Employment Law in China

Best Practices to Ensure that a Non-Competition Agreement is Enforceable in China

By Richard Chao and Haidong Yang

Introduction

After more than a year since the implementation of the PRC Employment Contract Law (the “Law”) (the PRC Employment Contract Law was promulgated on August 5, 2007 and became effective on January 1, 2008; the Implementing Regulations for the PRC Employment Contract Law became effective on September 18, 2008), the law governing non-competition agreements remains unsettled.  Employers should work closely with counsel to ensure that their non-competition agreements are up to date and enforceable in China.  The general rule is that the employee must receive reasonable compensation for the non-competition agreement to be enforceable.  Underneath this general rule, however, two traps wait silently for the unwary.

To Specify or Not to Specify Compensation?

The first trap for the employer is whether the non-competition agreement must specify the amount of compensation.  The statutory language would lead one to conclude that the amount of compensation does not have to be specified when the employee signs the non-competition agreement.  Article 23 of the Law states that an employer may specify the monthly compensation payable to the employee.  The word “may” suggests discretion on the part of the employer, which means that a non-competition agreement is enforceable even if the agreement does not specify compensation payable.

The employer would be right if the non-competition agreement were to be enforced in Shanghai.  According to the local judicial guidance, a court in Shanghai has the authority to determine the amount of reasonable compensation at the time when an employer seeks to enforce the non-competition agreement².  But, a local jurisdiction could act in contrary to the plain language of the Law. A recent case demonstrates the risk to employers. In that case, the non-competition agreement failed to specify amount of compensation for the employee. After the employee was terminated, the employer and the employee could not agree on compensation, and the case went before a municipal court in Beijing. The court could have imposed reasonable compensation and upheld the non-competition agreement. Instead, it ruled that the non-competition agreement was void partly because the agreement did not specify compensation payable.

How Much Compensation is Reasonable?

The second trap relates to the amount of compensation. How much compensation is reasonable in the eyes of a court and enough for it to enforce the agreement? The Law offers no guidance because the statutory language is silent regarding this issue. In practice, the amount of compensation that would be deemed reasonable—which greatly increases the likelihood that the agreement is enforceable—varies from jurisdiction to jurisdiction and may even vary within the same jurisdiction from time to time. Because the rate of increase in the cost of living varies from region to region, the local jurisdictions are better positioned to judge what is considered reasonable compensation. For example, the Shanghai Municipal Higher People’s Court issued guidance on reasonable compensation in March 2009.  The Shanghai authority said that the amount of compensation could be between 20 to 50 percent of the employee’s income if the employer and the employee cannot agree on the amount of compensation.

Nonetheless, what is considered reasonable compensation may change over time. Employers should not assume that the range of 20 to 50 percent of income would remain constant over time. The best practice in navigating safely through this unsettled area of law is to contact the relevant local authority at or near the time when entering into an employment agreement that contains a non-competition agreement.

Best Practices

When contemplating the use of a non-competition agreement under PRC law, an employer should follow these steps:

(a) prepare a well-drafted agreement and have the employee sign the agreement;

(b) clearly define competition (or the specific competitors), geographic coverage, the scope of competitive activities, and the non-competition time period (the maximum period is two years);

(c) specify the amount for liquidated damages or a formula for calculating liquidated damages;

(d) clearly define compensation for the non-competition agreement and use language to indicate the employee’s acknowledgement for the adequacy of such compensation;

(e) during the enforcement of non-competition, obtain the employee’s acknowledgment for the receipt of compensation; and

(f) with the assistance of counsel, understand and comply with any additional local employment regulations where the employee will work.

Conclusion

PRC law governing non-competition agreements remains unsettled. The general rule is simple but traps remain for the unwary. Employers should work closely with counsel to ensure that their non-competition agreements comply with both the Law and guidance from local jurisdictions.