Non-competition Practice Series (2) – Criteria and Payment of Non-competition Compensation (Mainland China)

October 2023

Joyce Wen and Teresa Huang

In practice, disputes over the standards and payment of non-compete compensation are relatively common in non-compete dispute cases.  The purpose of this article is to provide a summary of the criteria and payment issues related to non-compete compensation, supplemented with practical case examples for the guidance of employers.

I. Standards for Non-Compete Compensation

As previously mentioned in the first article of the non-compete practice series, the absence of an agreement on economic compensation between the employer and the employee when signing a non-compete agreement does not directly affect the validity of the non-compete agreement.  However, to prevent potential disputes on this matter, it is advisable for employers to explicitly specify the amount of economic compensation.

In accordance with Article 36 of the Interpretations (I) of the Supreme People’s Court on the Application of Law to the Hearing of Labor Dispute Cases, if the parties have agreed to non-competition restrictions in the labor contract or a confidentiality agreement but have not agreed to provide the employee with economic compensation after the termination of the labor contract, and if the employee has fulfilled the obligations of the non-competition restriction, the People’s Court shall support the request for monthly economic compensation.  This compensation should be 30% of the employee’s average monthly salary for the twelve months preceding the termination of the labor contract.  If the 30% of the average monthly salary, as mentioned above, is lower than the minimum wage in the place where the labor contract is performed, the compensation should be paid according to the minimum wage in that location.

However, it’s important to note that specific regulations regarding economic compensation may vary by region.  Therefore, employers should also take into account regional regulations.  The summarized regulations for different regions are as follows:

Region Legal Basis         Regulations
Shanghai Opinions of the Shanghai High People’s Court on the Application of the Labor Contract Law  13. If the parties only agree that the employee should fulfill non-compete obligations but do not specify whether compensation should be paid or do not explicitly define the payment standard, it is assumed that the non-compete clause remains binding.  If the compensation amount is unclear, the parties can negotiate the compensation standard.  If they cannot reach an agreement, the employer should pay 20-50% of the employee’s previous normal salary.  The maximum non-compete period should not exceed two years in case of no agreement.
Beijing Minutes of the Seminar on Legal Application Issues in Labor Dispute Cases by the Beijing High People’s Court and the Beijing Labor Dispute Arbitration Committee 38. If the employer and employee have agreed to non-compete clauses in the labor contract or confidentiality agreement but have not made agreements regarding compensation or specific payment standards, the non-compete clause should not be considered invalid.  During the employment relationship or upon the termination of the labor contract, the parties can remedy this through negotiation.  If they cannot reach an agreement, compensation can be determined at 20%-60% of the employee’s last year’s salary before the termination of the labor relationship.  If the employer explicitly states that it will not pay compensation, the non-compete clause is not binding on the employee.
Zhejiang Zhejiang Province Regulations on the Protection of Technical Secrets (Revised in 2008) Article 15: The standard for non-compete compensation is to be negotiated and agreed upon between the rights holder and the relevant individuals.  If not determined, the annual compensation is calculated as two-thirds of the total remuneration received by the relevant individual from the trade secret rights holder in the last year before the contract termination.
Jiangsu Jiangsu Province Labor Contract Regulations (Revised in 2013) Article 28 (1): Employers must provide economic compensation to departing employees within the non-compete period.  The monthly economic compensation amount must not be less than one-third of the employee’s average monthly wage for the twelve months preceding their departure from the employer.
Shenzhen Shenzhen Special Economic Zone Enterprise Regulations on the Protection of Technical Secrets (Revised in 2019) Article 24: Non-compete agreement stipulated compensation should not be less than one-half of the employee’s average monthly wage for the last twelve months before leaving the enterprise.  If compensation is less than this standard or not specified, compensation is calculated as one-half of the employee’s average monthly wage for the last twelve months before leaving the enterprise.

II. Is the Inclusion of Non-competition Compensation in Wages Valid?

In practice, there is considerable variation in how courts determine the validity of agreements that include non-competition compensation in an employee’s salary.  In the Shanghai region, the prevailing tendency is to recognize such agreements as valid when the employer’s salary breakdown clearly distinguishes non-competition compensation.  However, in Beijing, Shenzhen, and Jiangsu, agreements to include non-competition compensation in wages are typically regarded as invalid.

Shanghai First Intermediate People’s Court (2017) Case No. Shanghai 01 Civil Final No. 5453 

The court’s judgment was as follows: While it is legally permissible for employers to include non-competition clauses in labor contracts or confidentiality agreements and to stipulate the monthly payment of economic compensation to employees during the non-competition period after the termination of the labor contract, the nature of this economic compensation remains unchanged, regardless of whether it is paid in advance or in monthly installments in accordance with legal provisions.

Shanghai First Intermediate People’s Court (2021) Case No. Shanghai 01 Civil Final No. 10801

The court ruled that in accordance with the relevant legal provisions, employers may agree with employees on non-competition clauses and commit to providing employees with monthly economic compensation during the non-competition period following the termination of the labor contract.  However, it is important to note that while employers typically pay monthly economic compensation to employees during the non-competition period after contract termination, the law does not prohibit employers from making advance payments for non-competition compensation during the employee’s term of employment.  In this particular case, it was established based on the Appellant’s personal wage schedule signed on July 31, 2015, and pay slips provided for the two months following the commencement of employment, that the wage composition included a category for non-compete compensation.  The Appellant had never raised any objections regarding this arrangement.  Therefore, the Court of First Instance concluded that the Appellant, Shanghai A Co., Ltd., and the respondent company had mutually clarified the composition of the Appellant’s salary through practical execution.  The monthly salary for the period from December 2012 to July 2015 encompassed the non-competition compensation that the respondent company had paid in advance from May 1, 2017, to July 31, 2017, on a monthly basis, and this was considered appropriate.

Shenzhen Intermediate People’s Court of Guangdong Province (2021) Case No. Yue 03 Civil Final No. 31512 

The court determined that the non-competition compensation specified in the agreement between both parties was, in reality, a portion of the salary during the employment period designated as non-competition compensation after leaving the company.  However, non-competition compensation should be disbursed following the termination of the employment.  Since the parties had agreed that Cai Xiangyang’s in-employment salary included economic compensation for non-competition, this agreement was considered invalid.

Beijing Third Intermediate People’s Court (2015) Case No. Third Intermediate People’s Court No. 01995

The court determined that the provision in the “Confidentiality and Non-competition Agreement” signed by Wang Zhesan and Xinnongyuan, which stated, “Party A agrees to pay confidentiality and non-competition compensation to Party B for the confidentiality and non-competition obligations assumed by Party B after its departure from the company, and this compensation is included in the monthly salary and remuneration that Party A pays to Party B,” was not in compliance with legal regulations.  The available evidence could not establish that Xinnongyuan had indeed paid Wang Zhesan the non-competition compensation.  Consequently, Xinnongyuan was ordered to pay Wang Zhesan the economic compensation for non-competition.  The first-instance court considered Wang Zhesan’s salary and other factors in determining the specific amount, and this decision was deemed appropriate.

Jiangsu Province Suzhou Intermediate People’s Court (2019) Case No. Su 05 Min Jian 7833 

The court determined that the employment contract between both parties clearly stipulated that the salary did not include compensation for non-competition.  Additionally, Zhifu Zhanteng Company failed to provide evidence confirming that they explicitly informed the employee about the inclusion of non-competition compensation when issuing the monthly salary.

Furthermore, the court emphasized that the original design of the non-competition compensation system aims to protect both the rights of the workers and the legitimate competition of the enterprise.  Therefore, non-competition compensation should be paid after an employee leaves the job.  Consequently, the court did not accept Zhifu Zhanteng Company’s position.

In summary, while the Shanghai region leans toward recognizing agreements that include non-compete compensation in salaries, it is advisable for employers to provide monthly economic compensation to employees within the non-compete period after terminating employment contracts with employees who have non-compete agreements.  This practice helps prevent the non-compete compensation issued during the employee’s tenure from being deemed ineffective, considering the varying interpretations in different regional courts.

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