In September 2008, Mr. Li signed a three-year fixed-term employment contract and a non-compete agreement with Company A, an internet finance business. It was agreed that, as a business specialist in Company A, during his employment and for one year afterwards, Mr. Li would not engage in any competitive conduct without the consent of Company A. There was a liquidated damage clause for breach of the non-compete obligation.

In May 2010, Mr. Li and a third party set up a joint venture (“Company B”) doing the same type of business as Company A. Company A alleged that Mr. Li had violated his non-compete obligation during his employment and claimed liquidated damages.

Mr. Li argued that, as he was not a director or senior manager, under the Company Law of the People’s Republic of China (“Company Law”), he should not bear a matter-of-course non-compete duty during employment, and the non-compete and liquidated damages obligations should not apply to ordinary employees until after termination of the employment contract as set out in the Employment Contract Law of the People’s Republic of China (“Employment Contract Law”) . Therefore, the agreement regarding non-compete and liquidated damages during the employment of an ordinary employee is in conflict with laws and is invalid.

In response to Mr. Li’s argument, the in-house counsel of Company A looked at the Company Law and the Employment Contract Law, and deliberated on the non-compete provisions. The assertion of Mr. Li seemed reasonable, yet unconvincing. Should Mr. Li be right, the dramatic conclusion would have been that agreement between employers and ordinary employees on non-compete during the employment was useless.

The Company Law explicitly states that directors and senior managers have non-compete obligations during their employment. The Employment Contract Law clearly provides that employers may negotiate non-compete obligations with employees; employers shall compensate resigned employees for the non-compete period and employees must pay liquidated damages for breaching the non-compete obligation. However, whether non-compete obligations and liquidated damages are applicable to ordinary employees during their employment remains ambiguous.

To probe deeper into this issue, we retrieved some cases in Beijing, Guangdong and Shanghai in an attempt to solve the puzzle in judicial practice.

The validity of a non-compete clause during the employment of an ordinary employee

To begin with, we collected 12 relevant cases in Beijing. All the judgments point out that, with mutual consent, an agreed non-compete obligation during employment will be valid if the agreement does not violate the mandatory provisions of laws. If an ordinary employee broke a non-compete promise during employment, he/she should pay the liquidated damages agreed to the employer[1].

In addition, the First Intermediate People's Court of Beijing and the Third Intermediate People's Court of Beijing incline to underscore the arrangements made in non-compete agreements, i.e., an employee is certainly liable for breach of any mutually agreed non-compete obligation during employment[2]. Furthermore, the People’s Court of Haidian District and the People’s Court of Chaoyang District expound: an ordinary employee receives remuneration from an employer and has duty of loyalty, which includes the non-compete duty, similar to that of directors and senior managers. Therefore, an employee is liable for breaching his/her non-compete obligation[3].

Next, we included into our research cases in Guangdong and Shanghai. Among the nine cases we retrieved in Guangdong and eleven cases in Shanghai, except for two in Shanghai, the courts’ views resemble those of Beijing. That is to say, it is recognized that employers may reach an agreement with ordinary employees involving non-compete obligation during employment. As for the basis of the obligation and responsibility, mutual agreement and the loyalty duty are emphasized as well[4].

The non-compete obligation during employment, therefore, is not only for directors and senior managers as set out by the Company Law. Employers may require ordinary employees to carry the burden of non-compete obligations during employment and claim liquidated damages following employees’ default.

This conclusion also corresponds with the legislative intent of current employment laws. Generally speaking, current employment laws derive from the standard employment relationship which aims to manage full-time employment. The mainstream view is that employees in an employment relationship are personally dependent on employers. During employment, employees transfer their labor to employers, and employers provide payment as the consideration in exchange. To guarantee a stable and sustainable employment relationship, employees bear the loyalty duty which involves accepting the employers’ management and working hard; employers undertake obligations such as the necessary labor protection, working conditions and social security. Employers are also entitled to the exclusive and preferential right to the employees’ labor.

These rules are laid down in all the various employment laws, including the Employment Contract Law. For instance, the protection of employers’ exclusive and preferential right over employees’ labor is reflected directly in the restrictions on employees’ part-time job in Article 39 of the Employment Contract Law. With regard to loyalty, the Company Law clearly allocates the obligation to directors and senior managers because of their special roles.

The arguments above may shed light on the case at the beginning of this article. On the precondition that employees have loyalty duty and employers possess the exclusive and preferential right over employees’ labor, all directors, senior managers and ordinary employees can be constantly and more easily exposed to employers’ confidential information during their employment. Thus, if employees are disloyal and conduct themselves adversely to employers’ interests, especially by competing, such conduct will obviously cause more serious harm to employers than such conduct after employees leave (whether the employee in question is director, senior manager or ordinary employee is not material at this time).

Comparing the benefits, since the Employment Contract Law explicitly imposes limits on part-time work during employment as well as on competitive conduct after departure, and the Company Law specifies the non-compete obligation during employment of directors and senior managers, the non-compete obligation of ordinary employees during employment is very reasonable.

It is worth noting that despite the above cases and employment law theory support for non-compete during employment, current laws do not explicitly recognize the validity of the non-compete agreement during employment. Besides, we collected only a limited number of cases. Hence, there is no complete certainty that ordinary employees’ non-compete obligations during employment will be absolutely upheld by the court.

However, the People’s Court of Qingpu District, Shanghai and the First Intermediate People's Court of Shanghai take a different position in their judgments. They hold the point that the liquidated damages to be paid by employees should be explicit in law; but the Employment Contract Law merely requires employees to pay liquidated damages for violation of a non-compete obligation after departure. Following this line, agreements not to compete during employment and the resulting liquidated damages cannot be sustained[5].

Adjustment of liquidated damages for breach of a non-compete obligation during employment

We have noted that the liquidated damages for an ordinary employee’s breach of a non-compete obligation during employment relies on the agreement, as most cases manifest. That is to say, courts usually consider the amount of the liquidated damages based on the contractual terms, as long as employers can provide evidence of the employee’s violation of the non-compete obligation during employment.

In a situation where the employer or employee requests the court to adjust the amount of liquidated damages, a unified criterion remains to be seen. The discretionary considerations presented in the cases above are exhibited as follows:

Frequency

Consideration

6

The consequence of the breach of non-compete obligation

5

Principle of equity

The income of an employee

4

The compensation standard for non-compete obligation

2

The fault of an employee

The nature and extent of violation of non-compete obligation

1

The duration of the breach of non-compete obligation

The expectation of the legal consequence by an employee

The performance period of an employment contract

The balance of the entitlement and duty stipulated in the non-compete clause

The professional integrity of the business

The injury brought by an employee’s competitive conducts to an employer’s competitiveness and business secret

In summary, the principle of equity is a frequent consideration for courts in altering the amount of liquidated damages, which is at the courts’ discretion. Apart from that, objective considerations take up the majority, which suggests the judiciary’s preference to focus on objective evidence.

Suggestions

In light of the analysis above, three suggestions are made for enterprises as follows:

  1. Non-compete obligations during employment of ordinary employees may be contained in an employment contract or a non-compete agreement. The non-compete clause should be expressly treated as part of the loyalty duty and the consideration is the remuneration paid by employers.
  2. For the liquidated damages trigger, objective conditions that give rise to non-compete liquidated damages should be specified. And employers should be prudent in including economic losses as a trigger for liquidated damages.
  3. When non-compete disputes emerge during employment, employers may seek to increase the amount of liquidated damages. The key point is to be reasonable in such requests and have sufficient objective evidence that supports the allegations.