As one of the core carriers of trade secrets and business resources, employees have gradually become the main target for enterprises and capitals in business competition. This further drives the flow of senior officers, key technicians and other important employees among competing enterprises and capitals. Out of legislative and judicial practices and other considerations, entering into non-compete agreements (“NCA”) with employees has become a very important, or even the most important, defense in practice for enterprises to protect their own trade secrets and business resources. A great number of labor dispute cases arising out of breach of NCA has emerged in recent years and continues to increase rapidly. As showed in the White Paper of Labor Dispute Adjudication in Haidian District, the People's Court of Haidian District accepted 332 labor disputecases concerning non-competition from 2010 to 2016. The number of non-competecases have increased year by year, which have become the primary type of labor disputes for high-tech enterprises.
NCA is the determinant crucialissue in a non-compete case, and it has great significance for preventing and circumventing risks. Loopholes or defects in NCA may expose an enterprise to huge legal risks and serious adverse impacts, or even induce its key employees and competitors to blatantly commit acts of breach, infringement and unfaircompetition. Yet sadly in practice, it is not rare to see serious impairmentson legal validity and binding effect of NCAs due to loopholes or defects in the terms and conditions thereof. The Authors are going to explore and analyze from different perspectives the typical mistakes in drafting NCAs and the possible risks as a result thereof.
It is stipulated in the NCA between a Company and one of its sales employees that:
2. For the purpose of this Agreement, "Trade Secret" means technical information and business information which are unknown to the public and can bring economic benefits and competitive advantages to Party A, and which are practical and protected by Party A through certain confidentiality measures, and other information which the Parties agree to or the internal rules of Party A require to keep in confidentiality.
Author's Comments and Analysis:
The Labor Law has certain limitations on the scope of persons on whom non-compete obligations may be imposed. Article 23 of the Labor Contract Law provides that, “employers and employees may include in their labor contracts confidentiality provisions in respect of the employer’s trade secrets and confidential matters with regard to intellectual property. With regard to the employees bearing confidentiality obligations, the employer may stipulate non-compete clauses with such employees in their labor contracts orconfidentiality agreements…” Companies could and should enter into NCAs with the employers who bear confidentiality obligations on “employer’s trade secrets and confidential matters with regard to intellectual property”, and NCAs with other employees will be invalid due to incompetency of contracting party. The clause, which stipulates “for the purpose of this Agreement, 'Non-compete' means that an employee who possesses trade secrets...” on the basis of there strictions under the law, further limits non-compete Obligors to employees who possess trade secrets.
The period for Party B to fulfill the non-compete obligation is the term of employment with Party A and one year after separated from Party A.
The non-compete term stipulatedin this Case is too short, making it difficult to obtain support from the judiciary for claims demanding employee to stop breaching the contract and continue to fulfill the non-compete obligation, and therefore unable to force the employee to stop competing.
1. The total package of salary and benefits of Party B is RMB80,000/month, including basic salary (40%), performance-based salary (30%) and non-compete compensation (30%), paid on the 6th day of each month.
However, in the job offer issued to such senior officer, the Company undertakes that “the salary standard for you after entry will be RMB80,000/month.”
In this Case, the Company's practice to pay the non-compete economic compensation (herein after referred to as the “Compensation”) together with salary is very likely to be considered as invalid, and therefore the Company faces legal risks such as having to make additional payment of Compensation and liquidated damages be substantially reduced.
It is stipulated in an NCA between a Company and its employees that:
2. Such non-compete notice must be sent by fax, express mail service or registered mail.
Author's Comments and Analysis:
Pursuant to the provisions of the NCA, the Company may only send the NC Notice by fax, express mail service or registered mail, which easily causes the NC Notice not be served. Firstly, employees generally have no fax machine at home. The fax numbers of the employees are not provided in this Case, thus the company is unable to serve the NC Notice by fax. More over, circumstances such as rejection and invalid consignment could render the service ineffective to both express mail service and registered mail service. Besides, if an employee plans to engage in competing activities after departure, generally, he/she will not accept any notice or give any reply after submitting the resignation letter. It makes it difficult for the Company to prove that the NC Notice has been properly served. While effective evidence could not be obtained through other means, and the Company gives notice by public announcement, such notice will be deemed properly served only upon expiration of the period of notice. However, pursuant to the Labor Law, the labor relationship will be terminated after 30 days upon submission of the resignation letter by the employee. If the NC Notice isserved after the termination of the labor relationship, it would not be conformed to the stipulation in the NCA, as such the NCA would not be binding, and the Company has no right to demand the employee to fulfill the non-compete obligation. Hence, in this Case, the unreasonable restriction on NC Notice actually traps the Company itself, making it difficult to timely serve the NC Notice as required in the NCA and causing the NCA unable to take effect.
It is stipulated in an NCA between a Company and its senior officer that:
2. The total non-compete compensation shall be equal to total salary of Party B in the last half year before departure.
Author's Comments and Analysis:
The liquidated damages criteria stipulated in the NCA in this Case is “four times of the non-compete compensation obtained by Party B”. As the senior officer joined and worked for the competitor immediately after departure, the Company has not yet paid any compensation to the employee. Also, the Company is not required to pay anycompensation to the extent that the employee has breached the non-compete obligation. In this sense, the compensation obtained by Party B is zero, making the liquidated damages of four times of the compensation is also zero. Under these circumstances, the Company cannot demand the employee to pay any liquidated damages according to the NCA.
In this Case, the material defect in liquidated damages clause, on one hand, would the Company unable to pursue payment of liquidated damages if the employee breaches the non-compete obligation, on the other hand, would induce the employees to engage incompeting activities immediately after departure and openly.
It is stipulated in the NCAs between a PRC Company and its Chinese employees working in Shanghai that:
2. The Parties agree that any dispute arising out of or in connection with this Agreement shall be determined by the courts in Hong Kong Special Administrative Region.
The choices of law and jurisdiction in this Case is invalid. It is difficult for the Company to hold the employees accountable for legal liabilities through courts in Hong Kong or by applying Hong Kong laws, as agreed in the NCA.
Besides, the Company made two mistakes when drafting the jurisdiction clause: one mistake is that it stipulated that courts shall exercise jurisdiction over the disputes rather than labor arbitral committees. China adopts the special procedure of “one arbitration and two trials, and arbitration is first” for the adjudication of labor dispute cases, and no employer or employee may directly choose litigation over labor arbitration. The other mistake is that it stipulated for wrong jurisdiction. Stipulated jurisdiction means that the parties to contract disputes or property disputes choose the court to exercise jurisdiction in the form of a stipulation, the legal basis of which is Article 34 of the Civil Procedure Law. However, Article 21 of the Law of the PRC on Mediation and Arbitration of Labor Disputes provides that, “labor disputes shall be handled by the labor dispute arbitration commission at the place where the labor contract is performed or at the place where the employer locates.” Paragraph 1, Article 8 of the Interpretations of the Supreme People's Court on Several Issues on the Application of Law in Adjudicating Labor Dispute Cases provides that, “labor dispute cases shall be subject to the jurisdiction of the district people's court at the place of the employer or at the place where a labor contract is performed.” In this Case, Hong Kong is neither the domicile of the employer, nor the place of performance of the labor contract; therefore, choosing Hong Kong ASR courts to exercise jurisdiction is invalid.
It is stipulated in the NCA between an Internet company and its CTO that:
2. Where Party B breaches the non-compete obligation, Party A may demand Party B to stop the act of breach, refund any obtained non-compete compensation, pay liquidated damages, and compensate Party A and/or Party A's Affiliates for losses so suffered.
The salary of this CTO was about RMB 1 million/year, with restricted stocks worth RMB 3,000,000 released each year.
This NCA generally has no problem for ordinary employees. However, for the CTO, it has significant risks.
Moreover, the standard for liquidated damages is twice of the salary of the employee in the last year before departure. On the one hand, most of the remuneration and benefits of this CTO are paid in the form of restrictive stocks, which are not salary. On the other hand, twice of one-year salary is RMB2,000,000, which is too low for the business value and significance of a CTO who possesses the company’s management and technical secrets. If this CTO starts his/her own business or joins a competit or after departure, the benefits he/she obtains and the damages the Company suffers are very likely to be much higher than this amount. Thus, the liquidated damages in this Case can barely stop or deter the CTO from doing any of the aforesaid.
The Authors believe that it is necessary to study and analyze from different perspectives when drafting an NCA in order to prevent and mitigate risks on the legal validity and binding effectof the NCA. According to the experience of the Authors, companies may start from the following points:
1. Competency of the Contracting Parties
2. Non-compete Territory
3. Non-compete Term
4. Non-compete Method
5. Non-compete Compensation
6. Non-compete Notice
7. Determination of Breach of NCA
8. Liquidated Damages
9. Governing Laws and Jurisdiction
10. Non-compete Degree
