Economic compensation is a mandatory element of any non-competition clause.
PRC law1 requires non-compete compensation to be paid by the former employer to the former employee every month during the non-competition period. This means that, after the former employee stops its employment relationship with the former employer, the former employer shall pay every month – for the whole duration of the non-compete period – the indemnity.
In practice, however, companies often do not implement such post-termination payment system, but still prefer to pay the non-competition indemnity during the employment relationship, relying on clauses such as “the parties agree that the salary already includes the non-competition indemnity to the Employee”.
Is such a system enforceable under PRC law?
When disputes arise, former employees usually invoke application of article 23 of the Labor Contract Law to (i) claim that the pre-paid indemnity is merely part of the salary and (ii) challenge the validity of their non-compete obligations on the grounds that no indemnity has actually been paid to them.
Such reasoning however is not accepted by all courts or arbitration commissions.
In Shanghai, for example, courts appear to have a more flexible approach and to value more the Parties’ agreement.
In a recent case, currently under appeal before the Intermediate Court n. 1, a labor arbitration commission in Shanghai held the non-competition clause to be valid even if the indemnity had been paid during the employment relationship. Specifically, in this case, the labor contract stated that – out of the total salary – an amount of 500 RMB was paid per month as non-compete indemnity2.
In another similar decision, dating back to 2011, the labor arbitrator dismissed the former employee’s claim that the non-compete clause was invalid due to its conflict with article 23 of Labor Contract Law and ruled in favor of the former employer, expressly stating that “the non-compete clause was inserted into the labor contract, which indicated that both parties had autonomously agreed on such non-compete obligation”.
Even if – for employers – the safest practice remains post-termination payment of non- compete indemnity pursuant to article 23 of the Labor Contract Law, it appears that – at least in Shanghai area – employers have higher chances of winning non-competition litigations even when the non-compete indemnity has been paid in a different way.
The key point is that the amount of the non-compete indemnity shall be clearly determined; otherwise, the employee can successfully claim non-competition clauses as invalid3. Such determination shall result clearly from the employment contract; alternatively, some arbitrator may also allow such determination to be proofed through evidence, such as payment slips to the employee – but this require separate payments for the salary and for the indemnity (i.e. during the employment period every month the company should pay to the employee through separate bank remittances the salary and the non-competition indemnity, and each payment shall show the appropriate justification).