The recent publication of an employment case in China serves as a useful reminder that China has a unique, civil law, legal system, that differs in many aspects from common law systems. The case held that the PRC court would not support a non-competition clause, if the employer did not agree to the corresponding economic compensation with the employee. The Beijing Dongcheng District People’s Court held that the non-competition clause would be nullified on the grounds that no agreement of non-competition compensation had been agreed upon between the employer and employee. The court ruled that, according to the provisions of Article 23 of the PRC Labor Contract Law, the employer and employee could agree on non-competition clauses in a labor contract or a confidentiality agreement, in which they also agree to pay a monthly compensation to the employee within the non-competition period after dissolving or terminating the labor contract. The employee should pay penalties to the employer for breaching the non-competition clauses according to the agreement. However, in the present case, although the employee and employer had agreed to the non-competition obligation, they failed to reach agreement on non-competition compensation payable to the employee; thus the employee was not bound by the non-competition obligation and did not have to pay penalties to the employer.
Low Compensation Decision
In another case published in the recent Gazette of the Supreme People’s Court of China, the Nanjing Gulou District People’s Court nullified the non-competition clauses agreed upon between an employer and an employee in a confidentiality and non-competition agreement on the grounds that the economic compensation agreed upon and paid by the employer for the noncompetition obligations was “too low”. The court referenced a Jiangsu province local rule which provides that the annualized economic compensation for non-competition obligations shall not be less than one third of the income that the employee received from the employer in the 12 months preceding the termination of the employment. However, in the present case, the agreed upon compensation for the one-year non-competition period was one month’s salary, although the employer claimed to have actually paid three months’ salary as compensation, which was still lower than one third of the employee’s 12 months’ salary. The court thus ruled that since the compensation is “too low”, the employee was not bound by the non-competition obligations.
Lessons learned from these cases are that, although the confidentiality obligations would not be affected if so agreed in the relevant labor contract or confidentiality agreement, the noncompetition obligation must be supported by a corresponding economic compensation to make it effective and enforceable. Moreover, the compensation to be agreed upon must not be “too low” in order to not put the non-competition clauses at risk of being nullified by the court. It is advisable for the employer to check the local labor rules applicable to the employment with its employee, in addition to the national laws and regulations to ensure full compliance. It is also worth noting that even if the corresponding economic compensation has been agreed upon in the relevant labor contract or confidentiality agreement that would not be regarded as “too low”, the employer would still be at risk of losing the non-competition protection if it fails to pay the compensation in accordance with the agreement. We understand that PRC courts and arbitration tribunals have taken a similar position on this issue.