Chinese Supreme Court Guidelines Make It Easier for Employers to Enforce Non-Compete Covenants

by Davis Wright Tremaine LLP

On Jan. 18, 2013, the Supreme People’s Court of China promulgated Judicial Interpretation IV on Several Issues Concerning the Application of Law in Hearing Labor Dispute (the “Interpretation”). The Interpretation went into effect Feb. 1, 2013. It aims to address issues arising from labor dispute trial practices since the Labor Contract Law of PRC was implemented in 2008. It covers issues mainly relating to compensations and damages, non-compete clauses, calculation of service terms, foreigners working in China without work permits, etc.

Following are highlights of the Interpretation:

Transition between arbitration and litigation (Article 2 and 3 of the Interpretation)
Article 47 of the Labor Dispute Mediation and Arbitration Law of the PRC stipulates that for certain types of small-amount labor dispute cases,  labor arbitration awards have final and binding legal effects. However, such final and binding rules only apply to employers, while the employees may still bring up lawsuits in people’s courts if the employees disagree with the arbitration awards pursuant to Article 48 of the Labor Dispute Mediation and Arbitration Law. The Interpretation further specifies employers’ rights to bring up lawsuits in people’s courts:

  • If the employer disagrees with the final arbitration award, it may apply to the intermediate people's court for revocation; if the employer disagrees with the non-final arbitration award, it may bring up a lawsuit in the basic people's court.
  • Whether the arbitration award is final is determined by the written arbitration award. If it is not specified in the written arbitration award, the basic people's court can determine it.

Inter-Group transfers (Article 5 of the Interpretation)
If an employee was arranged by his/her employer to work for a new employer for any reason other than the employee’s personal reason—and the former employer fails to pay severance compensation to the employee when the employee later terminates the labor contract with the new employer in accordance with Article 38 of the Labor Contract Law (or if the new employer proposes to terminate the labor contract)—a court will get involved. According to Article 5, the relevant people's court will support the employee’s request to include the number of service years with the former employer into that with the new employer for the purpose of calculating the number of service years for payment of financial compensation or damages. This includes when:

  • The employer remains on the same position in the same working premises while the party to the labor contract switches to the new employer from the former employer;
  • The transfer is in the form of the employer’s secondment or assignment;
  • The transfer is caused by reasons such as a merger or split of the employer;
  • The labor contract with the employee is entered into alternatively with the employer and its affiliated company; and
    Other reasonable circumstances.

This provision is an extension of Article 10 of the Implementing Measures for the Employment Contract Law, providing that “If an employee has been transferred from the former employer to a new employer for any reason that is not attributed to the employee, the employee’s service years with the former employer shall be calculated into the employee’s service years with the new employer. If the former employer has paid financial compensation to the employee, the employee’s service years with the former employer shall be deducted from the employee’s service years with the new employer when the new employer calculates financial compensation for termination or expiration of the labor contract.”

Since the Labor Contract Law came into effect in 2008, some employers change the party to eliminate the service years of employees in order to reduce financial compensation for termination or expiration of the labor contract. Therefore, based upon Article 10 of the Implementing Measures for the Employment Contract Law, the Interpretation further addresses this problem.

Non-Compete (Articles 6 to 10 of the Interpretation)
Compensation for Non-Compete Covenant:

  • If a non-compete covenant is agreed upon, but compensation is not mentioned in the labor contract or confidentiality agreement, and the employee has fulfilled the non-compete covenant, the court can award up to 30 percent of the employee’s salary; and
  • If the above-mentioned 30 percent of the average monthly salary is lower than the minimum salary standard in the city, the latter shall be paid instead.

Before the Interpretation was promulgated, it was always uncertain how much compensation the employer was required to pay to employees who performed non-compete covenants. Some localities provided directory percentage (e.g., 20 perecnt~50 percent in Shanghai) but most localities did not. Now, the Interpretation provides that 30 percent of the employee’s salary can be awarded by the people’s court.

For some employers whose labor contracts contain non-compete clauses without compensation, if an employee leaves and does not work at all or works for non-competing entities, the employee may return to claim compensation on the grounds that he/she performed the non-compete covenant—even though he/she did not intend to (rather, the employee just could not find new or competing jobs). The interpretation provides that:

Actual performance

  • If the employer and the employee have agreed upon both a non-compete clause and financial compensation in the labor contract or confidentiality agreement (unless otherwise agreed upon), the relevant people's court shall, in the event of termination of the labor contract, support the employer's request for performance of the obligations under the non-compete clause by the employee—or the employee's request for payment of financial compensation by the employer after he/she has fulfilled the obligations under the non-compete clause.

Termination of non-compete agreements

  • Termination by employer: During the non-compete period, if the employer requests termination of the non-compete agreement, the people’s court shall support the request, as long as the employer pays at least three additional months’ compensation for the non-compete.
  • Termination by employee: If the compensation fails to be paid for three months due to the employer’s reason, and if the employee requests termination of the non-compete agreement, the people’s court shall support the request.

In practice, some employees deliberately cancel their bank accounts to escape the non-compete obligation. The Interpretation avoids such circumstance.

Breach of non-compete agreements

  • If an employee violates the non-compete agreement and pays damages to the employer, and if the employer requests that the employee continue to perform the non-compete covenant, the people’s court shall support the request.

In practice, it is likely that the new employer will pay the damages to the former employer on behalf of the employee in order to buy out the non-compete period. The Interpretation provides that the employee is still obligated to perform the non-compete covenant after the payment of damages. The payment of damages cannot replace the performance of non-compete obligations.

Oral variation of labor contracts (Article 11 of the Interpretation)
Oral variation of a labor contract will be legally recognized if the employer and the employee have actually performed the oral variation of a labor contract for more than one month and such variation does not violate any laws, regulations, state policies, and public order or morals.

Termination without prior notice to the trade union (Article 12 of the Interpretation)
When an employer with a trade union terminates the labor contract with an employee in accordance with Article 39 or Article 40 of the Labor Contract Law, but fails to notify the trade union in advance in accordance with Article 43 thereof, the relevant people's court shall support the employee's request for payment of compensation on the grounds of illegal termination of the labor contract, unless the employer has remedied relevant procedures before the employee files the lawsuit.

Financial compensation for termination due to expired business license (Article 13 of the Interpretation)
If the continued performance of a labor contract is made impracticable after the application of the Labor Contract Law because the employer no longer continues with business operations upon expiration of its business term, the relevant people's court shall support the request of the employee for payment of severance compensation.

Labor relationship of foreigners and people from HK, Macao and Taiwan (Article 14 of the Interpretation)

  • If foreigners or residents of Hong Kong, Macao, and Taiwan sign a labor contract with a Chinese domestic employer without a work permit, and if either party requests a determination of the labor relationship, the people’s court shall not support the request.
  • If foreigners possess a foreign expert certificate and a foreign expert permit for working in China, the labor relationship may be regarded as being established.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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