The court decided that the JV's technical information and formulae for its chocolate products were trade secrets. Further, the clause prohibiting Mr Li from working in competitor companies restricted Mr Li's employment opportunities but did not deprive him of his right to work. Moreover, Mr Li was unable to prove that the restrictive covenant failed to express his genuine intent. Accordingly, the agreement was valid.

The Appeal

The appellate court considered the disputed clause in the agreement to be a restrictive covenant whose main purpose was to protect the trade secrets of the employer. According to the Labour Bureau's (now the Ministry of Labour and Social Security) Issues Concerning the Mobility of Enterprise Workers Notice, employers may prohibit employees from working for their competitors after termination for a period not to exceed three years, provided that they pay the employee an unspecified amount of compensation. Regulations by the then State Science and Technology Commission (now the Ministry of Science and Technology) and a number of local regulations including in Guangdong, Shenzhen and Zhuhai give employers similar rights. All of these regulations provide that the restrictive covenant would be automatically terminated if the employer fails to pay the employee compensation or delays payment without good reason.

However, according to the PRC Administrative Litigation Law, courts are bound by laws (falu) and administrative regulations (xingzheng fagui - that is, regulations passed by the State Council), and local regulations (difangxing fagui) passed by people's congresses and their standing committees of provinces, autonomous regions, cities directly under the central government and major cities and special economic zones. In contrast, courts need only consider guizhang2 for reference purposes (canzhao) and need not even consider normative documents (guifanxing wenjian).3

Because all of the applicable regulations are either guizhang or normative documents, and hence not binding on the courts, different courts have come to different conclusions regarding the validity of restrictive covenants and the effect of the failure to pay or the delay in payment of compensation. In this case, the appellate court held that the confidentiality agreement was valid even though it did not provide for compensation to Mr Li.

Practice Points

To increase the likelihood of a court holding a restrictive covenant valid, companies should limit the term to three years and provide for compensation during the restricted period. Naturally, it will be difficult to agree on the appropriate amount of compensation once the employee has been terminated or becomes aware that termination is imminent. Accordingly, the amount of compensation should be negotiated in advance.

Some employment contracts provide that such compensation shall be folded into the employee's salary, especially when the employee is a senior manager receiving a high salary. However, this practice should be avoided. The contract should state separately the amount of compensation.

To enhance investors' confidence and reduce uncertainty, the State Council should pass an administrative regulation establishing the right of employers to rely on restrictive covenants, providing guidelines on how much compensation is required and clarifying whether the compensation may be folded into the employee's salary.

By Feng Jinwei and Randy Peerenboom
Yiwen Law Firm, Beijing

ENDNOTES

1 The JV also sought an injunction against, and damages from, Company B for misappropriating its trade secrets under the PRC, Anti-Unfair Competition Law.
2 Guizhang include government rules passed by people's governments of provinces, autonomous regions, cities directly under the central government and major cities, and ministry rules passed by central level ministries, commissions, agencies or entities (such as the People's Bank of China) directly under the State Council.
3 Normative documents include all types of legislation other than laws, administrative regulations, local regulations and rules.