December 2023
Joyce Wen and Teresa Huang
In recent years, it has become more common for enterprises to adopt equity incentives to attract and retain employees, while some enterprises also agree with their employees to use equity incentives as compensation for non-competition for cash flow and other considerations. This approach is relatively new and its compliance is a major difficulty in practice. The purpose of this article is to organize typical cases issued by the Beijing No.1 Intermediate People’s Court (2021)J01MZ1751 and common dispute adjudication rules for civil cases involving equity incentives issued by its discussion group [1] for the reference of relevant enterprises.
I. Introduction
Gao left Company F in August 2018. Both parties had entered into a Confidentiality and Non-Competition Agreement, which stipulated Gao’s non-competition obligations after his departure, and agreed that Company G, the parent company of Company F, would issue a number of stock options as economic compensation for non-competition upon Gao’s departure. Later, Gao and Company F had a dispute and Gao sued Company F for more than RMB120,000 Yuan of economic compensation for non-competition. Company F argued that Gao prepaid the exercise price in August 2018 to retain the option proved that the company had paid economic compensation for non-competition by retaining the option. Gao claimed that he and Company F had entered into two labor contracts, in each one Company F had committed to have Company G grant a number of options to be vested in installments; upon leaving the company, he had been granted with 21,250 shares of options to be qualified to exercise the option, but as Company G had not been publicly listed, he paid the prepaid exercise price of the option to Company F; such exercise had nothing to do with the economic compensation for non-competition because Company F did not direct him to exercise such options as the economic compensation for non-competition. As to how many times Gao had exercised his rights, Company F said it was not clear. The People’s Court requested Company F to submit the agreement in relation to the option grant signed by both parties but Company F failed to do so.
II. Court’s Views
The court held that Gao’s statement was consistent with general practice. In order to find out the facts, the court requested Company F to submit agreements in relation to the option grant but Company F failed to do so. As a result, Company F should bear the adverse consequences of not providing relevant evidences and it was recognized as having not paid the economic compensation for non-competition. The parties agreed to use the stock options of Company G as the economic compensation for non-competition, but Company G had not been publicly listed that there was no trading price accepted by all parties. It was difficult to determine whether Gao could make profit by exercising the options and whether the profit could reach the minimum standard of compensation for non-competition required by law, besides, the stock options lacked liquidity, which made the agreement between two parties relatively unfavorable to the workers compared with the mandatory provisions of the Labor Contract Law. Therefore, the court held that the parties’ agreement to use stock options as economic compensation for non-competition was invalid and should be considered as no financial compensation had been agreed upon. Gao claimed the compensation for non-competition at a rate of 30% of his average monthly income before leaving the company, which was justified by law and supported by the court.
III. Views of the discussion group of Beijing No.1 Intermediate People’s Court
Article 23(2) of the Labor Contract Law clearly stipulates that compensation for non-competition shall be paid on a monthly basis. Its legislative intent is to solve the difficulties that may arise in the life of the workers due to employment restriction, therefore, this provision is mandatory for the employer and should be complied with. When an employer agrees with a worker to provide stock or stock options as economic compensation for non-competition, the employer shall determine whether the agreement is more favorable to the worker than the above provisions, and if so, there is no need to negate the validity of such agreement. On the other hand, if such agreement is unfavorable to the worker, the economic compensation agreement shall be considered invalid from the perspective of protecting the worker’s rights and interests.
As for whether equity incentives can be used as economic compensation for non-competition, it is not possible to generalize, but its necessary to distinguish between different subjects for analysis. The views of the discussion group are organized in the form below.
| Type of Subject Matter of Equity Incentive | Discussion Group’s Views |
| Stock options are agreed to be the economic compensation for non-competition | For enterprises that are not publicly listed, the price of their equity is uncertain, and it is hard to determine whether the incentive recipient can exercise the stock options, and as such options can not be freely exchanged and circulated like currencies, it is quite unfavorable to the incentive recipient. Therefore, if the incentive recipient claims that the agreement is invalid, such claim can be supported. |
| Shares of a listed company are agreed to be the economic compensation | 1) For common stocks that can be listed and circulated at any time when the time limit for the termination of the labor contract has expired, they have most of the advantages of compensation in monetary form, such as a relatively certain amount and the ability to be cashed out at any time, and therefore it can be used as economic compensation for non-competition. |
| 2) For the stocks which are still in the restricted period when the labor contract is terminated, they could not be realized in time during the restricted period or cashed out on a monthly basis, and Article 38 of the Interpretation to Certain Issues by the Supreme People’s Court on the Application of Laws to the Trial of Cases over Labor Contract Disputes (I) stipulates that, after the termination of the labor contract, if the economic compensation for non-competition has not been paid for 3 months due to any cause of the employer, the worker shall have the right to request for the dissolution of the agreement on the restriction of non-competition. Therefore, it is not suitable to be regarded as economic compensation for non-competition. | |
| 3) In the event that the stock is delisted before the registration is changed to be under the name of the incentive recipient, the incentive recipient’s claim that the relevant agreement is invalid should be supported. | |
| Equity of an unlisted company is agreed to be the economic compensation | In view of the uncertainty of the valuation of the equity of the unlisted company and the difficulty in its realization, it is not suitable to be used as economic compensation for non-competition. If the incentive recipient claims that the agreement is invalid, it should be supported. |
Considering the above adjudication rules of Beijing No. 1 Intermediate People’s Court’s views of its discussion group, if enterprises agree to make equity incentives as the compensation for non-competition, it must be noted that the rights and interests of employees shall not be restricted, that is, this kind of compensation shall not violate the mandatory provisions of Article 23(2) of the Labor Contract Law. While conforming to the standard, enterprises shall combine with different subject matters to conduct the analysis to ensure that the agreement with the employee is lawful and valid.
[1]Relevant personnel of Beijing No.1 Intermediate People’s Court constitute the discussion group to conduct in-depth studies, research and summaries on specific legal issues.
Related Articles
- Non-competition Practice Series (1) – Issues Related to the Determination of the Validity of Non-competition Agreements (Mainland China)
- Non-competition Practice Series (2) – Criteria and Payment of Non-competition Compensation (Mainland China)
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