Restrictive Covenants in China

Definition and Types of Restrictive Covenants

Restrictive covenants including non-compete clause, non-solicitation, etc. are commonly used in practice.

In PRC Employment Contract Law, there is no express definition of restrictive covenants. Nevertheless, restrictive covenants are commonly used in practice. For example, an employment contract and a separation agreement may include an obligation not to violate the conflict of interest policy, confidentiality obligation, non-disparagement obligation, non-solicitation obligation and non-compete obligation.

Types of Restrictive Covenants

Regarding post-termination non-compete clause, the maximum non-competition term is 2 years and the default standard for the monthly non-compete compensation is 30% of employees’ average monthly salary under PRC laws. Regarding non-solicitation clauses, they are not expressly incorporated into PRC Employment Contract Law, but are requested by most employers in practice.

Non-compete clauses

According to PRC Labour Contract Law, an employer and an employee may add a post-termination non-compete clause in a labour contract or confidentiality agreement. Employees who may be subject to non-compete obligation include senior management, senior technical personnel and others who have confidentiality obligations.

The maximum non-competition term is 24 months. During the non-compete period, the employer is obliged to pay compensation to employees for the performance of non-compete obligations after termination of employment, and the employer is entitled to have the employee assume the agreed liabilities for the violation of non-compete obligations.

The default standard for the monthly non-compete compensation is 30% of employees’ average monthly salary under the Interpretations of the Supreme People’s Court on Issues Relating to Laws Applicable for Trial of Labour Dispute Cases (I). However, the regulations and practical rules for post-employment non-competition usually vary by region.. For instance, in Shenzhen, it is half of the employee’s average monthly salary; in Jiangsu Province, it is one-third; and in Zhejiang Province, it is two-thirds.

The following rules deserve special attention:

• if the compensation for employees abiding by the non-compete obligations is not explicitly stipulated in writing, then the non-compete clause is still binding upon the employees;
• the default standard for the monthly non-compete compensation is 30% of employees’ average monthly salary in the last 12 months prior to employment termination, which shall be no lower than the monthly minimum wage announced by the local government;
• if an employer fails to pay such compensation for three months, the employee is entitled to request relief from the non-compete clause; and
• an employer may waive the employee’s non-compete obligation during the restricted period and such employer shall pay three additional months of compensation, if so requested by the employee.

Non-solicitation of customers

Although a non-solicitation obligation is not expressly incorporated into PRC Employment Contract Law, normally in the employment contract or specific non-competition and non-solicitation agreement, the employer will request that during the employment period, and for a certain period of time after termination of the employment relationship, the employee shall not solicit any customer, consultants, agents, representatives, vendors, etc. of the employer or its affiliates.

Non-solicitation of employees

In addition to the obligation of non-solicitation of customers, non-solicitation of employees is also requested by most employers in practice. For instance, the employer will request that during the employment period and for a certain period of time after termination of the employment relationship, the employee shall not directly or indirectly solicit, induce, recruit or encourage any employees or any other member of the employer to leave their employment.

Enforcement of Restrictive Covenants – Process and Remedies

The employee can be required to pay liquidated damages due to the violation of no-compete obligation. Regarding those non-solicitation clauses, the liquidated damages agreed upon are likely to be deemed invalid. Instead, employers are required to provide evidence of actual losses caused by such solicitation.

If an employer has a non-compete agreement with an employee, but does not want to enforce such agreement, it is advisable for the employer to expressly waive the non-competition duties before the termination of employment. Otherwise, once the employment is terminated, the employer will be obliged to pay the non-competition compensation on a monthly basis, or would need to pay three additional months’ non-compete compensation if it intends to rescind the non-compete agreement.

Under PRC Employment Contract Law, the employee can be required to pay liquidated damages to the employer only under two circumstances, one of which is the violation of his or her non-compete obligation. In other words, if the employee has violated his or her non-compete obligation, the employer may require the employee to bear the agreed liabilities, which usually include payment of the liquidated damages, refund of the paid compensation, continued performance of the non-compete obligation and compensation for actual losses suffered by the employer, beyond the amount of liquidated damages.

For non-solicitation obligations, the employer may enforce the relevant clauses in the employment contract, etc. and claim damages for any loss incurred thereof. In non-solicitation cases, employers are usually required to provide factual evidence of the solicitation and the related actual losses.

Where a non-competition or non-solicitation obligation is breached, despite the remedies in the form of economic compensation, it is often quite difficult for judicial bodies to rule on the specific performance of the non-competition or non-solicitation obligation, as such enforcement is believed to conflict, to a certain extent, with personal freedom.

Use and Limitations of Garden Leave

Garden leave is not a legal concept under PRC employment laws but may be applied in practice in China.

The concept of garden leave does not derive from the PRC employment laws and regulations, but it is widely used in daily HR practice in China. Garden leave refers to the period when the employee is relieved from all job duties, maintains his/her employment relationship with the employer and receives normal remuneration. Garden leave is often arranged in the situations where i) the employee is suspected of misconduct and under investigation; or ii) the employer expects the employee to break away with the confidential information or trade secrets, before the employee’s departure from the company.

The use of garden leave is unlimited in most cities in China. However, we have seen exceptional cases where the arrangement of garden leave is viewed as a deprivation of the employee’s working conditions, which entitles the employee to terminate the employment and claim severance from the employer.