Non-disclosure and Non-competition Agreements in the PRC

In the absence of a specific non-disclosure agreement and a non-competition agreement, an aggrieved party may resort to the general tort principles. Under the tort principles, the aggrieved party must prove that:

(i) the former employee has misused the commercial secrets of the employer;

(ii) there is negligence or intentional wrong-doing on the part of the former employee;

(iii) there is damage to the employer; and

(iv) there is a causation between the misuse of the commercial secrets and the damage to the employer.

There are several disadvantages of relying on tort for legal remedies. Unless the aggrieved party can prove that the employment relationship with the competitor involves the misuse of commercial secrets, the aggrieved party cannot rely on the tort principle to enforce the non-competition obligation or seek legal remedy on the ground of the former employee's employment with a competitor.

The employer has the burden to prove the fault on the part of the former employee. As a practical matter, it may be more difficult proving the fault, which is a state of mind on the part of the employee, than to prove a breach of a written contract, which is often an objective factor. The employee can claim that he had no knowledge that he should keep the information in question confidential.

PRC legal scholars indicate that the damage that may be awarded to a tort claim is limited to only the actual loss1. However, for most companies claiming the infringement of their commercial secrets, the most significant damage is the loss of income expected to be derived from using the commercial secrets. Of course, the aggrieved party may also seek to enjoin the former employee from further misusing the commercial secrets. However, the difficulty in proving a tort claim, together with the argument that the right to work is a constitutional right of a PRC citizen, would make it difficult for employers to seek injunctive relief.

(b) Anti-Unfair Competition Law

In the absence of a specific non-disclosure agreement and a non-competition agreement, an aggrieved party may also resort to the PRC Anti-Unfair Competition Law (中华人民共和国反不正当竞争法) (Anti-unfair Competition Law), promulgated by the Standing Committee of the National People's Congress, effective December 1 1993, if, among other things, the employer has taken the protective measures to keep the information secret. The Anti-unfair Competition Law does not address the non-competition issue, however, if by virtue of working for a competitor, an employee is proved to have used the commercial secrets learned from his former employer, the former employer may seek legal remedy on the ground of the employee's misuse of the former employer's proprietary information.2

The Anti-unfair Competition Law prohibits "business operators" from engaging in "unfair competition". It lists specific activities that are deemed to be unfair competitive activities. Such specified unfair competitive activities include the infringement by a business operator of commercial secrets.3 The Certain Provisions Concerning the Prohibition Against the Infringement of Commercial Secrets, promulgated by the State Administration for Industry and Commerce (SAIC Provisions) on November 23 1995, broadens the scope of the specific unfair competitive activities and includes in them any violation by an employee of a confidentiality agreement or an employer's request to maintain confidence of commercial secrets.4

In addition to the prohibition against an employee's disclosure or use of commercial secrets, both the Anti-unfair Competition Law and the SAIC Provisions provide that a third party may be deemed to have infringed upon the commercial secrets of the others if such third party knowingly used or allowed the use of commercial secrets that were obtained through infringement activities5. This provision would allow a proprietor of commercial secrets to bring action against not only an individual who violated the confidentiality obligations but also the individual's new employer if the new employer uses or allows the use of the commercial secrets knowing that such commercial secrets were disclosed to them in violation of a confidentiality agreement or request.

In order to obtain the legal remedy in the event that an employee is believed to have disclosed the commercial secrets to a third party and the third party is believed to have used such commercial secrets, the employer must prove, among other things that the:

(i) information disclosed or used constitutes commercial secrets; and

(ii) employee indeed disclosed, and the third party indeed knowingly used such commercial secrets.

THE LAW WHERE AN AGREEMENT IS IN PLACE

Various laws and regulations permit employers to require employees to enter into non-disclosure and non-competition agreements. Article 22 of the PRC Labour Law (中华人民共和国劳动法)(Labour Law)6 provides that the parties to a labour contract "may provide the maintenance of confidentiality of commercial secrets" of the employer. Article 2 of the Notice Regarding Certain Questions relating to Mobility of Enterprise Employees promulgated by the Ministry of Labour on October 31 1996 (Ministry of Labour Notice) states that an employer may require an employee "who possesses commercial secrets not to take a position with another entity which produces the same kind of products or engages in the same kind of business and which is a competitor [of the employer] or otherwise do the same on his own within certain period of time (usually not more than three years) after the expiration or termination of the labour contract..." In Shanghai, the Notice concerning Certain Questions in connection with the Implementation of the Rules of the Labour Contracts of Shanghai Municipality promulgated by the Shanghai Labour Bureau on March 19 1998 (Shanghai Notice) includes a provision that is substantially the same as Article 2 of the Ministry of Labour Notice.7 Other cities such as Shenzhen and Zhuhai have promulgated similar local regulations.8

A non-disclosure and non-competition agreement affords an employee many advantages. In the context of the Anti-unfair Competition Law, one of the elements of commercial secrets, that is the protective measures have been taken, would be satisfied once a non-disclosure agreement is signed. Where such a non-disclosure agreement is absent, the employer would have to prove that other protective measures have been taken. The failure to prove would have the consequence that the information involved would not be deemed commercial secrets under the protection of the Anti-unfair Competition Law.

When there is a non-competition agreement in place, and provided that the non-competition agreement well defines who competitors are, the burden of proof of the breach of such a non-competition agreement is much easier to meet than the burden of proof of a former employee's disclosure of the employer's commercial secrets when working for a competitor.

More importantly, when an employee signs a non-disclosure and non-competition agreement, and the terms of the agreement are such that are enforceable, the interest of the employer to protect its commercial secrets from unauthorized disclosure and misuse would be protected by both the Anti-unfair Competition Law and the PRC Contract Law (中华人民共和国合同法)(Contract Law). Consequently, an employer may avail itself to the remedies provided under both the Anti-unfair Competition Law (中华人民共和国反不正当竞争法) and other similar regulations and local rules, on the one hand, and the Contract Law, on the other hand.

Under the Contract Law, a non-disclosure and non-competition agreement may be made in the form of a written or an oral agreement. As a practical matter, however, because the burden of proof of the existence and content of a non-disclosure and non-competition agreement is on the employer, the employer would be in a disadvantageous position if it cannot present a written agreement.

ENFORCEABILITY

From the perspective of an employer, there are many advantages of requiring an employee to sign a non-disclosure and non-competition agreement. As discussed above, non-disclosure and non-competition agreements should be drafted to maximize the protection of the interest of an employer, yet still
remain enforceable.

(a) Non-Disclosure Agreement

The most important elements of a non-disclosure agreement are:

(i) what constitutes confidential information which may not be disclosed;

(ii) the limitations on the manner in which an employee may disclose or use such information; and

(iii) the term during which the employee may not disclose or use the information.

A typical non-disclosure agreement would define confidential information very broadly. However, regardless of how inclusive the definition of confidential information may be, as a matter of law, only the information that meets the definition of "commercial secrets" under the Anti-unfair Competition Law (or the definition of "technical information" under the Shenzhen Rules, Zhu Hai Rules) may be protected. As discussed above, information may be considered to be commercial secrets, subject to the protection afforded under the law and regulations cited above only if it:

(i) is unknown to the public;

(ii) can produce economy benefits to the proprietor;

(iii) is of practical value; and

(iv) the proprietor has taken protective measures to keep it secret.

A typical non-disclosure agreement would also state that the employee may use the commercial secrets only to carry out the duties of his job. Article 2 of the Ministry of Labour Notice also permits the agreement to provide that the "employer has the right to change the employee's job duty and other related terms of employment not more than six months prior to the expiration of the term of the labour contract or immediately after the employee submitted the resignation".

The term of the non-disclosure obligation is also important, especially if such obligation extends after the termination of the employment. Under the Contract Law, a post-termination obligation such as a confidentiality obligation after the termination of the employment contract must be specifically provided9. The Shenzhen Rules also provide that in the absence of a specific non-disclosure period, the confidentiality obligation ends upon the expiration of the labour contract or termination of employment. Furthermore, under the PRC Civil Law, a contract that is "obviously unfair" is a voidable contract.10
An excessively long non-disclosure period may be held as "obviously unfair", and therefore, unenforceable.

Finally, note that the Shenzhen Rules require the employer to "pay an employee a fee for the employee's performance of his post-termination non-disclosure obligation, the amount of which may be as agreed by the parties".11
However, if the employer fails to pay such fee, the Shenzhen Rules provide that the non-disclosure agreement will terminate automatically.12

(b) Non-Competition Agreement

The most important elements of a non-competition agreement are:

(i) who are competitors;

(ii) what constitutes anti-competition activities; and

(iii) the time period within which the employee is prohibited from engaging in anti-competition activities.

Typically, an employer would wish to define the term "competitor" as broadly as possible. The Ministry of Labour Notice and the Science Commission Opinions, as well as certain local rules such as the Shanghai Notice, the Shenzhen Rules and Zhuhai Rules appear to limit the competitors to entities that produce the same kind of products or those that engage in the same kind of business.13 This is a fairly narrow definition.

In a typical non-competition agreement, an employee would be required not only to not take a position with a competitor, but also not to be a consultant to the competitor or own a substantial amount of equity interest in the competitor. Note that none of the regulations, notices and rules cited in the preceding paragraph state that an employer may require an employee not to be a consultant to, or a shareholder of, a competitor.

From the employer's perspective, the longer the term, the greater the deterrence to an employee who may wish to join a competitor. However, both the basic fairness principle under the PRC, Civil Law and the argument of a citizen's right to work would require that the term of non-competition period be reasonable. The Ministry of Labour Notice and the Science Commission Opinions state that the non-competition period should generally not be longer than three years.14 The Shenzhen Rules and the Shanghai Notice allow for the same non-competition period.15 The Zhuhai Rules allow up to five years.16

Finally, all of the regulations, notices and rules cited in the preceding paragraph require an employer to pay an employee a fee for the employee's performance of his non-competition obligation.17 Failure to compensate an employee would render the non-competition agreement unenforceable.18 However, what would be considered adequate compensation is difficult to determine. Neither the Ministry of Labour Notice nor the Science Commission Opinions nor the Shanghai Notice specifies the amount that would be considered adequate or otherwise provides any guideline. The Shenzhen Rules provide for the minimum amount to be two thirds of the relevant employee's annual income in the year immediately prior to the termination of the employment.19 The Zhuhai Rules provide for the minimum amount to be 50% of the relevant employee's annual income in the year immediately prior to the termination of the employment.20 Such amount may serve as the guideline to what would be considered adequate compensation for a three-year non-competition commitment.

SOME POINTS FOR EMPLOYERS

In light of the analysis above, it is suggested that employers require all key employees to sign both non-disclosure agreements and non-competition agreements, as each such agreement has its own unique benefits and also its own limitations. The combination of the two agreements would offer employers the greatest protection.

(a) Advantages of Non-Disclosure Agreements

The greatest advantage that is unique to a non-disclosure agreement is that an employer can not only bring an action against the former employee, but also the competitor who uses or allows the use of the commercial secrets knowing that it is subject to a confidentiality agreement. In such a case, the former employee and his new employer may have joint and several liability.

The other advantage is that the aggrieved party may seek immediate remedy from the relevant administration for industry and commerce. Article 25 of the Anti-unfair Competition Law authorizes the relevant administration for industry and commerce to order the infringer to cease its illegal activities immediately and to pay a fine up to Rmb200,000.21 If such authority is willing to take this action, the aggrieved party does not have to wait until a court decision is rendered.

Finally, except for the Shenzhen Rules, no other law or regulations require any compensation to an employee for its performance of non-disclosure obligations.22

(b) Limitations of Non-Disclosure Agreements

One of the limitations of the enforcement of a non-disclosure agreement is that in order to obtain any legal remedy, an aggrieved party must prove that the employee indeed disclosed the commercial secrets. Such proof may be difficult. Even if the aggrieved party can prove the unauthorized disclosure and is able to obtain a judgment to order the former employee to cease such illegal activity, such judgment may be difficult to enforce, since for as long as the employment relationship between the former employee and the competitor continues, it is possible that the former employee continues to disclose and the competitor continues to use the commercial secrets.

Moreover, the monetary damage under the Anti-Unfair Competition Law may be more limited. Under Article 20 of the Anti-Unfair Competition Law, it would appear that the monetary damage would be limited to the actual loss. If the "actual loss cannot be ascertained", then the profit is "realized by the infringer as a result of the infringement".23 However, since the burden is on the aggrieved party to prove, it may be difficult for the aggrieved party to know and prove its opposing party's profit earned from the infringement activities. Further, in the case of an action against a former employee (as opposed to his new employer), such "profit earned from the infringement activities" theory would not be applicable. This limitation could be overcome if the employer is able to convince the court to apply the anticipated benefit principle under the Contract Law (see item (c) below).

(c) Advantages of Non-Competition Agreements

One advantage of a non-competition agreement is that if a non-competition agreement is well drafted, it is easier to prove an employee's breach of a non-competition agreement than to prove an employee's disclosure of commercial secrets.

Another advantage is that the Contract Law recognizes the anticipated benefit under a contract. An aggrieved party (that is, an employer) can seek compensation for the loss of its anticipated benefit due to the breach of a non-competition obligation by an employee, a remedy not available under the Anti-Unfair Competition Law. Presumably, it would be easier to prove the anticipated loss than to prove the opposing party's profit earned from the infringement activities.

Finally, an order from the court to cease the breach would be easier to enforce, as there would not be any ambiguity whether the former employee complies with the court order or not. He must resign from his position with the competitor in order to comply.

(d) Limitations of a Non-Competition Agreement

One of the limitations is that in order to have an enforceable post-termination non-competition agreement, the employer must pay the employee a fee for his commitment not to compete.24 However, this limitation may be overcome by characterizing the compensation to the employee in such a way that one of the components is the compensation for the post-termination non-competition obligation.

The other limitation is that a breach of a non-competition agreement is not considered a violation of "public law", and therefore, the government authorities would not intervene. The aggrieved party may seek remedy only under the Contract Law and from the court.

ENDNOTES

1 See, Page 104-105, Professor Liang Huixin on Contract, published by the Second Economics Division of the Supreme People's Count of Sichuan.
2 Various local legislatures or administrative authorities have enacted or promulgated similar local rules and regulations. Examples include the Protection of Technological Secrets of Enterprises Regulations promulgated by the Standing Committee of the National People's Congress of Guangdong Province on November 3 1995 (Shenzhen Rules), the Protection of the Technological Secrets of Enterprises of Zhuhai MunicipalityRegulations promulgated by the Standing Committee of the National People's Congress of Zhuhai on July 10 1997 (Zhuhai Rules). In addition, the State Science Commission also issued the Strengthening Administration of Technical Secrets in the Course of Movement of Scientific and Technical Personnel on July 11 1997 (Science Commission Opinions) that contain similar provisions.
3 See, Article 10, PRC, Anti-Unfair Competition Law, promulgated by the Standing Committee of the National People's Congress, effective December 11993.
4 Article 3 of the SAIC Provisions provides that "[T]he following activities infringing commercial secrets are prohibited: ...an employee discloses, uses or allows others to use the commercial secrets he possesses in violation of an agreement or an employer's request to maintain confidence..."
5 See, Article 10 , Anti-Unfair Competition Law; Article 3, SAIC Provisions.
6 Promulgated by the Standing Committee of the National People's Congress on July 5 1994.
7 See, Article 3, Section 5 of the Shanghai Notice.
8 See, Articles 13 and 14, Shenzhen Rules; Articles 14 and 18, Zhuhai Rules.
9 See Article 92, PRC, Contract Law, promulgated by the National People's Congress on March 15 1999. Also see, "Post-termination Duties", Zhang Xing, April 1999, Journal of Sichuan Normal University, Pp 18 to 22.
10 See, Article 54, the PRC, Contract Law, promulgated by the National People's Congress on March 15 1999.
11 See, Article 9, Shenzhen Rules.
12 See, Article 12, Shenzhen Rules.
13 See, Article 2, Ministry of Labour Notice; Article 7, Science Commission Opinions; Article 3, Section 5, Shanghai Notice; Article 14, Shenzhen Rules, Article 18, Zhuhai Rules.
14 See Article 2, Ministry of Labour Notes; Article 7, Science Commission Opinions.
15 See, Article 16, Shenzhen Rules; Article 3, Section 5, Shanghai Notice.
16 See, Article 20, Zhuhai Rules.
17 See Article2, Ministry of Labour Notice; Article 7, Science Commission Opinions; Article 3, Section 5, Shanghai Notice; Article 14, Shenzhen Rules; Article 22, Zhuhai Rules.
18 See, Article 7, Science Commission Opinions; Article 19, Shenzhen Rules; Article 23, Zhuhai Rules.
19 See, Article 17, Shenzhen Rules.
20 See, Article 22, Zhuhai Rules.
21 See, Article 25, Anti-Unfair Competition Law.
22 See, Article 9, Shenzhen Rules.
23 See, Article 20, Anti-Unfair Competition Law.
24 See, Article 2, Ministry of Labour Notice; Article 7, Science Commission Opinions; Article 3, Section 5, Shanghai Notice; Article 14, Shenzhen Rules; Article 22, Zhuhai Rules.