China: Spousal Proxy Investments in Competing Businesses as a Violation of Non-Competition Agreements During the Restricted Period
Author: Carol Zhu and Lynsey Liu
On 31 July 2018, Mr. Zhang joined a Sports Company, serving as the General Manager of the Teaching and Research Development Centre, responsible for teaching and research management. The parties entered into a non-competition agreement, which stipulated that Mr. Zhang was prohibited from engaging in any activities that violated the non-competition restrictions during his employment and for two years following the termination of the employment relationship. The agreement also specified that the Sports Company would provide compensation to Mr. Zhang during the non-competition period. In the event of a breach, Mr. Zhang was obligated to pay liquidated damage amount equal to ten times the income he had received from the Sports Company and its affiliates in the 12 months preceding the termination or expiration of his employment relationship.
Mr. Zhang left the Sports Company on 31 July 2021, with an average monthly salary of RMB 34,097.44 in the 12 months preceding his departure. The Sports Company had paid Mr. Zhang non-competition compensation for five months. In December 2021, Mr. Zhang’s wife became an investor in Company A, holding 95% of the shares, and Company A’s business was in competition with the Sports Company. An affiliated company of Company A contributed to social insurance for Mr. Zhang.
The Sports Company contended that Mr. Zhang had violated the non-competition agreement and should return the non-competition compensation and bear the liability for breach, subsequently applying for arbitration with the Labour and Personnel Dispute Arbitration Commission. The Commission ruled that Mr. Zhang should return the non-competition compensation and pay liquidated damages. Mr. Zhang disagreed with this ruling and filed a lawsuit in court, seeking a judgment that he was not required to return the non-competition compensation or pay liquidated damages.
The effective judgment holds that Mr. Zhang, in his role as the General Manager of the Teaching and Research Development Centre, with decision-making authority over the Sports Company’s business management, was required to fulfil his obligations under the non-competition agreement. Company A, in which Mr. Zhang’s wife is an investor, has a competitive relationship with the Sports Company and falls within the scope of the non-competition restriction. Considering the close personal and property relations between Mr. Zhang and his spouse, the consistency of their economic interests, and the fact that the investment was made after Mr. Zhang left the Sports Company, it is determined that Mr. Zhang violated the non-competition agreement.
Key Action Points
Employers’ senior management, who invests in and operates businesses through their spouses that are in competition with their former employer, should bear the corresponding liability for breach if they violate the terms of the non-compete agreement. Employers are advised to explicitly outline in the non-compete agreement the specific instances that constitute a breach of the non-compete obligation, as well as the consequences of such a breach, to safeguard their interests and competitive advantage.
