Professional Interpretation

Abstract:

In order to protect trade secret and avoid repercussions of change in core staff, a number of companies would sign non-competition agreements with employees. But as the legal regulation on non-competition restriction is relatively generalized in China, the non-competition agreement has become one of the most contentious issues in labor contract disputes and trade secret protection in recent years. The Dispute Resolution Team of Beijing Docvit Law Firm hereby presents the analysis of common disputed issues related to non-competition agreement with relevant case studies for your reference.

A． Introduction

Non-competition agreement, in short, is a legal agreement that the employer and employee enter into to restrict the employee from harming the legitimate interests of the employer with a proper financial compensation being paid to the employee subject to non-competition obligations after the employment relationship ends. The non-competition restriction is designed to prevent unfair competition conducts, however, it is at the expense of the freedom of employment of the employees. Therefore, financial compensation needs to be paid to balance the interests of both parties. Currently, the rules on non-competition restriction in China could be found in the Labor Contract Law of the People’s Republic of China (hereinafter referred to as the “Labor Contract Law”) and the Interpretations of the Supreme People’s Court on Several Issues Concerning the Application of Law in the Hearing of Labor Dispute Cases (IV) (hereinafter the “Interpretations IV”) . But due to the generalization of stipulations in relevant provisions, many disputed issues have arisen in judicial practice, among which the scope of application of such provisions regarding the persons and businesses subject to confidential obligations appear to be particularly blurred. As such, this article will focus on the analysis of the two issues stated above in details.

B. Scope of Application Concerning Persons Subject to Non-Competition Agreement:

a. Common Disputed Issues:

According to Article 24 of the Labor Contract Law, “The personnel subject to non-competition obligations shall be limited to the Employer’s senior management, senior technicians and other individuals with confidentiality obligations. The scope, geographical limitations and term of the non-competition obligations shall be agreed upon by the Employer and the employee, and they shall not violate any laws and regulations.”

It can be concluded that the persons subject to non-competition restriction are defined as “senior management, senior technicians and other individuals with confidentiality obligations” in China’s current legislation. At present, no specific stipulations have been published to elaborate on the persons that should be identified as “senior management”, “senior technician” or “other individuals with confidentiality obligations” stated in the provision. In practice, the employer may sign non-competition agreements with all employees including those in auxiliary positions, such as security guards and sanitation staff for the sake of protecting own interests. Therefore, the scope of employees that fall under the provision of the Labor Contract Law on non-competition restriction has become a primary disputed issue in such disputes.

b. Case Study:

Case 1: Sichuan Xichan Plastic Surgery Hospital Co., Ltd. vs GE Jinhua

The court of retrial held that “In this case, despite that GE Jinhua was not senior management of Xichan Hospital, she had easy access to client information, which was trade secret of Xichan Hospital, as the receptionist. There is a possibility that she could take advantage of such trade secret at her subsequent position at Yue Hao Hospital that engaged in horizontal competition of the petitioner. Thus the adjudication of the court of first instance to identify GE Jinhua as ‘other individual with confidentiality obligations’ subject to non-competition restriction was appropriate.”

Case 2: Chongqing Solton Overseas Services Co., Ltd. vs LIU Ying & Beijing Wiseway Consulting Co., Ltd. Chongqing Branch

The court of second instance found that “Considering the copywriter assistant and consulting work that LIU Ying undertook at Solton Company did not fall in the scope of senior management and senior technician, besides Solton Company failed to prove that LIU Ying had got hold of trade secret of the company during the time she worked there, LIU Ying did not fall under the scope of application of non-competition restriction stipulated in Paragraph 1 of Article 24 of the Labor Contract Law of the People’s Republic of China. In conclusion, the non-competition clause in the Employment Contract between Solton Company and LIU Ying had no legal effect.” 

The essential aim of non-competition agreement is to protect legitimate trade secret of the employer. The two cases mentioned above showed that the adjudication of courts and arbitration tribunals on the applicable scope of persons subject to such agreement were generally made on the said considerations. In both cases, it could not be determined whether the employees are “senior management of technicians” stipulated in the Labor Contract Law by preliminary analysis of respective employment contracts. The key difference is that in the former case the employer showed evidence to prove the employee held its trade secret. Therefore, the universal pattern of employment contracts with non-competition clauses seems to lower the risk of trade secret exposure, but in fact such clauses may not be found to have legal effects, if the employer could not prove the employee actually holds trade secret and may leak such secret by working for a competitor instead.

In addition, the Interpretations IV stipulates that “where, in the labor contract or confidentiality agreement, the parties agree on non-competition and performs non-competition obligation and claims economic indemnity, the people’s court shall support such a claim.” Thus the employer may encounter potential economic loss, if corresponding procedures are not properly followed after the termination of employment contracts that includes non-competition clause with employee that does not have potential risks of trade secret exposure. For instance, in the labor arbitration case of Dalian Run Lin Auto Technology Co., Ltd. vs SONG Rouchen, the employer signed non-competition agreement with the employee without any such actual need in confining the subsequent re-employment of the employee, thus was adjudicated to pay for three months’ financial indemnity for not fulfilling the obligation to notify the employee to terminate such obligations in time when the employment relationship ended.

C. Scope of Application Concerning Businesses Subject to Non-Competition Agreement:

a. Common Disputed Issues

The scope of businesses that the non-competition agreement applies to is the center of non-competition obligations. The under-extension of such scope may hinder the protection of trade secret, while the over-extension would affect the free flow of talents and freedom of employment.

In most cases, the scope of applicable businesses would be defined in accordance with the stipulation of Article 24 of the Labor Contract Law on “competing Employers that produce or deal with the same type of products or engages in the same type of business, or setting up own business or produce or deal with the same type of products or to engage in the same type of business”. There is no further elaboration of “competitive relationship”. Thus it is always controversial to determine whether the competitive relationship exists between the contracting parties. In practice, some employers would list out their competing companies in the appendix of employment contract. However, the risk still remains even if exhaustive list of competitors is itemized, and other competitive relationships still need to be identified in non-exhaustive list.

b. Case Study

Case 1: Tianjin XX Technology Co., Ltd vs WANG

The two companies that WANG actually worked for did not have competitive relationships in terms of business scope stated on the business registration. However, the Chaoyang District Arbitration Commission of Beijing found that the actual controlling companies of the two employers had competitive relationship, thus WANG was decided to have violated the non-competition agreement.

Case 2: Tianjin Luo Sheng Enterprise Co., Ltd. vs LIU Yixing

The court held that “The scope of businesses subject to non-competition agreement that the Defendant was bound by was not merely determined based on the same type of business, but also decided upon whether there was competitive relationship between the latter employer and the Plaintiff. ”

Traditionally, the judicial authorities would decide the competitive relationship based on the business scope stated on the business registration of previous and current employers. It has been manifested in the two judicial decisions stated above that the business scope stated on the business registration remains one major adjudication standard.But in recent years, judicial authorities tend to review and judge comprehensive factors including whether the actual controlling companies of the employers, and still focus more on possibilities of trade secret violation. In an ever-changing competitive commercial world, most corporations are operated in varied models. Affiliated companies that derive from corporations become an active player in market competition. In the meantime, the competition for talents is the matter of life and death in the hi-tech industry. Some companies would intentionally poach the key employees of others and sign employment contracts with them in the name of affiliated companies that appear to have no competitive relationship to evade the non-competition clauses. In that context, the objective to protect legitimate trade secret and fair competition might not be fulfilled, if the traditional standard is still adopted.

D. Conclusion

To sum up, the Dispute Resolution Team of Docvit Law Firm recommends that companies need to set up an entire system for the non-compete agreement to effectively protect trade secret. First, the human resource management system needs to be perfected, to clarify positions that require non-compete agreements and specify the scope, term and compensation amount of different positions; Secondly, supervision and management on the enforceability needs to be in place after the signing of such agreements. Relevant documents must be kept safely for the purpose of providing evidence to ascertain the due responsibilities; Finally, relevant tracking system needs to be established to waive the non-compete agreements that do not need to be pursued and avoid unnecessary economic loss.

Furthermore, companies need to understand that non-competition restriction is merely one link of trade secret protection. Related effective protection measures must be taken as well.