How To Terminate A China Employee Non-Compete Agreement. Very Carefully.

China allows for non-compete agreements that prohibit high level employees from working for another company that competes with the employer. However, these agreements are generally limited to senior management, senior technicians and other high level personnel who have a confidentiality obligation to the company. In exchange for the employee’s promise to maintain the non-compete requirement, the employer is required to pay economic compensation to the employee. After an employee has left his or her employ with a company, the company many times would prefer not to continue paying the employee and thereby bring an early end to the non-compete agreement.

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”), employers that unilaterally terminate a non-compete agreement during the non-compete period must pay the employee with the non-compete agreement three additional months’ salary for the early termination. In other words, employers cannot just walk away from their previously signed non-compete agreements without a penalty. Our China lawyers frequently see non-compete agreements that purportedly allow the employer to unilaterally terminate the agreement by giving one month’s notice to the employee. As explained above, this runs afoul of Judicial Interpretation IV.

Note though that some labor bureaus refuse to comment on the application of judicial interpretations. Some (like Shanghai) say they still refer to the PRC Labor Contract Law as their guideline. The Shanghai Labor Bureau is of the view that neither party can unilaterally terminate a non-compete agreement during the non-compete period. The Shanghai authorities base their position on the basic contract law principle that agreements generally require mutual consent to be terminated. The Labor Contract Law does not actually address this issue at all.. As with the compensation required for an employee non-compete agreement, even 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 the applicable rule is as we are still seeing quite a lot of local differences.

Judicial Interpretation IV provides no guidance on how employers can terminate a non-compete agreement during the employment term (i.e., before the non-compete period begins). Some practitioners believe that given the pro-employee approach of Judicial Interpretation IV, it is likely that an arbitrator or court would mandate that the employer pay three months’ compensation. On the other hand, it could be argued that because terminating a non-compete agreement releases the employee’s non-compete obligation even before the non-compete period has begun, the employer should not be obligated to make any payment because the employee never performed his or her obligation not to compete.

Note also that Judicial Interpretation IV gives employees the right to unilaterally terminate a non-compete agreement, provided the following conditions have been met:

(1)   The employee has performed his or her non-compete obligation;

(2)  The employer has failed to make compensation payments for three months or longer;

(3)   The failure to pay the employee was caused by the employer itself. In other words, the employee cannot prevent the employer from making payment so to avoid the employee from having to perform his or her obligations.

Bottom Line: Once the non-compete period has begun, employers cannot terminate a non-compete agreement without being subjected to a penalty. Since it is unclear whether this also holds true for an employer terminating a non-compete agreement during the employment term, we recommend inserting a provision into your non-compete agreement or employee contract making contractually clear exactly what will happen with an early termination of your non-compete agreements.