Battling with China law over non-compete compensation
For most investors with intellectual property (IP) in China, protecting their IP is a high priority. Various strategies are available, such as ensuring proper registrations and including protective contractual provisions in IP licences. One strategy that should also be considered is the imposition of post-termination non-compete obligations on employees who have access to IP.
China’s Labour Contract Law permits an employer to include non-compete obligations in a labour contract or confidentiality agreement with certain employees. An employee subject to a non-compete obligation can then be prohibited from working for one of the employer’s competitors, or from running their own competing business, following the termination of their labour contract with the employer. Non-compete obligations can only be imposed on senior management, senior technical staff and any other staff who have confidentiality obligations.
A non-compete obligation must also satisfy certain requirements in order to be valid. First, the employer is required to pay monthly compensation to the employee during the agreed non-compete period. Second, the non-compete period cannot be longer than two years.
The geographic area and specific scope of a non-compete obligation may be agreed between the parties. Although not explicitly required by law, the restrictions should be reasonable.
One of the trickier aspects of non-compete obligations has been the amount of compensation that must be offered. Until very recently, there was no national-level guidance on how much was enough. Although some local guidance was issued, parties in most areas in China were left to negotiate the amount. The risk for employers, however, was that a labour arbitration tribunal or court would find a clause invalid due to insufficient compensation being specified. Contracts entered without specifying the compensation ran the risk of enforcement issues when an ex-employee refused to accept the amount offered.
China’s Supreme People’s Court (SPC) has now recently provided limited national-level guidance. Specifically, it has said that if the compensation is not specified in a non-compete clause, and the employee has duly performed their non-compete obligations, then the compensation for each month should be 30 per cent of the employee’s average monthly salary over the previous twelve months. The compensation, however, cannot be lower than the local statutory minimum salary.
Although this new rule is supportive of non-compete obligations, it has a very limited scope of application. It only provides the amount that an employee seeking enforcement against an employer can claim in situations in which when the contract itself does not specify any amount. The new rule stops short of directly obliging an employee whose contract is silent to accept compensation of 30 per cent. It also does not say that an employer can bring a court action to enforce a non-compete obligation in situations where the employment contract did not specify the amount of compensation.
For clauses currently being negotiated or renegotiated, the 30 per cent rule might be taken as the minimum allowable compensation for a post-termination non-compete clause to be valid. The parties would, of course, be free to agree to a higher compensation amount.
In addition to putting a value on non-compete obligations, the SPC has said that an employee may terminate a non-compete clause if the employer fails to pay non-compete compensation for at least three months. The employee can pursue the unpaid compensation following termination. This rule, however, only applies for non-compete obligations in which the parties have agreed to compensation. It’s unclear whether an employee can terminate if the specific compensation had not been previously agreed.
Further, the SPC has said that an employer may terminate a non-compete clause at any time, provided that the employee is offered additional compensation equal to three months of non-compete compensation. This new rule appears to create a right to three months’ compensation beyond date of termination. How it will be applied in practice remains to be seen.
The Road Ahead
Despite the lack of clarity as to termination of non-compete obligations, the recent SPC interpretations provide a welcome, though limited, benchmark for non-compete compensation. HR personnel should review contracts and, where needed, renegotiate employment contracts.
Herbert Smith Freehills has 2,800 lawyers and 460 partners in over 20 offices globally. It advises on dispute resolution and employment, among other areas. Karen Ip and Betty Tam are partners of Herbert Smith Freehills in Beijing and Shanghai, respectively.
EDITOR’S NOTE: The information in this article should neither be relied on as legal advice nor be regarded as a substitute for detailed advice in individual cases. If advice concerning individual problems or other expert assistance is required, the service of a competent professional adviser should be sought.