international employment law firm alliance L&E Global

China: Validity of the Agreement to Pay Non-Compete Compensation in the Form of Stock Options

On 8 August 2018, Mr. Gao resigned from his position and signed a Confidentiality and Non-Competition Agreement with Company A on the same day. The agreement stipulated a non-compete period of one year for Mr. Gao. At the same time, Company A’s parent company, Company B, agreed to compensate Mr. Gao for the non-compete restriction by granting him a certain number of stock options. However, the agreement did not specify the conditions for the ownership of the stock options, the exercise period, or the exercise price.  As of the expiration of the non-compete period, Company B was not listed.  Subsequently, Mr. Gao filed a labour arbitration claim that Company A had failed to pay the non-compete compensation.

After going through labour arbitration and the first instance, the case was ultimately decided by the Beijing First Intermediate People’s Court in the second instance proceeding. The court held that the Employment Contract Law clearly stipulates that non-compete compensation should be paid to employees in monetary form on a monthly basis. This provision aims to address the potential hardships that employees may face due to employment restrictions caused by non-compete agreements and provide them with continuous economic security. If the agreement between the parties regarding the payment method and timing of compensation is more advantageous to the employee compared to the mandatory requirement, it is not necessary to consider it invalid.  On the other hand, if the agreement is less favorable to the employee compared to the mandatory requirement, it should be deemed invalid.

In this case, the parties agreed to provide compensation for non-compete restrictions in the form of stock options. However, Company B is currently not publicly listed, which means that the stock ownership does not have an accepted and definite transaction price.  It becomes difficult to determine whether Mr. Gao can profit from exercising the stock options and whether the profits would meet the minimum legal standards for non-compete compensation. Additionally, due to the lack of public listing, the stock options cannot be readily converted into cash, resulting in a lack of market liquidity. Therefore, compared to the mandatory provisions of the Employment Contract Law, the agreement between the parties is less favourable to the employee and shall be deemed invalid.

Key Action Points

If the entity granting of the stock options is not publicly listed and the stock options cannot be publicly traded, the agreement to use such stock options as compensation for non-compete restrictions may be deemed invalid by the court.