Cases concerning conflicts of interest have taken up a great proportion in the labor disputes which we handled in recent years, occurred in employers of various industries and scale. Based on my pervious experiences and analysis to the practical cases, I would like to share some points of view with you regarding conflict of interest in employment relations.
- Definition of Conflict of Interest
Conflict of Interest, can be literally understood that there is a conflict between different interests. As to conflict of interest in labor relations, conflict of interest often refers to the conflicts between employee’s personal interests and his/her job responsibilities or employee identification. In another word, “dedication” is a basic requirement for employees, but employees may be driven by personal interests to make decisions or actions that are contrary to this basic requirement. There are usually three key factors for conflict of interest in labor relations: First is the existence of "personal interest". It is reflected in the labor relations as the personal interests of employee, which could be economic benefits, such as cash gains, investment returns, etc., and could also be to seek a special treatment or opportunity; Second is "responsibility", in labor relations, employee shall provide labor, perform job duties, abide by labor disciplines and be loyal to the employer, which is employee's obligations and responsibilities to the employer. Third is "conflict", that is the conflict between employee's personal interests and the responsibilities to bear has caused that the employee's normal performance or professional judgment interfered, and the existence of such conflict has caused, directly or indirectly, loss or harm to the interests of the employer.
Conflict of interest can be divided into conflict in narrow sense and those in broad sense. Narrow conflicts of interest typically include several types: (1) external employment or holding an external interest. Common case is that employee establishes labor relationship with other employer, holding an external position, or the employee's interested person works for the business partner or competitor of the employer, or employee or his/her interested person invests in or establish competitive business; (2) Self-dealing, where an employee takes advantage of the information or power gained in his/her position, inducing the employer to trade or cooperate with the company controlled by himself/herself or his/her interested person; (3) plundering trade opportunities, usually refers that employee takes advantage of his/her position to transfer the trade opportunities of the employer to a third party and make personal profit therein, most commonly by "flying orders"; (4) internal employment conflict, in which a marriage or kinship exists between two internal employees, which results in one party using or likely to use his/her power for the benefit of another. Conflict of interest in broad sense also include job grabbing and commercial bribery. This article only discusses and shares viewpoints on narrow conflict of interest.
II. Restriction scope of conflict of interest
Standing in the breach, employee him/herself shall be the “first-order” restricted person regulated by the policies of conflict of interest specifying to-dos or not-to-dos when conflicts between employee’s personal interest and his/her job duties/employer’s interest occurred. However, in many cases regarding conflict of interest, employee often uses the identity of his/her relative, friend, or other interested person to engage in issues with conflict of interest, in order to avoid direct conflicts. In this case, are the labor disciplines of the employer entitled to restrain the close or other relatives, or even friend of the employee? Based on previous case experiences and current judicial practice, a brief analysis is shared as follows:
1. Close relatives
Close relatives according to its statutory definition, include spouses, parents, children, siblings, grandparents and grandchildren. Since the close relatives are in more intimate relationship with the employee, and thus it is easier for the employee to use their identity, or such relationship may influence employee’s judgment and make the employee partial to the interests of his/her close relatives when conflicts occurred. Therefore, considering not only the necessity to control conflict of interest, but also the rationality to expand the scope of restriction, the employee's close relatives shall also be included in the restriction scope of conflict of interest.
2. Other relatives
Other than statutory close relatives, there are some relatives also in intimate relationship with the employee and they are also very likely to be involved in employee’s conflict of interest. Thus, many labor disciplines of employers also include other relatives into the restriction scope of conflict of interest. And as to the definition and scope of “other relatives” shall subject to the internal stipulations by the employer, which can be in the form of summary or detailed listing, such as uncle, brothers, cousins, other relatives in law, succession or adoption and etc.
3. Other interested person
In practice, there are many cases of conflict of interest, the involved persons are employees’ interested persons, such as clansman, friend, dates, alumni and etc. These interested persons are also in high possibility that may be implicated in conflict of interest. However, it is difficult to handle such cases of conflict of interest, since on the one hand, the employer can hardly have concrete and definite evidence of these kinds of relationship, and on the other hand, compared with relatives, the scope and definition of interested person are broader and hard to describe, there are risks that the judicial authorities may consider the employer rightless to request employee to disclose the employment and/or commercial activities of other person, and thus determine the labor disciplines of the employer vague and lack of rationality. Therefore, from the perspective of risk control, it is recommended that the employer includes "other interested person" by enumeration into the restriction scope in labor disciplines as a bottom clause. However, above risks still need to be brought to the attention of employers.
In summary, it is necessary to specify the restriction scope of conflict of interest clearly in the labor disciplines. It can serve as one of the legal basis for management of conflict of interest, preventing employee from "drilling loopholes".
III. Case study of conflict of interest
Shanghai Company A sells products in two modes, direct sales and indirect sales by distribution. Employee Li joined Company A in April 2007 as sales manager, in charge of both direct and indirect sales.
In March 2016, after receiving an anonymous whistleblowing and a thorough investigation, Company A found that Li established Company B as one of the stockholders with a registered business scope partially coincident with that of Company A. Also, according to the registration information of Company B, Zhang is its operating director and her husband is one of the stockholders of Company B. After verification, Zhang is the legal representative of a distributor of Company A, named Company C. By on-site investigation, Company A found that the actual office address of Company B and C is in a same place. Company A also found that Li referred the clients from whom he got inquiries and sales opportunities to Company C, and Company C made the deal with the clients eventually.
In view of this circumstance, Company A terminated the employment contract in May 2016 on the grounds that Li 1) failed to declare that he was engaged in competitive business and caused conflict of interest (establishing Company B), and 2) flew orders, causing conflict of interest and substantial economic loss to the employer. Li thought the termination is illegal and initiated the labor arbitration.
- According to Li’s viewpoints:
1) Company A only requested for conflict-of-interest declaration during on-board process in year 2007 while Company B was established in year 2013. The declaration made in year 2007 are all authentic information and after that Company A did not require further declaration;
2) Although the registered business scope of Company A and B partially coincide, Company B is a small company with a registered capital of RMB500,000 and has no capacity to compete with Company A, a world-renowned company.
3) Due to customer requirements for multi-party price comparison, Li exchanged the information of clients and their requests to the distributors. The ultimate goal is to win more orders for Company A. Also, Company A did not ban him from helping distributors selling products.
4) Company A did not get any harm or loss in this whole case.
- According to viewpoints of Company A:
1) The declaration from has requested for in-time further declaration of any changed information, but Li did not inform the employer of such information;
2) According to the agreement signed between Company A and Company C, Company A needs to pay rebates to Company C based on its sales revenue. In another word, direct sales mode gains more profits for Company A than distribution sales mode in same sales revenue. Judging from sales practices or thinking of maximizing profits, it was wrongful conduct for Li to refer the sales opportunity to distributor;
3) Also based on the agreement, the aim for Company A to set up distribution sales mode, is to expand more sales channels, promote sales revenue by sacrificing a portion of the profits (rebates). It is clearly contrary to the fundamental purpose of Company A as market expansion if potential clients of direct sales mode in Company A are referred to the distributors;
4) Li and Zhang co-founded Company B and Zhang is an interested person and have a special relationship with Li. Due to such special relationship, Li ignored the interest of Company A and referred the potential direct sales business to Company C, which clearly constituted a violation of labor disciplines and royalty obligations.
There are following focus of the dispute in this case:
- Is there any conflict of interest or competitive relationship between Company A and B?
In judicial practices, when judging competitive relationship, first step is to check whether the registered business scope of two companies coincides, regardless of their registered capital; second step is to check whether the two companies actually run the same business. Company B though with less registered capital, its business scope partially coincides with that of Company A, which is a solid evidence for conflict of interest, even competitive relationship. Although in year 2007 Company B has not been established, according to declaration form, “whether running or investing a business conflicting with interest of the company in the name of employee him/herself or the relatives” falls into the scope of the circumstances need declaration. Furthermore, it is requested to keep the company informed of any information update. Therefore, Li breached his duty of conflict-of-interest declaration.
2. Is there any conflict of interest between Li and Distributor C?
In general, whether a third party is an interest party of employee or such interaction need to be reported shall be subject to such interaction will affect the employee's neutral judgment in the performance of his/her duties. In this case, Li invested in Company B when serving as sales manager of Company A, while another shareholder of Company B is Zhang's spouse. Zhang herself is the operating director of Company B, and is also the legal representative of Distributor C. Company B shared office address with Distributor C. It is obvious that Li and Company B, Distributor C and Zhang has associated relationship. Such relationship has gone beyond the proper limit which a sales staff and distributor should keep, and is enough to affect employee’s judgment. However Li did not make any declaration to Company A during his employment.
3. Is there a conflict of interest between Reseller C and Company A?
Ostensibly there is a cooperative relationship between Distributor C and Company A, however in this case, whether there is a conflict of interest shall be subject to if there is any tradeoff for interest between the two Companies. Distributor C as a distributor of Company A has the same interest orientation with Company A. However Company A also has its direct-sales department and its own clients. If the products are sold in distribution-sales mode, Company A has to pay rebates to the distributor in accordance with the agreement. Li referred the potential clients of direct-sales mode to Distributor C and promoted the transactions between them, resulting in the loss of direct sales business and costing Company A rebates additionally. Obviously it is detrimental to Company A's interests. Thus, there is conflict of interest in some extent between Company A and Distributor C in this case.
4. Is employer’s loss an accountability requirement for misconduct regarding conflict of interest?
The harm of conflict of interest to the enterprise may be a direct economic loss, but it may also be potential threats or loss of opportunities. Since the latter is quite difficult to prove and identify, in order to avoid the situation that no discipline can be taken, usually enterprises will stipulate that the existence or failure to report conflict of interest is a violation to the labor disciplines, without emphasis on employer’s actual loss caused by such misconduct. Namely the consequence is not a necessary factor for determining a misconduct and its corresponding disciplinary action. Of course, if the enterprise has already specified in the labor disciplines that actual loss shall be a determining factor for misconduct and disciplinary actions, namely accountability requirement, it must be obeyed and implemented when handling conflict of interest. In this case, labor disciplines of Company A clearly state that “serious violation of discipline: failure to declare his/her engagement in business with conflict of interest and causing actual loss to the company”, which indicated that actual loss of Company A is one of the accountability requirements for Li’s behavior. As analyzed above, Li’s referral of potential clients of direct-sales mode to distributor did cause loss of Company A, and thus the court determined that Li committed serious violations. If Li only invested in Company B without other related shareholders but did not make any referral of clients, the loss of Company A and thus Li’s serious violation would be hard to prove.
IV. Prevention and response suggestions for conflict of interest
For the frequent case of conflict of interest, enterprises shall make precautionary measures to actively and effectively respond to specific incidents, reducing or avoiding legal risks. In this regard, I suggest that employers can focus on the following aspects:
- Formulate clear rules regarding conflict of interest
According to the provisions of Article 4 of the Labor Contract Law, the employer shall establish and improve the labor rules and regulations in accordance with the law to ensure that laborers enjoy labor rights and perform labor obligations. In order to manage, rule or control employees' conflict of interest, enterprises must firstly have clear internal rules and regulations or labor disciplines. Though according to judicial practices and precedents of some districts, some misconducts have violated common labor rule and professional ethics which of course shall be acceptable and abided by the employee, the employer still may terminate the employment contract accordingly even if such misconducts are not specified in internal rules and regulations of the employer. However such misconducts shall be in great malignancy. According to the analysis of the first and second points of this article, there is no statutory stipulation on definition and restriction scope of conflict of interest. Therefore, the control and restriction of conflicts of interest depends more on the specific requirements and rules set by the employer. Therefore, I recommend employers to formulate clear rules regarding conflict of interest based on their own business and management needs, focusing on following aspects:
1) Define the restriction scope of conflict of interest, and identify other interested person who also be involved and controlled other than employees themselves;
2) List common situations of conflict of interest, such as outside employment, investment or self-transaction with the company;
3) Identify the disciplinary actions corresponding to the misconduct of conflict of interest, including the disciplinary measures that the enterprise can take, the countermeasures after the employee declares or the company finds the conflict of interest;
4) Establish a conflict-of-interest reporting system, design declaration form, and regularly request employees to update the declaration of conflict of interest during the employment, and at the same time clarify the obligation to disclose all the changes in time;
5) Establish an inquiry mechanism regarding conflict of interest to provide a channel of consultation and information acquisition for the employees who have confusion;
6) Improve the whistleblowing and investigation system, standardize the whistleblowing channel, and establish screening and investigation mechanisms for internal and external whistleblowing.
2. Strengthen the training on internal policies regarding conflict of interest
Formulating comprehensive rules and regulations of conflict of interest is to make employees avoid conflict of interest effectively and effectively. If enterprises only simply send the policies to employees, it is hard to attract their attention. For the enterprises with high compliance requirements, it is recommended to conduct different types of training and interpretation on policies of conflict of interest when on-board or during their employment, remind them of consequences of violations and thus make the employees fully understand and strictly observe.
4. Conduct conflict of interest investigations through multiple channels
If an employee is suspected of violating the policies of conflict of interest, enterprise on one hand shall conduct an investigation to determine whether the employee has violated the disciplines or even violated the law timely and on the other hand, may also timely discover the risks in the management or internal policies of enterprise and make improvements. Procedures for conflict of interest investigation and processing can usually be as follows:
1) Develop an investigation strategy, including the plan, scope, time, investigators and their division, steps, and the materials needed for investigation;
2) Conduct investigation and evidence collection. It refers to selecting the subject of evidence collection subject to the difficulty and method of obtaining evidence, and making further investigation based on relevant evidences, such as interviews with relevant personnel, internal and external documents and information review, public information inquiry, and engaging external professional investigation agencies, administration for market regulation, public security or other official channels if necessary;
3) Conduct effective analysis, identify and screen all kinds of information and materials collected from the investigation, draw investigation conclusions to determine and take action on employee’s misconducts;
4) Make decision based on the information got from investigation, taking action on employee’s misconduct in accordance with rules and regulations of enterprise, such as disciplinary action, changing position or job duties and etc., and summarize the experiences in the case to improve the conflict-of-interest management and policies.