Analysis, recommendations on China’s non-compete disputes

Article 23 of the Labour Contract Law stipulates that, “the employer and employee may agree in the labour contract to keep the employer’s business secrets and confidential matters related to intellectual property rights. For employees with confidentiality obligations, the employer may set out non-compete clauses in their labour contracts or confidentiality agreements, and agree to give them monthly financial compensation during the non-compete period after the termination or expiration of the labour contract. In the event of a breach of the non-compete agreement, the employee should pay liquidated damages to the employer in accordance with the agreement.”

The author summarises the following characteristics of non-compete disputes in China after researching on publicly available judgment documents since 2016, retrieved from China Judgments Online.

The disputes are concentrated in certain industries. Non-compete disputes noticeably occur more frequently in the internet, IT and high-end manufacturing industries. This is closely linked to the characteristics of such industries, such as high technological levels, fierce competition, active entrepreneurship and frequent talent flow.

The verdict upholding rate in the second instance is high. The author retrieved 293 public judgments of the first instances in non-compete disputes for the three years between 2018 and 2020 nationwide. In 267 cases, the original judgment was upheld in the second instance, representing an upholding rate of 91.26% and a reversal rate of only 8.74%. This points to the extreme difficulty in changing the verdict in general non-compete cases.

Both employers and employees should therefore attach great importance to the first-instance proceedings of a non-compete case, collect and organise solid evidence and information, and engage counsel with rich experience in non-compete cases to represent them in court.

COMMON CLAIMS

The author investigated the public judgments of the past three years and compiled statistics on the common claims in non-compete cases. The top three are: requests for payment of liquidated damages, accounting for 85.6%; requests to continue performing the non-compete obligations (54.4%); and requests for return of non-compete compensation (35.7%). Requests for payment of liquidated damages are the most typical and frequent dispute type in non-compete cases.

In addition, requests for termination of non-compete agreements and requests for compensation for lawyers’ fees account for 19.5% and 13.8%, respectively, ranking fourth and fifth among common claims.

ASSESSING DAMAGES AMOUNT

In non-compete cases, liquidated damages are commonly determined by: (1) directly agreeing on a fixed amount of liquidated damages; (2) agreeing that the liquidated damages shall be a certain multiple of the employee’s monthly wage prior to his/her departure; and (3) agreeing that the liquidated damages shall be a certain multiple of the non-compete compensation.

The author discovered that the amount of liquidated damages agreed in non-compete agreements for breaching after departure is on the rise. As courts in China do not charge fees for accepting labour disputes based on the amount in dispute, an employer claiming excessive liquidated damages will not incur extra litigation expenses even if it cannot completely win the court over.

The court may reduce such an amount, but predicting whether, and by what standard, the excessive amount will be scaled down can be difficult. For opportunistic reasons, the employer may set out disproportionately high liquidated damages in advance.

In cases concerning liquidated damages, whether the amount is too high is often one of the focal disputes, as former employees tend to request a reduction of liquidated damages to an appropriate level.

Based on the author’s experience, when deciding whether to reduce liquidated damages, the judge will mainly consider the following factors: (1) the length of the breach of contract; (2) whether there is a great disparity between the rate of liquidated damages and that of compensation; (3) whether the employer demands both the return of compensation and the liquidated damages at the same time; (4) the actual amount of loss incurred; (5) the importance of the confidential information held by the employee; and (6) whether the former employee intentionally made misrepresentation and his/her attitude in the court hearing. According to the research, about 80% of employees’ applications for reduction of liquidated damages between 2018 and 2020 were supported by court. This suggests that applying for reduction of liquidated damages is a relatively common and effective defence strategy for former employees in violation of their non-compete obligations, and that the agreed amount of liquidated damages is generally too high.

EVIDENCE COLLECTION

How does an employer prove that its former employee has joined a competitor? Common types of evidence collected include: (1) certificate of payment of individual income tax; (2) record of social security payment; (3) an express delivery sent to the former employee at the address of the competitor, which becomes proof when signed for; and (4) video of the former employee entering the competitor’s premise.

STATUS UPDATE

The author recommends that employers require employees to provide regular updates of their whereabouts after departure, as part of the non-compete clause. If a former employee intentionally provides false information and receives compensation for non-competition, the action may be determined as fraud and the employee could be held for criminal offence in serious cases.

BEST TIMING

Non-compete is not a mandatory clause in labour contracts, but requires negotiation and consent. For an employer, the best time to obtain a signed non-compete agreement is at the employee’s moment of entry as part of the larger labour contract. The employee may be more willing to accept the non-compete bind in the hope of securing the position.

PREDICTING RISKS

Employers are advised to research candidates’ non-compete status, obtain the content of their non-compete clause, and review the relevant legal risks with in-house or external legal counsel.

Xie Yang is a senior partner at Zhilin Law Firm