China: Non-Competes And Employee Post-Departure Reporting Obligations

Last Updated: 29 March 2017
Article by Wentao Wang

"Non-compete" refers to an agreement concluded between an employer and an employee at the time of hire, which provides that for a certain period after the termination or rescission of the employment contract, the employee cannot conduct business of same or relevant kind to the employer's, on his or her own or for others, nor can the employee be employed by other employers conducting the same or relevant kind of business. It is generally a clause in a larger employment agreement but it can also be a completely separate document.

In brief, a non-compete means that employer and employee have agreed that:

  • A specific party, i.e., the employee
  • Cannot be engaged in a specific business
  • In a specific region
  • For a specific period

The employee's post-departure obligation to report employment status

The obligation to report employment status refers to an employer's stipulation in the non-compete agreement that the employee make a statement of his or her employment status after the termination, and provide corresponding employment materials. In civil law theory, there is a distinction between "positive acts" and "negative acts" according to the forms of expression. A "positive act," i.e., an action, refers to a legal act positively and actively occurring, such as a sales personnel completing a monthly sales mission. A "negative act," i.e., an inaction, refers to a legal act that is manifested in a negative or restraining form of expression, such as fulfilling one's duty not to be absent from work not to be late for work or not to leave work early.

The connection between non-competes and the obligation to report employment status

The non-compete agreement is contractual in nature and is concluded for the purpose of clarifying the employee's non-compete obligations. While the core of the agreement is the non-compete obligation itself, emanating from that core, like the spokes of a wheel, are the required details of such obligation, such as the scope of the company's trade secrets, if any, and the employee's duty to maintain the confidentiality of those trade secrets and any other proprietary and non-public information. The employee's duty to report his or her employment status may also be provided in the agreement.

As can be seen from the above analysis of positive and negative acts, the non-compete obligation is a negative act (i.e., expressed in the form of inaction), whereas the obligation to report employment status is a positive act (i.e., expressed in the form of action). Therefore, the non-compete obligation and the report-employment-status obligation are two fundamentally different aspects of the non-compete agreement and, as such, should be dealt with on their own terms.

For example, the non-compete obligation should be performed in the form of inaction by the employee. Only when the employee engages in a positive behavior violating the prohibitive or restrictive covenants stipulated by the non-compete is the employer entitled to claim liquidated damages from the employee.

Case study

Is it a breach of a non-compete obligation for a former employee to fail to report his or her employment status after employment termination ?

Event playback

Mr. Wang was employed as a client manager by a materials company in Nanjing, China. On April 17, 2012, the company (Party A) and Mr. Wang (Party B) entered into a Confidentiality and Non-Compete Agreement (the Agreement) in which:

  • Clause 4 "non-compete after Party B leaves company" provided that:

    • "...if Party B leaves Party A for whatever reason, Party B shall actively report to Party A in written form as regards to the performance of the non-compete agreement no later than 30th of every month for the period of two years after termination. The first non-compete report shall be submitted within 15 days after Party B leaves Party A otherwise it shall be deemed as breach of agreement.
  • Clause 6 "liability for breach of contract" provided that:

    • "...2. If Party B fails to fulfill non-compete obligation and violates Clause 3 and Clause 4 Sub-clause 1 to 4 of this Agreement, it constitutes serious breach of contract and Party B shall pay liquidated damages of 500,000 RMB to Party A..."
    • "4. It shall be deemed as serious breach of contract if Party B fails to provide monthly non-compete report in writing after receiving written notification twice from Party A."
    • "5. If Party B's default has caused damages to Party A, in addition to the liquidated damages, Party B shall also compensate for Party A's loss and return all profits achieving from the default of non-compete obligation to Party A."

On July 16, 2012, the company terminated its employment relationship with Mr. Wang on the ground of expiration of the employment contract. From August to November 2012, the company remitted RMB 1,000 to Mr. Wang's wage account, for a total of RMB 4,000. On November 5, 2012, the company applied to the Labor Dispute Arbitration Committee for labor arbitration. When the Committee didn't accept the case within five days, the company, following the rules and procedures on labor dispute resolution, filed an action with the court.

The company argued that Mr. Wang had failed to provide monthly non-compete reports for three consecutive months and that the company was therefore entitled to RMB 500,000 in liquidated damages for breach of the non-compete obligation. During the trial, the company claimed that Mr. Wang didn't submit non-compete reports as required by the confidentiality and non-compete agreement, constituting a breach of contract. The company failed, however, to provide any evidence to prove that Mr. Wang had breached his core non-compete obligation and benefitted from the breach. The court of first instance rejected the company's claims.

The court's analysis

According to Article 25 of the Labor Contract Law, except for the circumstances stipulated in Article 22 (special training) and Article 23 (non-compete), an employer shall not negotiate with an employee on liquidated damages to be paid by the employee. In the present case, the company set up a positive obligation on the employee's part—submitting a monthly non-compete report—in the confidentiality and non-compete agreement. The company further stipulated that the employee's failure to submit such a report would be deemed to be a breach of the agreement and that high liquidated damages shall be paid as a consequence of the breach. The court held that such a clause ran contrary to the prohibitory labor law provisions and shall be regarded as void and without any binding effect on the employee. Besides, the court noted, the company failed to provide any evidence to prove the employee's default of his non-compete obligation in the Agreement, nor did it produce any evidence of profits resulting from such a breach. Therefore, it concluded, that there were no factual or legal grounds obligating the employee to pay liquidated damages, submit non-compete reports or disgorge profits.

Conclusion

An employer is entitled to include in a non-compete agreement an obligation on the part of an employee to report his or her employment status post-departure during the performance of the non-compete agreement.However, in an action for damages against the former employee for violating the employee's post-departure reporting obligation, it is important for the employer to collect evidence, if possible, of a violation of the non-compete obligation itself. Such evidence includes, but is not limited to,

  • The employment/working contract or other agreements entered into with the competing company
  • Proof of payment of social security fees and building provident contribution
  • Pay slip of wages or other service fees
  • Work certificate
  • Key card to the office
  • Evidence proving the employee conducted business and transactions in the capacity of the competing company's personnel
  • The competing company's employee list
  • Promotional materials containing the employee's information
  • The approval or filing by the special industry's administrative department,
  • Witness statements and audio-visual materials, etc.

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