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Difference Between Confidentiality and Non-Competition Agreement in China


Author: Sabrina Wang
Translator: Shawn Huang
Editor: Francis Pan

In recent years, increasing the protection of trade secrets has become an international trend. In order to cope with the complicated and ever-changing international situation, the protection of trade secrets has also become a strategic measure at the national level, and this can be seen from the successive revision of the Anti-Unfair Competition Law in China. In the newest amendment, “breach of contract” is replaced by “breach of confidentiality obligation”, which expands the scope of confidentiality responsibility of employees, trade partners, and other personnel who may obtain trade secrets. Under this background, the applicable law of competition restriction among labor disputes may have certain change. This essay analyzes the judicial practice trend in Shanghai regarding the validity of the confidentiality agreement, hoping to benefit the practice.

Case One
Company A and Jiang signed a non-fixed-term labor contract on April 1, 2011. The job position is an application engineer with an annual salary of RMB 348,956.97. On September 26, 2012, Jiang resigned and signed a memorandum of separation, clarifying that “the confidential information obtained during the work is subject to confidentiality obligations”, and the period of confidentiality obligations continues after the separation. On November 1, 2012, Jiang entered Company B, who has direct competition with Company A.

Article 2 of the Employment Invention and Information Confidentiality Agreement attached to the Labor Contract signed by Company A and Jiang on April 1, 2011, states: “Any confidential information obtained or completed by me during the employment... All reasonable precautions will be taken to ensure that such information is neither disclosed to unauthorized persons nor used without authorization, either during or after the term of employment.” And Article 23 of the Labor Contract stipulates that: if Party B terminates the contract in violation of the conditions stipulated in the contract or violates the confidentiality of trade secrets stipulated in the contract and the Employment Invention and Information Confidentiality Agreement, and causes economic losses to Party A, it shall be liable for compensation according to the extent of the losses.
During the performance of the labor contract, the parties did not sign an agreement on competition restrictions. Company A also failed to prove that it had paid Jiang compensation accordingly for requesting Jiang to fulfill this obligation.
On September 24, 2013, Company A applied to the arbitration and then the court of the first instance, requesting that the respondent, Jiang, violated the confidentiality obligations stipulated in the contract and should compensate the loss of RMB 300,000 due to his breach of contract. None of the requests are supported.

Opinion of the Second Instance Court
Regarding the relation between the confidentiality agreement and the non-competition agreement and the validity of the confidentiality agreement.
The non-competition obligation is based on the agreement between the employer and the employee, and one of the main differences between the non-competition agreement and the confidentiality agreement is that the former limits the freedom of the employee when choosing a new job. Now that the parties have not concluded an agreement on the competition restrictions, indicating that Jiang does not have the non-competition obligation to Company A, hence it is legal for Jiang to enter the competitive Company B after resignation. However, for employees, regardless of whether or not they sign a confidentiality agreement, they have the obligation to protect the trade secrets of the employer. Moreover, in this case, Jiang not only signed a confidentiality agreement but also made it clear that the period of confidentiality obligation lasts during and after the employment. In view of the fact that the agreement is the genuine intetion of Jiang and the content is not illegal, it is binding. On the grounds that the two parties did not sign the competition restriction agreement, the first instance court believed that Jiang did not need to assume the obligation of confidentiality after leaving the company. Nevertheless, this determination confuses the relation between the confidentiality agreement and the non-competition agreement, which is not correct and shall be corrected.

Whether Jiang shall be liable for compensation.
Although Jiang shall be bound by the confidentiality agreement, whether he is liable for compensation shall be decided by Article 90 of the Labor Contract Law. Company A shall bear the burden of proof for the constituent elements of the liability and bear the consequences of the inability to provide evidence. The first instance court’s decision of not supporting the claim of Company A is correct and shall be maintained. The appeal was dismissed, and the original judgment was upheld.

Case Two
On April 1, 2010, Li joined Company C as the sales manager. The term of the last Labor Contract signed by the two parties is from July 1, 2014, to June 30, 2019.

Article 4 of the labor contract stipulates that Li shall keep the company's relevant confidential information safely abiding by the secrecy system. Li also promises not to engage in the same industry and type of work within one year after leaving the company and assume corresponding legal liabilities for violations. Without the company's consent, Li must not establish labor relations (including de facto labor relations) or labor dispatching relations with other companies or individuals. Article 9 stipulates that Li shall pay RMB 5,000 as compensation to the company for taking part-time jobs in other companies without consent. In addition, on July 1, 2011, Article 8 of the Confidentiality Agreement attached to the Labor Contract signed between the two parties stipulates that Li promises that during his tenure at Company C, he will not take any position, including but not limited to shareholders, partners, directors, supervisors, managers, agents, consultants, etc., in any other enterprises, institutions, or social organizations who operates similar products or provides similar services to others without the prior consent of Company C. And Li must not serve in a company of the same industry within one year after leaving Company C. Article 13 stipulates that if Li violates any of the terms of this contract, he shall pay Company C a penalty of 10 times of his annual income. There is no agreement between the two parties on compensation for competition restrictions nor Company C ever paid.

On January 21, 2014, Li became a shareholder owning 49% shares of Company D, whose business range was significantly overlapped with Company C. On March 24, 2017, Company C canceled the working mobile phone card of Li and notified customers that Li's work would be transferred to Mei. All the actions taken by Li in the future have nothing to do with Company C.

On December 18, 2017, Company C applied for arbitration, requiring Li to pay RMB 960,000 as a non-competition penalty and RMB 5,000 as compensation for a part-time job in violation of confidentiality agreement. The arbitration award supports the claim for RMB 5,000 as compensation for a part-time job and rejected other claims.

Company C then appealed to the court of the first instance. The first instance court held that the Confidentiality Agreement was legally binding on both parties. Li’s non-competition obligations are not exempted automatically because Company C has not paid compensation. Li shall perform the confidentiality obligations and non-competition obligations (including during the labor contract period). However, during the labor contract, Li jointly established Company D with others, whose business scope clearly overlapped with Company C. In the name of Company D, he bade and won the bids for the similar business operated by Company C to the two units outside the case, violating the terms of the competition restriction agreement agreed by both parties. The court of the first instance adjusted the liquidated damages to RMB 288,000 in light of the time when Li established the company and the total amount of his wages. Moreover, Li did not file a lawsuit within the prescribed time limit after the arbitral award, so he shall pay Company C for part-time job compensation of RMB 5,000 according to the arbitral award.

Opinion of the Second Instance Court
Both the Labor Contract and the Confidentiality Agreement stipulate that Li shall not engage in the same industry and type of work within one year after leaving the company, and any violation of the agreement shall bear the corresponding legal liability. The above stipulations are contents of competition restrictions. In the case that Company C did not explicitly waive Li’s non-competition obligations, Li shall abide by it. Even if the two parties do not specify the economic compensation for the non-competition restrictions, it does not affect the validity of the agreement. The judgment made by the first instance court shall be maintained for its clear summary of the facts and correct application of the laws.
The above two cases share many points in common:
1. Instead of signing a specific non-competition agreement, the relevant provisions are stipulated in the labor contract or confidentiality agreement;
2. Both confidentiality agreements are attached to the labor contracts and signed during the existence of the labor relationship;
3. The confidentiality agreement only stipulates the liability of the employee when breaching the contract, without stipulating the economic compensation the company shall pay;
4. The validity of the confidentiality agreements is both confirmed.
However, the circumstances of the two cases are different:
1. There is no clear agreement on the non-competition restrictions in the confidentiality obligation in the agreement of Case 1, while there are specific requests in Case 2.
2. The liability for breach of confidentiality agreement was stipulated without a certain amount of compensation in Case 1, while the liquidated damages were clarified with a specific amount of liability in Case 2.
3. The breach of confidentiality obligations occurred after separation in Case 1, while it occurred during the period of employment in case 2.
Although the employees in both cases were found to be in breach of the confidentiality agreement, the results of the litigation were very different:
In Case 1, although the validity of the confidentiality agreement was recognized, due to the lack of a non-competition term, it was determined that the employee was not subject to non-competition restrictions. In addition, the difficulty in proving the company’s actual loss led to its failure in claiming damages from the employee.
In Case 2, not only the validity of the non-competition clause was confirmed, but also the claim for a non-competition penalty in the period of employment was supported. And the liquidated damages were supported by the second instance court due to the clear agreement on the calculation method.
A Simple Analysis of the Judicial Practice Trend on the Liquidated Damages for Competition Restrictions During the Employment:
“The validity of the liquidated damages clauses for competition restrictions during the employment” In Case 2, is a controversial topic in the judicial practice in Shanghai for recent years. There are two opposite explanations for whether or not the damages for competition restrictions during the employment can be agreed. Some believe that the Labor Contract Law has clearly limited the application of employee's liquidated damages for competition restrictions to a certain period of time after the termination of a labor contract, and shall be strictly observed. The obligation of confidentiality is an accompanying obligation of the labor contract. In light of that the law does not clearly stipulate the non-competition penalty during the employment, if the employee has a violation during the employment, the company may claim the tort liability for the relevant loss. Others hold that the competition restrictions are the honest and trustworthy obligation of the employee for the company during the labor relationship. The law does not preclude the possibility of applying a competition restrictions penalty during the employment and hence employees are subject to competition restrictions and the damages during their employment.
Through the public judgment documents researching, the author inquired about two related cases in 2018. The two different second instance courts uphold the same opinion that it is illegal to set damages for competition restrictions during the employment because the current law only stipulates that the employee violating the non-competition agreement after leaving shall pay liquidated damages according to the contract. The employee is not required to pay the liquidated damages in violation of the agreed confidentiality obligations during the employment. Without legal provisions, employers and employees are not allowed to arbitrarily agree on damages.
However, it is worth noticing that Case 2, judged in early 2019, broke through this point of view and clearly recognized the validity of the non-competition clause during the employment period, believing that the employee shall fulfill the confidentiality obligations and non-competition obligations (including during the employment).
Lawyer's advice
For employees with confidentiality obligations, the company may conclude non-competition clauses with them in the labor contract or confidentiality agreement, clearly defining the part-time and job-choosing limits of the employee during the employment and within two years after leaving the company, as well as the method of calculating the liquidated damages for non-competition. If the compensation liability is also agreed at the same time, it is recommended to clarify the specific amount, so as to achieve the effect of the terms of the competition restriction when the dispute arises and to fully protect the trade secrets and competitive interests of the company.

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