Analysis of key issues in non-competition disputes in Shanghai

The non-competition system helps businesses prevent employees from joining competitors and leaking trade secrets, but it also restricts employees’ freedom to choose their jobs. Balancing these interests is a core challenge in non-competition disputes. Given the complexity of this issue, practices vary significantly across regions.

This article examines non-competition disputes in Shanghai, focusing on the eligibility of subjects, the relationship between non-competition and the declassification period, and non-compete agreements related to stock options to provide compliance guidance for businesses.

Eligible subjects

Article 24(1) of the Labour Contract Law restricts the obligation of non-competition to senior management, senior technical personnel and other employees with confidentiality obligations. Disputes often arise over who qualifies as “other employees with confidentiality obligations”.

Is the mere signing of a non-compete agreement sufficient to impose non-compete obligations on an employee? Some argue that employees owe a duty of loyalty to their employers and that mutual agreement on non-compete terms should suffice without the courts needing to assess whether an employee has confidentiality obligations.

Others advocate for a stricter approach, suggesting that restrictions on an employee’s rights should be predicated on the protection of trade secrets. To prevent employers from abusing their position of power, courts should verify whether employees have confidentiality obligations.

In Shanghai’s judicial practice, the prevailing view leans towards a rigorous assessment of whether employees have confidentiality obligations. The Shanghai First Intermediate People’s Court clarified in its Guidelines and Key Points for Adjudicating Non-Compete Dispute Cases that when determining if employees have such obligations, one can refer to the rules used in trade secret infringement cases.

Specifically, if an employee holds a position in sensitive areas such as technical research and development, sales or finance, it can be presumed that they have access to the employer’s technical or business secrets. However, if the employee’s role does not fall within these sensitive categories, the employer must prove two things: first, that the company has specific technical or business secrets; and second, that there is a possibility the employee had access to these secrets.

The Supreme People’s Court, in its recent publication of typical labour dispute cases, emphasised that employees who do not have confidentiality obligations should not be bound by non-compete agreements even if they have signed one. It was specifically clarified that workers who only have access to general business information during their normal duties are not considered as “other persons with confidentiality obligations”.

The courts must clearly oppose the generalised application of non-compete clauses that unlawfully infringe on workers’ rights to freely choose their employment. Reflecting this judicial stance, the control over eligible subjects for non-compete restrictions in the Shanghai region is expected to become stricter. This also advises companies to pay close attention to the scope and subjects of confidentiality when implementing non-compete agreements.

Non-compete, declassification periods

In practice, besides the non-competition system, enterprises also use the declassification period system to enhance the protection of trade secrets. The former Ministry of Labour’s Notice on Several Issues Concerning the Mobility of Enterprise Employees stipulates in article 2 that, “when an employer and an employee who has access to trade secrets agree on confidentiality matters in the labour contract, they can agree to adjust the employee’s position and change relevant terms in the labour contract within a certain period (not exceeding six months) before the termination of the labour contract, or after the employee proposes to terminate the labour contract…”.

Article 15(2) of the Regulation of Shanghai Municipality on Labour Contract also has similar provisions. Based on this, courts in Shanghai, as seen in cases such as Wu v Dalian Bank Shanghai Branch, and China Merchants Bank Shanghai Branch v Tao Jiaqing, tend to uphold the validity of declassification period agreements.

It is important to note that article 16(2) of the regulation of labour contract states, “If the parties to a labour contract agree on a non-compete obligation, they should not additionally agree on a notice period for the termination of the labour contract”.

This means that businesses in Shanghai must choose between applying a non-compete agreement or a declassification period, as the two have different legal applications and specific adjustment scopes (such as duration, compensation and obligations). Companies can tailor their approaches to fit their actual needs, developing solutions that adhere to practical requirements.

Non-competition related to stock option

As non-compete agreements become more widely used, recent years have seen an increase in cases where stock options and other non-monetary forms are used as compensation for non-compete obligations. However, given the uncertainty associated with the exercise and value of options, along with their lack of liquidity compared to cash, there is significant controversy over whether such stock option-based non-compete compensation is feasible. These factors may undermine the legitimate rights of employees, raising questions about the viability of this approach.

In the Shanghai region, there is a relatively open stance towards agreements involving equity incentives as compensation for non-compete obligations. Existing cases indicate that if an employer and an employee reach an agreement on equity incentives as non-compete compensation on a basis of equality, good faith and voluntary negotiation, the courts tend to recognise its validity.

For instance, in the case of Xu Zhenhua v Tencent Technology (Shanghai) regarding a non-compete dispute, the court affirmed the validity of the agreement signed by both parties, which granted restricted stocks as compensation for non-compete obligations, as well as the corresponding liabilities for breach of contract. Furthermore, in Zhang v Pinduoduo, in a non-compete dispute, the court noted that once stock options are agreed on as non-compete compensation, there is no need to provide additional compensation for the non-compete agreement.

Shaw Zhao is a partner and He Yanling is an associate at Jingtian & Gongcheng