Safeguarding Valuable Information Where to Strike a Balance?

A technology company desires to include a non-compete clause in the employment contracts of all incoming employees, because it will be difficult to have employees sign a separate non-compete agreement when they leave the company upon termination. Another reason cited by the technology company for this practice is that it is hard to determine which employees the company needs to bind with a non-compete covenant at the initiation of employment. Is this a good practice? Is the non-compete covenant imposed in this manner enforceable under Chinese law?

What is a Good Practice?

It is recommended for technology companies to obtain non-compete covenants from employees as part of their initial employment contracts. However, such a company should restrict this practice to certain levels and/or types of employees that are likely to have access to the company's trade secrets, rather than adopting this practice across the board to all incoming employees.

The Notice Concerning Several Problems on the Mobility of Enterprise Employees, issued by the former Ministry of Labour in 1996 (1996 Notice), provided that "an employer may restrict employees who are in possession of trade secrets from being employed by [a competitor]". A reasonable interpretation of this provision is that non-compete covenants imposed on all new employees runs afoul to the rationale that only those employees who have access to trade secrets can be subjected to non-compete restrictions.

The risk remains that a standard non-compete clause found in all of a company's employment contracts could be held unenforceable on the grounds that it unreasonably restricts employee job mobility and interferes with employee economic well-being. If the standard non-compete clause applicable to all employees were held to be unenforceable, all employees (including those who had access to the company's trade secrets) would then be free to compete with the company, subject only to the relevant statutory obligations (i.e., Anti-Unfair Competition Law(反不正当竞争法)) concerning the use of trade secrets.

The key reason why a non-compete clause is needed, is to protect the trade secrets of the employer. The specific methods of an employer in protecting the confidentiality of trade secrets may generally require that only employees needing to know trade secret information, in order to perform their jobs properly, should have access to such information. An implication of the proposed practice of applying a non-compete clause to all employees, regardless of the nature of their job and position, is that they gain access to trade secrets. This implication could potentially be used to undermine the existence of trade secrets, which, according to a best practice and protection method, should only be disseminated and distributed selectively in the company and should be available to employees on a need-to-know basis.

Protection of trade secrets and other confidential information is treated through a holistic or systemic approach. An employer should consider adopting appropriate protection measures that are no more than necessary to protect its legitimate interest, without damaging the interests of its employees to earn a living. The recommended approach is to implement a non-compete clause or agreement selectively to certain employees who have access to trade secrets. Overprotection of trade secrets should be avoided not only to balance the interests of employees to continue to maintain his or her livelihood after termination, but also to bolster a plausible argument in favour of finding the existence of trade secrets.

Enforceability of Non-Compete Clauses

With regard to the enforceability of a non-compete covenant, the 1996 Notice provides a general guideline, which can be summarized to include the following factors: (i) the non-compete clause must be based on the protection of the trade secrets of the employer by restricting only employees who have access to trade secrets; (ii) the restriction must be on "competing" activities to be engaged by those employees; (iii) the duration of the restriction may not exceed three years; and (iv) a certain amount of economic compensation must be paid.

Factor (i) appears to be very difficult to apply in reality because (a) the standard or criteria as to what constitutes trade secrets in a particular case may be highly case-specific and therefore unpredictable; and (b) the particular facts of each situation where a non-compete clause is warranted to protect an employer's trade secrets again vary on a case-by-case basis.

It is expected that the "competing" business as described in factor (2) may be determined in terms of geographic consideration and the scope of activity proscribed and, therefore, cannot be generalized by clear-cut or black letter rules. The three-year limitation on duration described in factor (3) should be relatively straightforward, although a reasonable duration may depend on the lifespan of the trade secrets and the industry involved. Factor (4) needs to be clarified by further legislation as to, among other things, the circumstances in which the compensation is payable and, if so, the amount of compensation to be paid. Indeed, since the fact patterns and the relevant economic considerations vary from one case to another, as well as from one locality to another, implementation of a national uniform standard is out of the question.

In sum, whether or not a particular non-compete clause is enforceable has become a test that is very much similar to the 'rule of reason analysis' adopted by some other jurisdictions by considering all the circumstances in the totality.