How to protect your trade secrets: how the non-compete clause is applied

A non-compete clause is one agreed by an employer with a worker who is under a duty to keep the employer's trade secrets, in the employment contract, an agreement on the ownership of intellectual property, or a technical confidentiality agreement: that is, the worker may not, within a certain period after the employment contract is terminated or discharged, take a post with an employer producing the same kind of product, carrying on the same kind of business, or otherwise in a competitive relationship, nor produce on his own account, or carry on, the same kind of product or business as his former employer in a competitive relationship with it. The period is agreed in advance by the parties but may not exceed two years. In an employment contract a non-compete clause is a clause taking effect later, that is, it takes effect once the other clauses of the contract have ceased to be legally binding. Minton's lawyers consider that a non-compete, as a measure for protecting trade secrets, can prevent loss in advance, make good many of the defects of a remedy taken only after loss has occurred, and to a certain extent avert the loss of trade secrets and the damage that does to the company.

I. What benefits does a non-compete clause bring a company?

(a) It prevents trade secrets from leaking

A non-compete clause restricts the worker, after leaving, from working in the same or a similar industry, which is to restrict the places in which he could profit from the company's trade secrets. In reality senior managers or technicians often move to a competitor, or set up on their own making the same or similar products and services as the company. In either case the departed employee may use the trade secrets of his former employer that he holds to make a profit. A non-compete clause cuts off, for a certain period, his route to "moving jobs" or "setting up on his own", and so to a certain extent can prevent a leak.

(b) It reduces the difficulty of proving infringement

A company may provide or agree that its employees must not disclose its trade secrets or use them in business, but whether an employee has in fact disclosed or used them is very hard for the rights holder to investigate. Once a non-compete has been agreed, however, the company need only show that the employee has broken the agreement by working for a competitor, or by producing or dealing in a competing product or business on his own account, to prove the breach with ease and require him to bear liability for it.

(c) It reduces the risk of losing talent

An enterprise's senior managers and technicians are the people who can create the greater part of its value, and their departure means not only the risk of a trade secret leaking but plainly a loss of talent. In agreeing a non-compete with an employee, a company restricts his career development after he leaves. For an employee of real standing in the industry, being unable to work in the field for a year or two is a considerable loss to his career; and if he wants to stay in the same or a similar industry, he must pay an economic price for breaking the agreement. An employee bound by a non-compete will therefore think carefully, before leaving or moving, about what the clause means for his career and his finances, and may for that reason choose to stay with the company.

II. How should a company use a non-compete clause?

Legal basis: article 23 of the Employment Contract Law provides that an employer and a worker may agree in the employment contract to keep the employer's trade secrets and matters related to intellectual property confidential. For a worker under a duty of confidentiality, the employer may agree non-compete clauses with him in the employment contract or in a confidentiality agreement, and may agree to pay him monthly compensation during the non-compete period after the contract is discharged or terminated. Where the worker breaches the non-compete agreement, he shall pay the employer liquidated damages as agreed. The law, however, lays down no standard for that compensation, which makes it hard in practice to fix a reasonable figure when applying the clause.

Who may be bound: the persons subject to a non-compete are limited to the employer's senior managers, senior technicians and others under a duty of confidentiality. An ordinary employee, who cannot reach the company's important trade secrets, does not need a non-compete clause added to his confidentiality agreement.

Compensation: the law requires the company to pay monthly compensation to a worker who bears a non-compete obligation. The law does not state how the compensation is to be fixed, and the company may agree a reasonable sum with the worker. As to the amount, a worker may at the least require 30 per cent of his average monthly wage, and some local regulations provide for as much as 50 per cent.

The statutory maximum term: because a non-compete encroaches on the worker's right to choose his employment, it cannot be unlimited. The maximum period may not exceed two years, and the company may agree with the worker any period shorter than two years.

Liquidated damages: the draft Employment Contract Law once stated a ceiling on them, namely that where a worker breached a non-compete agreement he should pay the employer liquidated damages not exceeding three times the non-compete compensation the employer had paid him, but that provision was deleted from the Employment Contract Law as formally enacted. There is at present no clear legal rule on how non-compete liquidated damages are to be calculated, so in practice Minton's lawyers see the amount and its calculation generally dealt with by agreement in the contract.

A non-compete is a double-edged sword: while it effectively averts the leak of trade secrets and the loss of talent, the law also sets comparatively high requirements for its use. How a company uses a non-compete clause correctly, in the light of its actual business and the character of its employees, is therefore of the first importance.

Appendix:

A summary of non-compete compensation standards in various places

The compensation standards laid down in local regulations or in the guidance of adjudicating bodies in some places are gathered below for reference:

The standard in the judicial interpretation

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: 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.

Where the 30 per cent of the average monthly wage provided in the preceding paragraph is lower than the minimum wage at the place where the employment contract is performed, payment shall be made at that minimum wage.

1. The standard in Shenzhen

Article 24 of the Regulations of the Shenzhen Special Economic Zone on the Protection of Enterprise Technical Secrets (2009 revision) provides that the compensation agreed in a non-compete agreement shall, calculated monthly, be not less than one half of the employee's average monthly wage for the last twelve months before he left the enterprise. Where the compensation agreed is less than that standard, or none is agreed, it shall be calculated at one half of that average monthly wage.

2. The standard in Zhuhai

Article 22 of the Regulations of Zhuhai Municipality on the Protection of Enterprise Technical Secrets provides that where an enterprise and an employee have agreed a non-compete, the enterprise shall during the non-compete period pay the employee compensation as agreed in the agreement; where no agreement is made, the annual compensation may not be less than one half of the annual remuneration the employee received from the enterprise in the year before he left.

3. The standard in Zhongshan

Article 6.1 of the Reference Opinions of the Intermediate People's Court of Zhongshan Municipality, Guangdong Province on Several Issues in the Trial of Labor Dispute Cases (November 2011) provides that where an employer and a worker have agreed a non-compete but have not at the same time agreed compensation, or where the compensation agreed is manifestly too low to sustain the worker at the local minimum standard of living, this falls within the circumstance provided in article 26, item (2), of the Employment Contract Law, "the employer exempting itself from its statutory liability and excluding the worker's rights", and the non-compete clause is invalid.

4. The standard in Foshan

Article 15 of the Opinions of the Intermediate People's Court of Foshan, Guangdong, on the Trial of Labor Dispute Cases provides that as to the standard of non-compete compensation, if the contract provides for it, the agreement governs. If it does not, how the standard is to be fixed lies within the judge's discretion, but it is generally calculated annually at not less than one third of the total remuneration the worker received from the enterprise in the last year before he left. Where no compensation is agreed in the non-compete agreement, it shall be calculated at that minimum standard.

5. The standard in Beijing

Article 39 of the minutes of the seminar of the Beijing Labor Bureau and the Beijing Higher People's Court on issues of the application of law in Labor Dispute cases provides that where an employer and a worker have agreed a non-compete clause in the employment contract or a confidentiality agreement but have not agreed whether compensation is to be paid or on what standard, the clause shall not on that ground be held invalid, and the parties may remedy the omission by agreement; where they cannot agree, compensation may be paid at 20 to 60 per cent of the worker's wage in the last year before the employment relationship ended. Where the employer states expressly that it will not pay compensation, the non-compete clause is not binding on the worker.

Article 44 of the Regulations on the Zhongguancun Science Park provides, in its second paragraph, that an enterprise shall, as agreed in the non-compete contract, pay a former employee under a non-compete obligation compensation annually, in an amount not less than one half of that employee's annual income in his last year with the enterprise.

6. The standard in Shanghai

Article 13 of the Opinions of the Shanghai Higher People's Court on Several Issues concerning the Application of the Employment Contract Law (Hu Gao Fa [2009] No. 73) provides that where the parties to an employment contract have agreed only that the worker shall perform a non-compete obligation, without agreeing whether compensation is to be paid or, if it is, on what standard, the clause may be taken as still binding on both, since the parties share a common intention on the non-compete. Where the amount is unclear the parties may continue to negotiate the standard; where they cannot agree, the employer shall pay 20 to 50 per cent of the worker's previous normal wage. Where they cannot agree, the restricted period may not exceed two years.

7. The standard in Zhejiang

Article 15 of the Measures of Zhejiang Province for the Protection of Technical Secrets (2008 revision) provides that the standard of non-compete compensation shall be determined by agreement between the rights holder and the person concerned. Where it is not determined, the annual compensation shall be calculated at two thirds of the total remuneration the person concerned received from the rights holder in the last year before the contract ended.

8. The standard in Jiangsu

Article 17 of the Regulations of Jiangsu Province on Employment Contracts provides that an employer and a worker under a duty to keep trade secrets may agree a non-compete clause in the employment contract or a confidentiality agreement, and shall at the same time agree the compensation to be paid to the worker after the contract is discharged or terminated, the annual compensation being not less than one third of the total remuneration the worker received from the employer in the twelve months before he left. Where the employer does not pay the compensation as agreed, the non-compete clause agreed is not binding on the worker.

9. The standard in Suzhou

The minutes (No. 1) of the seminar of the Intermediate People's Court of Suzhou Municipality and the Labor Dispute Arbitration Committee of Suzhou Municipality provide that the employer shall, before the worker completes the necessary formalities, agree the standard of compensation with him; where they cannot agree, the employer shall pay monthly compensation at not less than one third of the worker's average wage for the previous twelve months.

10. The standard in Ningbo

Article 17 of the Regulations of Ningbo Municipality on the Protection of Enterprise Technical Secrets provides that during the non-compete period the enterprise shall, as agreed in the non-compete agreement, pay a certain compensation to the person subject to the restriction, the annual compensation being not less than one half of the total annual remuneration that employee received from the enterprise in the year before he left.