Chinese Law Prof Blog

Editor: Donald C. Clarke
George Washington University Law School

Monday, June 9, 2008

Interesting case on non-competition clauses in employment contracts

In the course of doing some research on fiduciary duties, I just ran across an interesting 2005 case from the Haidian Basic-Level Court in Beijing. In this case, a director, shareholder (albeit small), and senior executive of a company affiliated with the Chinese Academy of Sciences violated a contractual agreement not to compete for two years following separation from the company. The plaintiff sued both the executive (in contract and tort) and the competitor that hired him (in tort, for unfair competition).

The judgment contains two interesting employer-favorable rulings. First, it allows an escape from the normal rule that employment disputes must first go through labor arbitration proceedings (PRC Labor Law, Chapter 10) - proceedings that are often (or so I'm told) tilted in favor of the employee. The court held that there was no legal objection to the plaintiff's choosing to sue both the executive and the competitor jointly in tort for unfair competition arising out of the breach of the contract, and that such a choice turned the dispute into an ordinary civil case ("本案中原告以竞业禁止为由起诉被告陈晋苏和索贝公司不正当竞争,明确主张陈晋苏违反竞业禁止约定成为侵犯原告权利的手段,索贝公司 由于共同侵权而成为不正当竞争者,原告选择的不正当竞争之诉于法不悖,该争议已转化为普通的民商事纠纷").

Second, the judgment allowed an exception to the normal rule that non-compete agreements must be supported by specific, separate, and identifiable consideration. In this case, the plaintiff argued that the consideration was part of the defendant executive's overall compensation package, and the court agreed.

I'm not a labor law expert, but it's my impression that Chinese courts and labor arbitration bodies have been pretty rigid in their rejection of this kind of argument, even though I think it's a sensible one: employees sign on to a package of rights and obligations, and employers sign on to a package of rights and obligations. It makes no more sense to insist on separating out the value of the non-competition agreement than it does to separate out the value of the agreement to do any other part of the job. The court may have accepted the plaintiff's argument in this case for very idiosyncratic reasons unlikely to be repeated in other cases. First, the plaintiff was a company affiliated with the Chinese Academy of Sciences, a quasi-state organ. The non-compete obligation was spelled out not only in an employment contract, but also in internal rules of the CAS and in the company's Articles of Association, which (it was argued but not clearly decided here) can bind shareholders, directors, and senior executives. Second, the defendant was a highly compensated senior executive, shareholder, and director, in addition to being a co-founder of the company, and so his argument that the non-competition obligation was something forced on him against his will and that he did not understand was not terribly convincing. Thus, that the plaintiff was almost a state organ and that the defendant was a highly compensated and sophisticated person seem to have been important facts.

It's also worth noting that this decision pre-dates the explicit requirement of consideration contained in the recent Labor Contract Law - consideration that must be paid during the post-employment period during which the restriction is in effect. To be sure, there was a requirement of consideration in effect at the time - it was spelled out in a 1996 Ministry of Labor document  (see para. 2), and has generally been interpreted to mean explicit, separate, identifiable consideration. Thus, the decision might be helpful in thinking about how courts might interpret similar rules. But the rule now strikes me as much harder to get around.

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If I were an employer in China who wanted my non-compete agreement to stick, I would set out and pay separate compensation for it, particularly in light of the new labor contract law's specific requirements. The next question is how much to pay and on that we are all still pretty much just left to guess. Do you have any ideas on that?

Posted by: Dan Harris | Jun 9, 2008 6:18:23 AM

I recall that most of the literature I've seen suggests that mandatory labour arbitration benefits the employer (who use it to delay and prolong the proceedings), and that employees would generally prefer to go directly to court (because of better enforcement capacity). For those interested, an seemingly balanced report on this has recently been promulgated by China Labour Bulletin.

Posted by: Mike Dowdle | Jun 9, 2008 12:34:40 PM

I concur with Mike's endorsement of China Labour Bulletin as a good source. I was careless in my "or so I'm told" remark - this is what I'm told by lawyers whose experience is with foreign or foreign-invested firms in China. Their views can be squared with what the China Labour Bulletin says if one or more of the following is true: (a) both labor and employers subjectively view the process as biased against them; and (b) while labor arbitration tribunals may be in the pocket of local domestic political power, which backs local enterprises, they are not in the pocket of foreign and foreign-invested enterprises, and thus ruling against them is cost-free. Explanation (b) seems like a good one to me.

Posted by: Don Clarke | Jun 11, 2008 7:19:06 AM

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