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[Talk to My Lawyer]: "Service Time Periods" and “Non-Competition Clauses” Explained

Looking at issues that arise with two common labor contract clauses
2022-03-02 12:00:00


"Talk to My Lawyer" is an ongoing SmartShanghai column discussing legal matters in Shanghai. SmSh invites qualified lawyers from our directory to give us legal advice on a range of issues, including commercial law, property law, contract law, and keeping-us-out-of-jail law.

For foreign employees in senior management, specialized high-level, and directorial positions, two common employment clauses are routinely included in labor contracts : "Service Time Periods" and "Non-Competition Clauses".

In our work at the firm, we frequently deal with labor disputes concerning these specific two areas. So, today, I thought we'd do a deeper dive on these two provisions, explain what they mean, and how they are uniquely understood under Chinese labor law. We're going to look at what issues may arise in a labor dispute related to these two areas and explain what the law says on said issues.

Let's start with the first one.

What is a "Service Time Period" agreement?

Simply put, a "Service Time Period" refers to the period during which the employee promises to continue working for the employer after receiving specialized technical training provided at the behest of the employer.

According to the law, an employer may sign a service time period agreement with an employee, saying that after the employer provides special technical training for the employee and pays the corresponding fees, the employee shall not resign during the specified service time period — otherwise a certain amount in damages are owed to the employer from the employee.

So, the key issues here are the type of training provided and the scope of the damages, should the employee break the agreement.

What kind of training is "special technical training"?

Regular on-the-job training is NOT "special technical training". For example, if you're an HR manager and your employer trains you in how to make personnel files, how to do peer reviews, or how to use online meeting software, that's just regular training.

However, if your employer sends you to a specialized language school in order to improve your ability to manage a specific group of foreign employees, or, say, sends you to a linguistics or psychology program in order to equip you with high-level personnel communication skills, this definitely falls under "special technical training".

In our practical experience, the type of training that can be used to form the basis of a service time period agreement must be a training for a special skill or technology that is different from regular training. Specialized technical training usually requires employers to pay training costs. In many cases, specialized technical training may also require the employer to pay for the travel and living expenses of the trainee. Finally, during the training period, the employer must still pay the employee their labor remuneration as normal, even though the employee may be just studying and not working as usual for the employer.

If you're a software engineer, for example, and your company sends you off for a year to get an MBA to increase your skillset and they foot the bill, a service time period agreement can be initiated to make sure your company gets a return on their investment in you.

Broken agreements, damages, and limitations

So, the common scenario is that an employee breaks their service time period — they leave the job — and the employer is seeking damages to compensate. Usually, at the outset of the agreement, employer and employee agree on a given damages amount should this situation arise. In reality, however, and as supported by the court should it get to that, is that there are limitations on damages owed to the employer.

The amount of liquidated damages cannot exceed the total of training expenses, travel expenses, and other direct expenses actually paid by the employer for the training. Note that "actually paid" means that the employer bears responsibility of providing the court with evidence — invoices, receipts, or transfer records, to prove that those expenses were actually paid.

For example, even though the employer and the employee have agreed on a liquidated damages amount of RMB 100,000 or whatever, if they don't have receipts to show that that's what they paid for the specialized training, the court will not support the claim. Generally, a reduced amount is agreed upon.

The world runs on fapiaos, people... make sure you hang on to those.

Not all resignations will lead to liquidated damages

According to the law, if an employee resigns during the service time period because of the illegal behavior of an employer, the employee's resignation will not be deemed as a breach of the service time period agreement.

Said illegal behavior of an employer, typically, includes the situation that the employer fails to pay the labor remuneration in full and on time.

The agreed service time period can exceed the remaining labor contract term

The law allows the employer and the employee to agree on a service time period that exceeds the remaining period of the labor contract. For example, even if the labor contract between you and the employer is about to expire in one year, a two-year service time period agreement can still be concluded between you and the employer. In this case, the employer needs to extend the labor contract with you to at least the last day of the agreed service time period.

Moving on to...

What is a "Non-Competition" agreement?

Simply put, an employer and employee can undertake an agreement specifying that within a maximum of two years after the employee leaves their job, they shall not go to work for competitors of the employer, or set up their own enterprises that may compete with the employer. In order for the agreement to have validity, for this period, the employer must pay compensation to the employee.

Okay. So. Here, our central issues are which types of employee can be bound in such agreements, what is the scope of "competition", and what damages are owed if a dispute should arise.

Non-competition restrictions cannot be enacted on any employee

According to the law, non-competition clauses can only be made with an employer's senior managers, senior technical personnel, and other employees who have access to the employer's important business technologies. In other words, if an employee is not a director, a supervisor, a general manager, nor a core technical personnel of the employer, the employer generally cannot impose a competition restriction with that employee.

If you've got access to the "special sauce", they can bind you in a non-competition clause. If you're just manning the deep fryer, they cannot.

They have to pay you a minimum amount to "not compete"

The employer must pay the employee a monthly compensation after they leave the company. The amount of compensation cannot be lower than 30% of the employee's average income in the previous 12 months to their departure. That's in addition to the local monthly minimum wage announced by the local government.

What constitutes "competition" and how are the "competitors" defined?

The law allows the employer and employee to agree on a list of companies or industries that the employee cannot work for, or in, or open by themselves.

However, the scope of such a list should be realistic and the work of the court is to make this determination.

For example, let's say you're the GM of a major hotel chain and want to quit to open a catering business. A non-competition clause that states that you cannot work in F&B after leaving your job would be considered overly broad and revoked by the court.

If the employer and the employee have not clearly agreed on a specific list of restrictions at the outset of the agreement — and I really recommend that you do this — then the court will determine whether a certain company or enterprise is a competitive entity to the employer based on the individual situation.

Limit of term for a non-competition agreement

The law stipulates that a competition restriction can only be limited to a maximum of two years, which means that even if the employer compensates you, they can only ask you not to work for a competitor, or you to not become their competitor yourself for two years.

How much is owed for a broken non-competition agreement?

The law allows an employer and an employee to agree on a certain amount as a liquidated damages, so that in the future the employer can claim compensation from employee who violates the non-competition agreement. Although the law does not limit the amount of this liquidated damages, it is obvious that the excessive liquidated damages may not be supported by the court.

According to our experience, the amount of liquidated damages should usually be around the potential losses that the employees may bring to the employer due to her violation of the non-competition agreement.