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Enforceability of non-compete under Chinese law

China non-compete agreement

As in other countries, non-competition covenants in China are seen as a restraint on trade and are not favored by the courts, particularly if drafted by the employer and not negotiated between the parties. Enforcement of non-competition clauses results in a balancing of the employer’s legitimate protectable interest(s) against the hardship imposed upon the employee by the restriction upon the employee’s ability to work. As experienced China lawyer in the field of non-compete agreement, we share our insights below.

There are two situations where a company typically encounters a non-compete: (1) when it has a valuable employee, information or contacts it wants to keep within the organization; and (2) when a new potential hire arrives with a non-compete that may restrict his/her ability to work for the company. In either case it is important to understand the fundamentals of how to use a non- compete agreement and when to avoid a potential employee who has one.

Consideration for non-compete

One indispensable component of an enforceable non-competition clause is that there must be adequate consideration for the employee to enter into the agreement. For a new employee, that consideration can be the job itself. Pennsylvania courts have uniformly determined that adequate consideration exists for restrictive employment covenants that are part of the formation of the employment relationship. For a non-competition agreement that is signed in connection with the acceptance of an offer, at the very beginning of an employment relationship, or shortly thereafter (i.e., within a few days or possibly a week or two), the position itself will likely be sufficient consideration.

The first principle to keep in mind is that in China, non-competes can and often are enforced by the China courts. There is a common misconception with many companies that non-competes are not enforceable and not worth the effort to put in place. The reality is that China courts are more aggressive in enforcing non-competes than many jurisdictions. A well rafted non-compete that is appropriate under the circumstances for a particular employee will be enforced by the China courts.

Factors to be considered when evaluating a non-compete enforceability

How do you make your non-compete enforceable and effective? China courts will look at three primary factors: (1) duration; (2) geographic scope; and (3) what the employer is trying to protect. Generally a one year non-compete is considered acceptable by the China courts. A longer one may be acceptable if it is connected by special consideration such as the sale of a business. The geographic reach should be consistent with the geographic area the employee worked in. A better approach can be to limit the reach to customers or prospective customers with which the employee had a relationship. The most important factor is to be able to articulate what the employer is trying to protect. If the non-compete is simply designed to restrict the employee’s future employment choices so that it is more likely the employee will stay with the company, the China courts will not be inclined to enforce the agreement. There has to be a legitimate employer interest that is being protected, like client relationships or specialized industry contacts or skills that the company has paid to develop. A non-compete for a salesperson will often be enforced because of the important client contacts a salesperson will develop with the company’s customers. A non-compete for a maintenance person likely won’t because those skills may be easily replaced by the company and there is no specialized knowledge in the position unique to the company.

The reality of non-compete enforcement is that the threat of enforcement is often sufficient to make the employee avoid competing employment. Most employees simply cannot afford the attorney’s fees involved in contesting a non-compete. A strongly crafted non-compete will also contain an attorney’s fees provision that increases the risk of also paying the company’s attorney’s fees if the employee should lose.

Avoid Overly-Restrictive Agreement

While it is important for employers to be adequately protected, oftentimes employers enter non-compete agreements that are overly-broad and unduly restrictive. This, more than any other factor, is most likely to lead to a court finding that the agreement is unenforceable. First, be sure to create an appropriate geographic radius for the non-compete. An agreement that includes a 50 mile radius from the employee’s office has been found acceptable. Under certain circumstances, a greater radius may be appropriate, for example, where the employee has a particular expertise not otherwise available in the area.

Second, it is important that the non-compete period not be for longer than necessary to sufficiently protect the employer’s interests. This period is the time after the employee ceases employment with the employer during which s/he may not work under the terms of the agreement. A 10 year non-compete will almost never be upheld as a reasonable restriction. Typically, a one year restriction will be found to be reasonable.

Third, the agreement should not be intended to intimidate employees but, rather, should be designed to protect the employer’s interests. Therefore, employers should avoid inclusion of liquidated damages provisions that are unreasonably high for the particular employee involved. Instead, it is better for employers to include language that allows them to recover the reasonable expenses incurred as a result of the employee’s breach of the non-compete, including attorneys’ fees and any lost profits.

For a company looking to hire someone with a non-compete, the downside can be substantial if a court decides to enforce the agreement. Under China law, a company that hires someone in violation of a non-compete can be found liable for the attorney’s fees of the company seeking enforcement. In addition, any profits either lost by the enforcing company or made by the hiring company can be a form of damage. China courts will often extend a non-compete for a time equal to any period during which the non-compete was being violated.

For additional information on non-compete issue during employee hiring and leaving process, please see the other articles in this blog and consult our China employment lawyer.

If you are considering hiring a person with a non-compete, it is important to recognize the potential downside and, if possible, craft the hiring in a way to avoid a violation. If there is a customer restriction, make sure they stay away from any of those customers and make sure you can prove it.  Be  prepared  to  negotiate  with  your  competitor  if you get  an  angry  lawyer’s letter demanding to cease and desist. Because of the misconception that these agreements are not enforceable, companies will often negotiate to a lesser restriction to avoid the potential that the agreement will not be enforced. At the end of the day, however, you should operate with the assumption that a properly constructed non-compete agreement can and may be enforced.

 

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