie specific performance) for the reminder of the specified restricted period.
  • A notice from the labor dispute arbitration tribunal in Shenzhen issued in September 2017 goes even further, adding that if an employee is required to pay liquidated damages and to perform the non-compete obligation for the reminder of the restricted period, he/she can be liable to pay the full liquidated damages again if the employee subsequently breaches the obligation again.

Based on the above, the focus of remedies is clearly on monetary compensation or damages for breaching non-compete obligations under the current legal framework in China. A key practical problem for companies is that it is often extremely difficult to quantify and prove damage or loss to the company due to breach of obligations. For this reason, it is common and also recommended to use a liquidated damages clause in the non-compete agreement or other relevant document. There is very little guidance in PRC legislation as to what constitutes a reasonable amount for this purpose. The general principle is that there should be a balance between rights and obligations of the parties. For this reason, it is helpful to set compensation payable to the employee during the restricted period at a higher level than the statutory minimum (which varies by location but is generally 30% of the employee’s remuneration at the time of exit) in order to help justify a significant level of liquidated damages. In practice, it is common for liquidated damages to be set as three or five times the amount of compensation payable to the employee during the restricted period, although there is no absolute requirement to link liquidated damages to compensation payable to an employee. The danger, however, is that a judge decides that the level of liquidated damages is not reasonable and that a much lower amount should be paid or that the company should show its actual loss, which may be hard to prove.

In any case, most MNCs tend to be more concerned with trying to prevent employees from competing for the duration of restricted periods, rather than receiving damages for loss, which may not adequately cover the actual or intangible (and unprovable) loss to the company. As mentioned above, even if a company obtains a judgment ordering a former employee to continue to perform a non-compete obligation for the remainder of the term, this can be extremely difficult to enforce. The courts tend to be more willing to enforce the continuing non-compete in situations where an employee is competing through a new independent entity or business which he/she has set up. However, the courts seem to be reluctant to do so in cases where a former employee has taken up employment with a new company and will not interfere with the new employment or order the new employer to cease or suspend the new employment.

As a result, much depends on whether any pressure can be brought to bear on the new employer and whether the new employer is willing to cooperate. A company can look to use the PRC Anti-unfair Competition Law to take action against the new employer directly. This provides that a party will be deemed to infringe the trade secrets of the legitimate holder if the former obtains, discloses, uses or allows others to use such trade secrets if it knows or should have known that the information is being unlawfully used by its employees who formerly worked for the legitimate holder.

Given the difficulties of enforcing non-compete clauses and obtaining the desired or adequate remedy for breach, employers should consider what protection can be obtained before an employee actually leaves the company. For example, employers can consider placing employees on garden leave during notice periods and ensuring that they do not have access to information and client contact during such periods, as well as trying to secure relationships on the customer or client side while the employee is on garden leave.

In summary, China remains a difficult environment in which to implement and enforce non-compete agreements, or at least to obtain adequate remedies. This does not mean that companies should not seek to do so, to the extent possible. But it does mean that companies need to have a clear strategy and tight documentation, including clear provisions regarding compensation payable to employees and the level of liquidated damages. Setting specific liquidated damages can act as a clear and useful deterrent to employees. In addition to the relevant agreements covering non-compete, we also suggest covering the protection of confidential information in other employment documentation, given that non-competes are so linked to the protection of confidential information. This can be used to support the company’s position in any dispute regarding non-competes and demonstrate the company’s commitment to and reliance on confidentiality in its business.

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This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.