The law on non-competition agreements in China has unique rules intended to balance the interest of three groups: employers, workers, and the general public. With the rise of R&D outsourcing to China, non-competes have become relevant than ever, but this puts intellectual property at risk. Therefore, tailoring non-competition agreements to China’s legal and social context is necessary to minimize risk of unexpected losses. This article describes how non-competes work in China and provides a guide on how to integrate them with local company policy.
Contents
Non-competes under PRC Employment Law
Policy Rationales under Chinese culture
Common conflicts and dispute resolution patterns
Effective non-compete business policy
Drafting the non-competition agreement
Non-competes under PRC Employment Law
The China Employment Contract Act dominates non-competition law in China, which is very different from most other jurisdictions, and non-compete obligations come into effect at the expiration of the statutory Employment Contract if there are non-compete provisions or an effective non-compete agreement in place. The law uses “employees” and not “workers,” thus it excludes independent contractors. A worker has employee status in China if employed under an employment contract that meets statutory requirements, i.e. they are on a full-time schedule, with a term of employment lasting more than one year.
Official translations of PRC law used by many attorneys to counsel clients confusingly state that a non-compete may only apply to a “laborer,” but analysis by professional legal translators at CBL has determined that the Chinese rules are actually referring to employees, a classification that excludes some workers.
The non-competition agreement may restrain the employee from subsequently working for an employer that produces similar goods or does similar work and prohibits them from doing so as an independent contractor. China requires that financial compensation be paid to the former employee during the non-compete term. A former employee breaching the non-compete provisions must pay the employer stipulated damages as provided in the agreement, but multinational companies should be cautious because judges may reject a liquidated damages approach as “excessive.”
Previously, multinational companies were often unwilling to allow important intellectual property rights into China for fear of theft. Today, non-competes are enforced more vigorously and are now considered an effective way to enhance business competitiveness by preventing former employees from disclosing IP.
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Non-competes are formally prescribed in the Employment Contract Act as a means of protecting employer trade secrets while ensuring the right to work. The Chinese approach embodies several qualities:
- Contractual: A non-compete is a provision to the Employment Contract that cannot arise separately from the primary contractual relationship. A non-compete agreement must be signed within the employment contract relationship.
- Legitimacy: A non-compete provision must be closely aligned with protecting the employer’s ability to use trade secrets commercially in a competitive market. IP protection is a legitimate purpose but obtaining labor “monopsony” is not.
- Tailored: The restriction is narrowly limited to relevant work activities, regions, and time limits. These limitations must be listed in the contract and reviewed by an attorney to ensure they do not conflict with another law that could render it unenforceable.
- Compensated: The former employee receives monthly financial compensation throughout the entire non-compete term. The financial compensation is associated with the degree to which the worker is restricted.
Chinese law classifies non-competes based on two types of factors. The first is based on how the legal effect arises, which is between statutory and contractual restraints. Some statutes have provisions that create a mandatory non-competition restriction, thus the non-compete can be statutory in nature. The parties may also agree to enter into a non-competition agreement that further restricts the employee.
The second division for non-competes is based on when the non-compete comes into effect: during employment vs. after employment. If signed during employment, China labor law will automatically incorporate a non-compete agreement’s provisions into the contract. A post-termination non-compete is agreed to after employment and takes effect immediately, but judges consider it an atypical obligation and this approach is not ideal. If part of an Employment Contract, the provision enters into force when the employment terminates.
Non-competes in Chinese culture
In China, where traditional culture emphasizes “harmony,” an important value for stakeholders created by these agreements is to establish a stable, harmonious relationship that preserves the business’s legitimate competitive ability. Chinese commentators have observed how US non-competes were abusive and extreme, leading to a conflict that resulted in the FTC banning most agreements in June 2024. That kind of social acrimony, political battle, and instability would be unacceptable in China. Instead, ancient Confucian logic about the “doctrine of the mean” has been applied to achieve balance and harmony.
Within this cultural context in the current Chinese economy, knowledge industry development has become a central national priority. Within this strategy, enforcing non-competes is seen as ensuring the integrity of major business enterprises. While Chinese law also allows for enforcement against trade secret theft, the economic recovery will generally be far inferior to the value of the non-compete preventative measure. There is preventative value in incorporating the full possible economic losses into the non-compete scope.
China’s rules on non-competes are intended to promote harmony by resolving the social power imbalance between labor and management. The Employment Contract Act restrictions on employer non-competes are intended to ensure that labor and management are equal, and the rules favor neither interest.
The rules pursue an ideal where employees’ duty of loyalty to the company is enforced by the courts, but employers are not able to gain excessive power by preventing workers from earning a wage outside the company. While these harmonizing provisions mainly reduce management’s power, note that the Labor Union Act also contains harmonizing provisions governing labor action.
Non-compete agreements also prevent unfair competition tactics once common in China, such as poaching talent with lures of high salary. As compared with the talent poaching heyday peaking in 2015, workers with knowledge of an employer’s trade secrets will be deterred by the non-compete clauses contained in their Employment Contract. Labor lawyers in China today say that when warned about the potential liability of violating a non-compete, terminated employees are generally willing to comply with its provisions.
Therefore, non-competes in China now protect intellectual property rights and ensure that the enterprise is able to fairly compete on know-how in markets. In the shadow of acrimonious trade secret theft allegations brought to trial, American technology corporations have set up offices all across Shanghai, including both cutting-edge artificial intelligence and semiconductor R&D operations.
Common conflicts and dispute resolution patterns involving non-competes in China
In the Chinese cultural context, the current legal policy on non-competes ensures three types of social interests are balanced: employees, workers, and the public welfare. The right to work and trade secret protection are both fundamental free enterprise rights and are also balanced. Chinese policymakers are particularly concerned about preventing non-competes from being used pretextually to achieve talent monopsony, which would reduce workers’ earning ability.
More seriously, it can prevent knowledge workers from continuing to gain experience in their fields, causing their skills to atrophy, and thus wasting otherwise valuable human resources. However, excessive protection for the right to work at the expense of trade secret protection can make it impossible for knowledge-intensive industries to function normally if intellectual property rights can be casually infringed upon by previous employees. Moreover, failing to place reasonable limitations on the right to work incentivizes market actors to use unfair competitive practices within the industry.
In China’s experience with the “Shanzhai” (copycat) business phenomenon, theft of trade secrets degraded market integrity and caused disinterest in innovation. The current China industrial policy seeks to eliminate all traces of the Shanzhai age, and places increased emphasis on intellectual property rights protection.
China believes that the law’s excessive concern for the public welfare would cause harm to individual workers, making it difficult for them to grow and prosper as individuals. Expert dialog cautioning against extremes makes reference to old Communist policies placing 100% of the emphasis on every individual to “serve the people”.
China’s contemporary Socialist policy aims to maximize the public good by encouraging reasonable free market competition with ownership of trade secrets being vigorously protected by the legal system to gain an advantage essential to making superior offerings to the general public. However, Chinese legal policy also opposes monopoly power, which gives tech giants that own extensive exclusive rights to industry know-how harmful levels of power in the markets.
When technology monopolies begin to emerge, trade secret protection can harm the public interest overall. In recent years, China has taken separate anti-trust action against its technology giants to curtail their power. In this spirit, non-competes are closely curtailed.
In Chinese non-compete litigation, there are eight different types of common disputes that fall into three general groups.
The first group of disputes relates to issues about whether a non-compete provision exists. Because of the statutory Employment Contract Act requirements, the existence of a valid non-compete provision is often a starting point for these disputes. The issues are as follows:
1. Factual disputes can arise around document titles and to which legal document the non-compete provision belongs. The non-compete provisions are often found in a section or exhibit to the Employment Contract, but, in some companies, are found in the company policy or employee handbook. A variety of titles are used, such as Non-Compete Agreement, Covenant Not to Compete, or Non-Disclosure Agreement.
2. In multinational companies, disputes can arise over agreement language; these documents are often translated into Chinese inexpensively or using machine translation. Consequently, the phrasing is often obfuscated, lacks logical relationships between subjects and objects, and judges themselves often complain that it looks alien. Judges and even litigation counsel have to re-read the terms and conditions in these documents repeatedly to get a basic idea of what they are trying to say.
In China, Micron was using employee policies that looked machine-translated, using words that native speakers would never use. When it alleged in the United States that a competitor in China had poached its talent to steal semiconductor trade secrets, it looked defamatory to the Chinese government, which issued bans and sanctions against the company for what it perceived as defamation (see news article).
Legalese-sounding machine-translated legal documents are often accepted in China because they lend the air of belonging to a prestigious multinational company operation. But they are misleading and are a huge litigation risk. Control risks by using professional translators.
3. In Mandarin Chinese, the distinction between non-disclosure and non-compete causes confusion. Although the two concepts have an overlapping role in protecting trade secrets, confidentiality and non-competition are two different legal concepts in China. Labor lawyers report claims arising from mere NDAs: sometimes from employees demanding compensation, or businesses treating them as non-competes.
The second group of disputes relates to the effectiveness of the non-compete provision. Disputes around the existence of non-compete provisions relate to unenforceability or whether the provision ever came into existence. The issues are as follows:
4. Whether the provision itself is unlawful. When drafting a non-compete, employers often fail to strictly comply with China Employment Act requirements for parties, time limits, and geographical limitations. Among multinational companies that do not localize contracts, a common mistake is using a non-compete term that exceeds the two-year statutory limit. As described in the policy section above, all of the desired provisions must be reviewed for compliance with China law.
5. Conditions governing legal effect and force are present in the non-compete clause. Examples of provisions that can cause unenforceability issues include “the non-compete obligation takes effect when employer begins paying compensation” or a condition “if Employer does not, within one month, pay financial compensation, Employee shall be released from its non-competition obligations.”
6. Disputes can arise over failure to correctly handle legal entity-related issues. A common example is where a holding company or affiliate is a party to the non-compete agreement, but a separate affiliate is the Employment Contract party, breaking the connection to the employment relationship. A second mistake is when an employee’s position is transferred to an affiliate, but a new Non-Competition Agreement is not signed.
A third group of disputes relates to whether the employee actually violated the non-competition restraint. Typically, a worker is sued for going to another company in their field but defends that the new role doesn’t violate the non-compete. The issues are as follows:
7. The activities subject to non-competition are not well defined and each party interprets the same agreement differently. Job role descriptions today are highly varied among narrow specialties and disputes can arise over where the boundaries lay. For example, an educational technology course designer responsible for elementary school tutoring courses goes to work at a different company now designing middle school courses. Judges are called on to decide whether this violates the non-compete. Control this risk by having expert linguists analyze what these words mean in China.
8. Violations of non-competition agreements are frequently concealed by independently serving clients, which leaves a much smaller paper trail. Further concealment is obtained using legal entities for the provider’s name.
Effective non-compete business policy
In this section, we will go over how to apply general China non-compete knowledge to develop an effective business policy that will lay the foundation for an effective non-compete agreement.
A good starting point is to clearly define all of the relevant parties, starting with executives. The roles of executives should be defined explicitly in the local entity’s Articles of Formation. The China Company Act §216(a) defines “executives” to include the Manager, Deputy Manager, and Treasurer; for public companies, it also includes the board of director secretary and other positions required in the Articles of Incorporation.
For a multinational company operating a local LLC, use the Articles of Formation to define executives and senior technical staff. Senior technical staff are people who have “senior” technical titles such as lead engineer or senior engineer, so ordinary technical workers cannot be subject to statutory non-compete obligations. Detailed provisions for these kinds of employees are necessary.
Separate NDAs can be signed with ordinary technical workers and technical salespersons who have contact with company secrets to bind them to non-compete obligations. Aside from company Managers and executive personnel, there is a statutory trade secret obligation in Chinese law covering “other persons with confidentiality obligations,” but the law lacks a specific definition, so relying on it is risky. Instead, sign NDAs with employees that have trade secrets access, including non-compete provisions tied to confidentiality obligations.
Ask which staff reasonably should be subject to non-compete obligations. In addition to the executives described above, consider R&D personnel, engineers, skilled technicians, sales staff, and certain administrative assistants. Identify specific staff in China and determine what kind of trade secrets they encounter.
Chinese law is not clear about what constitutes an employer’s trade secrets, therefore a trade secret protection policy needs to be in place and the organization needs to identify what exactly the secrets encompass. The results can be used by lawyers as a foundation for NDAs. A full understanding of the trade secrets landscape should be incorporated into employee agreements..
Employees can sign a separate employment contract and non-compete at a single sitting, and these agreements can also be consolidated into a single form. After having business managers design a trade secret protection policy, review the agreements from a legal perspective to ensure compliance with China’s labor laws. Do not rely on non-contract documents such as company rules, policies, or employee handbooks to create non-compete obligations.
Execute the forms correctly. After filling in the correct parties, designate a reasonable scope, geographic area, and duration. Non-compete job role scopes are best defined by supplementing the definition with a highly detailed and specific list that includes duties, knowledge areas, and job titles.
Identify industry competitors and list the names of each of those companies within the scope. For multinational companies with a China office, geographic limitations are crucial, and these should list regions in China and other countries where the non-compete obligations will be relevant. Some agreements are limited to only certain cities, but in many industries, a nationwide limitation is needed. The non-competition term cannot exceed two years under China employment law.
The maximum term is not necessarily best; instead, right-size the term to the trade secret characteristics. For example, a translation outsourcer’s primary asset is their freelancer lists showing who has passed a basic credentials check and is available for recruitment, but these lists lose their usefulness within months if not updated. Another drawback of excessively long non-compete terms is your payroll staff will continue to pay former employees financial compensation during the whole non-compete term, even if you aren’t benefiting.
Ensure management follows the termination process. Create checklists and forms for staff to fill in non-compete agreement status, terms, compensation rates, and bank account details for a termination. Audit documentation to catch errors such as forgetting to review non-compete information or providing necessary notifications to the former employee. From a legal perspective, these processes ensure staff document and collect all potentially relevant evidence, and can thus deter former employees from secretly working with a competitor. Overall, internal human resource management policy builds a strong foundation for non-compete agreements.
Drafting the non-competition agreement
The non-compete should include reasonable provisions for financial compensation, mode of payment, termination, and breach liability. Global non-compete agreement forms can be translated to Chinese to ensure consistency across jurisdictions, but ensure the process is handled competently. A good way to do that is for linguists to collaborate with local attorneys to ensure the agreement expresses the intention of the global policy, but also is appropriately adapted to Chinese law.
An employer that fails to comply with the full set of labor regulations governing non-competes will have its non-compete invalidated under Employment Contract Act §26(b), which penalizes failure to respect the lawful rights of workers. The main regulations to be mindful of are the Supreme Court Employment Dispute Rules #4. In addition to this, there are also local government rules that set specific minimums.
A China non-compete needs to have termination conditions that cover all possible scenarios with exact precision and make it easy for the employer to carry their burden of proof in court. Employers can terminate the non-compete at will, but doing so requires effective notice to the employee. The non-compete should therefore include the employee’s identifying information, including their residential address, how to contact them, and email address. Impose a duty for employees to notify the employer of any changes to contact information.
The damages provision in the Non-Competition Agreement should be closely adapted to Chinese law and social custom rather than resemble foreign agreements. As judges note, Chinese law does not recognize liquidated damages but instead uses a Chinese variant of more traditional “stipulated” damages. American-style liquidated damages clauses may be struck down as “excessive” under Chinese law, even if an American judge would accept it.
Getting damages wrong has risks. Inadequate damages will not deter the employee from taking trade secrets to a competitor. Setting the damages too high is also risky because those damages could be held “excessive,” and then the judge will come up with their own number of what damages seem reasonable. The result is often much worse for the employer than if they had stipulated appropriate damages to begin with.
Include monitoring provisions to prevent a terminated worker from circumventing the non-competition agreement. Consider a strategy appropriate to China’s highly regulated employment system: employers can periodically request social security records, typically every six months, which will reveal information about employment. Additionally, you can require any new contracts signed with new employers to be provided for your review.
If you are the new employer in this context and the new hire may possess trade secrets, you should request the employer’s termination letter and original employment contract. The former employee should make a representation and warrant that a non-competition agreement or similar provision has been signed with the previous employer. Concurrently, the employee should agree that they will not disclose trade secrets owned by their former employer or use those secrets in their work at all. If a new hire says their non-competition obligations have expired, then proof of their expiry should be provided: this includes the originals of the confirmation letter or notices sent to the terminated employee that confirm the non-compete obligations have expired.
Conclusion: avoiding common mistakes
In this article, we’ve learned that China has complex regulations around non-competes. To start with, the employer needs to review their organization to determine which members have access to sensitive information and need a non-competition agreement. The nature of the trade secrets, their expiration date, and geographic coverage should be well-understood for incorporation into the agreement. Global contract forms can be used, but make sure to use professional translators and not untrained staff or freelancers.
Avoid taking a liquidated damages approach used in foreign jurisdictions and pay special attention to ensure that any stipulated damages follow Chinese law and custom. After the non-compete bound worker is terminated, have an effective follow-up policy in place to begin paying compensation and monitoring the worker for possible violations of the non-compete.
FURTHER READING
Get authoritative insights about this topic from a official government guidance translated by CBL:
For a general overview of this topic, see also CBL’s China Employment Law FAQ.