Easing employers’ concerns over the departure of senior staff

Senior staff, depending on the management function they hold, usually have access to the core trade secrets and business information of their employers. As a result, the unexpected departure of a senior staff member not only has a negative effect on the company’s management, but also gives rise to the risk of the disclosure of trade secrets and the subsequent loss of competitive advantage. Against this background, in recent years, companies are paying more and more attention to controlling these potential risks. Li Xinyi of Luther Law Offices describes how non-competition agreements are one of the measures companies turn to for protection when senior staff leave.

Drawing up non-competition agreements

Companies should reach this agreement with senior staff at the time of their entry to the company or promotion to management positions. The conclusion of a non-competition agreement is subject to mutual agreement between the company and their senior staff. In practice, before the issuance of a job offer, companies usually hold stronger bargaining powers when negotiating work arrangements, remuneration and other issues with candidates. At that moment, candidates usually tend to accept the post-employment non-competition arrangement proposed by the company with the job offer. However, if companies fail to reach an agreement with senior staff members at an earlier stage but raise the same proposal when they signal they might leave in the near future, the company may face a difficult negotiation. In a worst-case scenario, the senior staff member may reject the proposal regardless of any benefit offered by the company.

If companies later find it unnecessary for a senior staff member to observe the signed post-employment non-competition agreement, they can release him/her from such obligations, but it is worth noting that the senior staff member concerned should be informed in writing before his/her departure. Companies should expressly state their decision in the termination agreement or notice. In the event that such notification is issued after the departure of the senior staff member, according to relevant regulations, he/she is entitled to claim a lump-sum compensation of up to three months of the amount of compensation agreed in the non-competition agreement (see below for more details on compensation).

Scope of non-competition obligations

Under a post-employment non-competition agreement, the following issues shall be prescribed in detail:

1. Scope of competitive business;
2. Restrictive territory: the senior staff member concerned is prohibited from engaging in competitive business in a certain country, region or even globally; and
3. Restrictive period: the term during which the senior staff member shall obey the non-competition obligation.

China’s Labour Contract Law only provides a statutory limitation on the period—i.e. a maximum of two years—while the scope of competitive business and restrictive territory shall be determined upon mutual agreement between the company and the senior staff member. It is recommended that companies define the scope and territory on the basis of their current business and business they plan to conduct in the near future. The prescribed scope of competitive business and restrictive territory should not be excessively large. If companies improperly restrict the senior staff member’s freedom to choose new occupations after his/her departure with an extraordinarily large scope of competitive business or restrictive territory, a court or arbitration commission may adjust the given scope if the senior staff member raises a claim.

Compensation

As per the Labour Contract Law, companies shall compensate senior staff who obey post-employment non-competition obligations on a monthly basis during the restrictive period. To ensure full compliance with the non-competition obligation by the senior staff member, companies should request the submission of proofing materials, e.g. social insurance contribution records, as a condition for the payment of the monthly compensation.

With respect to the amount of compensation, relevant regulations state that—if the company has concluded a non-competition agreement with the employee but fails to reach an agreement on the non-competition compensation—the employee who has duly observed their obligation is entitled to a monthly compensation amounting to 30 per cent of his/her average salary in the 12 months previous to the termination of the labour contract. In practice, many companies see this rule as a statutory standard for the determination of the compensation amount. Actually, upon mutual agreement between the company and the senior staff member, the amount of compensation may be lower than the 30 per cent standard, but the minimum amount should not be lower than the standard minimum wage in the location where the labour contract was performed.

Violation of non-competition obligations

China’s Labour Contract Law entitles companies to claim for liquidated damages against the senior staff member who has violated his/her obligations as agreed under a non-competition agreement. In practice, specifications regarding the calculation and amount of the liquidated damages under a post-employment non-competition agreement usually play a significant role in whether the company is able to recover part of its losses suffered due to a senior staff member’s violation. Some companies state the calculation of the liquidated damages shall be based on: “the benefits gained by the senior staff member from his/her breach of the non-competition obligation” or “the losses caused to the company by the senior staff member’s breach of the non-competition obligation”. With these provisions, when claiming for damages, the company bears the burden of proof with respect to the specific amount of benefits gained by the senior staff member or the losses suffered by the company. If the company fails to collect sufficient evidence, the court may not support the claimed damages in full.

In order to avoid such risk, we suggest companies abandon the calculation method on the basis of the benefits gained or the losses suffered, and instead specify an exact amount—e.g., Chinese yuan (CNY) 300,000—for the liquidated damages. In this case, if a senior staff member claims that the actual damages are lower, the burden of proof falls on him/her. Alternatively, companies may also propose that the damages shall be six times the senior staff member’s average salary in the 12 months previous to the termination of the labour contract.

Conclusion

To sum up, a well-formulated non-competition agreement can greatly reduce the potential risks to the company brought about by the departure of senior staff. As a result, companies are advised to conclude the non-competition agreement with their senior staff as early as possible, and to determine those material terms and conditions of an agreement—in particular, the scope of non-competition obligations, and the compensation and liability for any breaches—by taking into full consideration the concrete job functions of the senior staff members concerned and the company’s future business plan.

Luther

Luther Law Offices in Shanghai is fully licenced to offer legal services in China and provides advice on all questions of Chinese law. We support foreign investors in the Greater China region on all legal matters with particular focus on corporate/M&A, dispute resolution, employment law, white-collar crime, commercial and distribution law, IP law, construction law and tax law. We also provide ‘one-stop’ services covering corporate secretarial services, bookkeeping services, tax filing and payroll services.