China Non-Competes. Oh, Oh, The Price You’ll Pay

A Non-Compete Agreement is a contract where one party agrees not to compete with the other. These agreements reduce the likelihood of someone using information you provide them to compete against you. Non-compete agreements are fairly common between Western companies and their more important employees and it is common for those Western companies to want similar such agreements with their China-based employees.

In China non-compete (竞业限制) agreements between an employer and an employee are generally limited to senior management, senior technicians and other personnel who have a confidentiality obligation. China allows for non-compete agreements that forbid an employee (again though, a quite limited level of employee) to be prevented from taking a position with another entity that provides or markets a product or service that competes with that of the employer, or to engage in producing or marketing such a product or service.

China limits these non-compete provisions to two years or less after termination of the labor contract and it also requires that the employer pay economic compensation to the employee to maintain the non-compete requirement. There are a number of things to which an employer with a non-compete agreement should pay attention, but in this post I only focus on non-compete compensation. The most important thing employers must know about non-compete compensation in China is that the employer is required to pay this compensation after the employee leaves the company and a failure to do so means the employee ceases to be bound by his or her agreement not to compete.

Pursuant to the Judicial Interpretation IV of the Supreme People’s Court on Several Issues Concerning the Application of Law in Hearing Labor Dispute Cases (“Judicial Interpretation IV”), if there is an agreement between an employer and an employee regarding post-employment compensation for a non-compete provision, their agreement prevails. If the agreement is silent on the amount of post-employment compensation for the non-compete provision, the employer must pay the employee compensation at 30% of the employee’s average monthly salary in the 12 months before termination, or the local minimum wage, whichever is higher.

Before Judicial Interpretation IV, there was no statutory guidance (other than Labor Contract Law which does not say much) on the standard of non-compete compensation and locales dealt with this issue by coming up with their own rules. For example, Shanghai used to hold that if there was no agreement on the amount of post-employment compensation, the employer had to pay the employee 20% to 50% of the employee’s last monthly salary. In Jiangsu, the rule was different: the annual non-compete compensation had to be at least one third of the annual salary the employee received from the employer over the 12 months before leaving employment. Though Judicial Interpretation IV is supposed to supersede all the local rules, it is nonetheless advisable to check with the relevant authorities to figure out exactly what their standard is as we are still finding local differences.

A literal reading of Judicial Interpretation IV would mean that even if the amount of compensation agreed to in a non-compete agreement between an employer and an employee is less than the local minimum wage, it is nevertheless valid and enforceable, because the 30% rule applies only when the non-compete agreement does not specify the compensation. But ex-employees could also argue that any amount less than the minimum wage is unfair and against public policy and thus should not be enforced. Some municipalities faced with this argument, including Shanghai have upheld the “freedom to contract” and ruled against the poorly paid ex-employee.

The key is to draft your non-compete provisions (in Chinese, of course) in a clear and easy-to-understand manner so that your employee cannot claim confusion and so that the specified non-compete compensation will not trigger a default compensation rate. I will cover more on non-compete agreements in our future posts.