China’s Labor Contract Law requires that an employer pay an employee “reasonable” compensation during the term of a post-termination non-competition agreement (also referred to as a “non-compete”) and specifies that the non-compete may not exceed two years following termination. For more information about the requirements of the Labor Contract Law for non-competition provisions, see Ruilin Li’s article “China’s New Labor Contract Law” (January 2008). However, in practice the law has proved to be ambiguous, and both employers and employees have sought more certainty about the law’s obligations and protections.
On January 31, 2013, the Supreme People’s Court of the People’s Republic of China, China’s highest court, released Judicial Interpretation on Labor Disputes (IV) (“Interpretation IV”). The Court had published a draft of the Interpretation for public comments in June 2012. However, there are major differences between the final interpretation and the draft, which is intended to balance the interests of the employer and employee.
Interpretation IV has fifteen articles, five of which relate to non-competes. These answer some of the most significant questions about non-competes under the Labor Contract Law:
- In spite of the Labor Contract Law’s requirement for “reasonable” compensation during the noncompete period, many noncompetes do not provide for such compensation. There has been a question as to whether such agreements are enforceable. The Interpretation states that such a noncompete is enforceable and that the employer is required to pay monthly compensation equal to 30 percent of the employee’s average monthly salary in the preceding 12 months (but not less than the local minimum wage).
- In practice, employers and employees have not known what amount of payment is necessary to meet the “reasonable” compensation requirement for the non-compete period, and therefore employers have been uncertain about the enforceability of almost any noncompete for fear that a court would determine the compensation to be unreasonably low. Although the 30 percent figure discussed in the previous paragraph is not a binding standard, it at least gives the parties some indication of what might be considered reasonable, except for places that have a higher requirement under specific local rules.
- If the employer improperly terminates the employment contract (for example, the basis for termination is found to be legally insufficient), does this relieve the employee of the non-compete obligation in the same contract? The Interpretation concludes that the non-competition clause will remain binding upon the employee unless the parties agree otherwise.
- Local courts have disagreed as to whether, when, and under which circumstance the employee was discharged of the non-competition agreement when the employer failed to pay the compensation after the termination. The Interpretation determines that the employee is entitled to terminate the noncompetition agreement where the employer fails to pay the compensation for three months after the termination of an employment contract due to the “employer’s reasons.” Interpretation IV provides a particular emphasis on “employer’s reasons” because, in some cases, employees had cancelled their bank accounts so their employers could not pay the compensation and then tried to avoid performance of their noncompete obligations.
- An employer is entitled to terminate the agreement at any time during the non-compete period, by paying the required monthly amounts to the termination date plus an additional 3 months of compensation to the employee.
- Many non-competition agreements call for the employee to pay liquidated damages to the employer in the event of a breach of the non-compete, because it is often difficult to establish the employer’s actual damages from such a breach. However, there has been a question of the continued enforceability of the non-compete once the employee has paid the liquidated damages amount. The Interpretation clarifies that noncompetition clauses remain binding upon an employee after he or she pays the liquidated damages for his or her violation of the obligation where the employer requests the employee to continue the performance of the non-compete obligations. This is in response to the situation in which the employees intended to pay liquidated damages with a view to releasing themselves from their non-compete obligations.
As discussed above, Interpretation IV will have great impact on noncompetition provisions in both existing and future contracts, and even in previously terminated agreements. Employers who decide to use noncompetition provisions in their employment-related contracts will need to make appropriate revisions to their agreements and take the proper steps to ensure their enforceability during and after termination of an employee.