How a company should use a non-compete agreement, or clause, correctly

A non-compete agreement or clause with a worker is a common means by which an employer protects its trade secrets, but many workers and managers are unclear about how a non-compete applies; a company that does not use it correctly leaves the agreement a mere formality that fails to achieve its object and may even give rise to a Labor Dispute.

This article analyses how a company should use a non-compete agreement or clause correctly.

1. The non-compete

Under articles 23 and 24 of the Employment Contract Law, a non-compete is a clause by which an employer and a worker agree, in exchange for compensation, to restrict the range of employment open to the worker after he leaves. Signing a non-compete agreement is the result of the parties' autonomy, and its clauses both protect trade secrets and limit the worker's freedom to choose his employment.

2. Who may be bound

A non-compete does not apply to all of a company's employees: a company cannot sign non-compete agreements with every post without distinction, and where a post falls outside the scope provided by the Employment Contract Law, a non-compete agreement signed even for it may be held invalid by the court.

Article 24 of the Employment Contract Law provides: "The persons subject to a non-compete are limited to the employer's senior managers, senior technicians and others under a duty of confidentiality." A non-compete requires the worker, for a period after leaving, not to take a post with a competing employer producing or dealing in the same kind of product or business as his own unit, nor to set up on his own account to produce or deal in such a product or business. Such a restriction on employment may oblige the worker to leave for a time the industry he has worked in for years, or prevent him from using the experience he has built up in it, and so has a negative effect on him. The law therefore confines it to the company's core employees.

3. Compensation for the non-compete

Payment of non-compete compensation is a statutory duty: if the employer requires the worker to perform a non-compete obligation, it must pay the compensation, and otherwise the worker is not bound by the restriction.

The law lays down no mandatory standard for the compensation. Where the employer and worker have not agreed a specific amount, article 6 of the Interpretation (IV) of the Supreme People's Court on Several Issues concerning the Application of Law in the Trial of Labor Dispute Cases provides: "Where the parties have agreed a non-compete in the employment contract or a confidentiality agreement but have not agreed the compensation to be paid to the worker after the contract is discharged or terminated, and the worker, having performed the non-compete obligation, requires the employer to pay monthly compensation at 30 per cent of his average wage for the twelve months before the contract was discharged or terminated, the People's Court shall support the request."

In practice the standard differs from place to place. The Regulations of Jiangsu Province on Employment Contracts provide that the annual compensation shall not be less than one third of the total remuneration the worker received in the twelve months before he left; the Measures of Zhejiang Province for the Protection of Technical Secrets provide for not less than two thirds of the total remuneration; and Shanghai provides that the employer shall pay 20 to 50 per cent of the worker's previous normal wage.

4. The period of restriction and legal liability

Under the Employment Contract Law the period of a non-compete may not exceed two years. Within those two years the specific period may be agreed between the company and the employee in the agreement.

A worker who breaches the non-compete obligation must bear civil liability as agreed.

5. Starting and ending the non-compete

Is an employee who has signed a non-compete agreement necessarily bound by it after he leaves? The answer is no. The employee is bound only once the company requires him to perform the non-compete and pays him the non-compete compensation.

Starting the non-compete correctly is the key to the agreement. A great many companies have signed non-compete agreements but have not started the non-compete in accordance with law after the employee left, so that the agreement becomes a scrap of paper.

6. Signing and using a non-compete correctly

Drawing on years of practice and on an analysis of a large number of cases, Minton's lawyers summarise the following points for attention.

Lesson one: there must be a non-compete agreement that complies with local rules

Because local rules on non-competes differ, a company should draft an agreement to match the requirements of the courts and labor arbitration bodies where it is situated, so as to ensure that the agreement is itself lawful and effective.

Lesson two: the agreement should contain a clear "activation clause"

Under article 6 of the Interpretation (IV) and the decided cases, where an employee who has signed a non-compete agreement leaves and performs the non-compete of his own accord, even though the company did not require him to, the employee is entitled to claim the non-compete compensation from the company.

[Case]

A network technology company in Shanghai signed a confidentiality agreement with a worker which also provided for a non-compete obligation and a confidentiality fee, the fee being included in the employee's wage. The employment contract was later discharged, and the worker sued the company in court for non-compete compensation. The company argued that it had already paid a confidentiality fee, that the employee was bound by the duty of confidentiality and the non-compete, and that no further compensation was due. The court held that the confidentiality fee included in the wage under the employee confidentiality agreement was not the compensation that the law requires an employer to pay monthly to a worker during the non-compete period after the contract is discharged or terminated, and that the company should pay non-compete compensation to the worker as the law requires.

In this case the company failed to grasp the essential difference between a confidentiality fee and non-compete compensation. In practice many companies confuse the duty of confidentiality with the non-compete obligation and wrongly use a confidentiality fee in place of non-compete compensation, so that they neither protect their trade secrets nor stem the loss of talent, while adding unnecessary expense.

The lawyers suggest that a company should be careful in signing a non-compete agreement with an employee, and not only by examining strictly, at the time of signing, whether a non-compete is genuinely necessary for that employee: during and after the employment relationship it should also consider, as matters develop, whether the employee has actually had access to secrets during his employment and whether the company's business still requires him to be restricted. Where there is no longer any need to restrict an employee, the agreement should be terminated by notice in good time, so avoiding further compensation.

Lesson three: the exit review

The exit review is the test by which a company decides whether a non-compete is needed. By talking to the departing employee and reviewing his position, the company decides whether a non-compete is necessary for him, and on that conclusion issues either a notice to apply the non-compete or a notice terminating it.

The exit review may be said to be the key step in a non-compete, by which a company decides whether to impose one. The problem with many companies in the past was that, when an employee left, they attended only to the handover of work and materials and neglected to review the need for confidentiality and non-competition, so that the non-compete was not started in time and the compensation not paid, and the agreement became waste paper.

It should be explained here that a non-compete plays a considerable part in protecting a company's trade secrets, and can to a large extent restrict or avert their disclosure, but a company should use it with care, and only where there is a genuine risk of disclosure. A company should as far as possible not treat a non-compete as a bargaining counter in negotiations over an employee's departure, for that is not, after all, the purpose for which the institution was designed.