This article is from the WeChat public account: Lin Hua (ID: gh_4d992808ffdf), author: Lin Hua, and the header picture comes from: Visual China
1. Legislative dilemma and social backlash
Non-compete restrictions continued to dominate media headlines in China and the U.S. at about the same time. The U.S. Federal Trade Commission (FTC) announced in April that it would ban non-compete restrictions in the U.S. in an effort to protect freedom of work, increase innovation, and promote competition, with the exception of very few non-compete restrictions that are in effect and meet the criteria. The non-compete dispute between Pinduoduo and a group of junior and intermediate former employees also unexpectedly ignited emotions, and the continuous revelations and the progress of the lawsuit became a social issue that continued to rise in heat.
The focus of the Chinese public, legal scholars and the business community has gradually evolved from opposing the abuse of non-compete restrictions to questioning the rationality of the non-compete system. However, a comprehensive analysis of the reasonableness of the non-compete system will involve far more complex legal basis, industrial conditions, and social background than individual legal disputes, and it is difficult to explain the rationality of the non-compete system in the current Chinese environment by a change in overseas legislation.
It is worth adding that the non-compete restrictions that we discussed whether to be amended are actually only non-compete restrictions after the employee leaves the company, and the non-compete restrictions in the full sense include the provisions of the labor contract based on the employee's employment contract during the employee's employment, as well as the provisions of the Labor Contract Law on the employee's duty of loyalty and the prohibition of the coexistence of labor relations. At present, there is no legislation or legal doctrine that denies the validity and legitimacy of non-compete restrictions during an employee's employment. For the sake of convenience, unless otherwise specified, the non-compete restrictions discussed in this article refer to the non-compete restrictions after the employee leaves the company.
Even if we look at the FTC's changes, even though California, North Dakota and other three states have long banned non-compete restrictions separately before the federal legislation, and the FTC's substantial abolition of non-compete restrictions has high hopes for increasing employee income (which should be aimed at ensuring non-compete compensation is usually lower than employees' normal income), ensuring employment mobility, and promoting innovation and economic vitality, these should not make researchers ignore the results of the FTC's vote to lift the non-compete ban - only a narrow 3:2 victory, many influential American associations, and legal experts are clearly opposed to the new FTC bill.
The U.S. Chamber of Commerce (U.S. Chamber of Commerce), which has considerable influence in the United States, publicly criticized the FTC's legislation as overreach and arbitrary and capricious, saying that the U.S. Chamber of Commerce survey found that 80% of the companies surveyed applied restrictive covenants including non-compete agreements, and 67% of the companies surveyed believed that A complete ban on non-compete agreements will have a negative impact on a company's talent and compensation strategy. The Securities and Financial Markets Association (SIFMA), which represents Wall Street, also spoke out against the new policy, criticizing the FTC for abolishing non-compete agreements that have long been used by the business community to protect sensitive information, which is harmful to competition and the economy.
A number of law firms, such as Skadden, have also questioned whether the FTC has the statutory authority to establish a non-compete prohibition. The U.S. Chamber of Commerce has filed a lawsuit in the U.S. District Court for the Eastern District of Texas to declare the bill unconstitutional, and the assigned judge has a precedent in favor of the Chamber of Commerce to revoke government legislation, leading many media outlets to predict that the new FTC rules may not take effect as scheduled in September.
2. The core reasons for the non-compete restriction
Non-compete restrictions cannot be understood separately within the labor contract law system, but must be interpreted in conjunction with the three key words of "trade secrets", "personnel turnover" and "unavoidable disclosure".
The three concepts of trade secrets, turnover and unavoidable disclosure are independent of each other, but they are highly related to the issue of non-compete. The protection of trade secrets is the core reason for the non-compete legislation, and the turnover of personnel is the biggest risk of trade secret leakage, and the inevitable disclosure of trade secrets is the most difficult risk of trade secrets to prevent caused by the flow of personnel.
1. Trade Secret Protection
Many companies do not have their own patents or lack high-value copyrights and trademarks, but almost every company has its own important trade secrets. Trade secrets, which cover a wide range of technical solutions to business information, are indispensable and important assets for all industries and types of enterprises. In a 1996 report, the U.S. Senate also argued: "Trade secrets are as valuable to a business as a factory is to a business." The theft of trade secrets can cause even more damage than the burning of a factory by an arsonist."
Give an example of the critical role and value of trade secrets. The U.S. government forced ByteDance to sell TikTok in the name of fake legislation, and one of the core factors affecting TikTok's valuation from $20 billion to $100 billion was TikTok's algorithm. Algorithms are not only the most suitable for protection with trade secrets, but also have always been the core trade secrets of ByteDance. In fact, according to the mainstream opinions of China's Internet industry and ByteDance's own assessment, the algorithm is the core asset of TikTok, so Byte would rather completely withdraw from the US short video market than sell the algorithm.
Tip: California doesn't represent the whole world
It is often argued that California's opposition to non-compete proves that neither Silicon Valley nor the Internet is exempt from non-compete, and by analogy all companies do not need non-compete. But this conclusion ignores the fact that in 2005, in order to prevent Kai-Fu Lee from jumping to the position of global vice president of Google, which was in full swing at the time, Microsoft filed a lawsuit against Google and Kai-Fu Lee for breach of the non-compete agreement in Washington State District Court. The case won partial support from the court, and Microsoft and Google eventually settled under the table.
Steve Jobs used any threat to force Palm to stop poaching Apple employees, and the U.S. Department of Justice also forced six companies, including Apple, Google, Pixar, Intel, and Adobe, to settle with the government on the condition that they waive their enforcement and not poach each other after conducting an antitrust investigation in 2010.
If further analyzed, California's stance on non-compete restrictions is closely related to the geek culture pervasive in Silicon Valley and the ultra-high iteration frequency of the Internet industry. The cultural background and industrial characteristics of Silicon Valley are very different from those in traditional areas and even most high-tech industries. In terms of high-tech, industries such as chips, biomedicine, and new materials are highly dependent on manufacturing processes and processes, and the core of these technologies is not only far less effective than the protection of trade secrets, but also the right holder is usually far away from the evidence of infringement, and even if the evidence inversion and court evidence collection tools are exhausted, the plaintiff in civil litigation of trade secret disputes generally wins only 20%, so that the right holder often takes the criminal route full of risks for both parties at any cost.
It is difficult and costly to protect trade secrets after the fact, and it is indeed an effective way to control risks in advance by means of non-compete restrictions.
2. Control employee turnover
When Mr. Tao Xinliang was in class more than 20 years ago, he liked to compare the flow of employees and the loss of trade secrets to the associated relationship between sand and water, and the loss of trade secrets caused by employee turnover is far greater than that of commercial espionage that the media and film and television like to see, and is the biggest risk of trade secret protection. In the 2015~2023 Typical Trade Secret Case Report released by the Shanghai Intellectual Property Court in 2024 426, it pointed out that:
“...... From the perspective of the causes of the cases, disputes are mostly caused by the flow of talents. In the civil cases of trade secrets, 231 disputes, accounting for 89.53%, arose due to employees who had mastered or came into contact with the rights holder's trade secrets during their work and illegally disclosed, used or allowed others to use the trade secrets when they were employed or started a business in the same industry after leaving the company. Criminal cases involving trade secrets are all triggered by the flow of talent."
3. Unavoidable disclosure of risks
The risk of unavoidable disclosure is, firstly, a reality, and secondly, an Inevitable Disclosure Doctrine formed by American judicial practice. As a reality, the unavoidable disclosure risk refers to the scenario where the functions of the departing employee's position after changing jobs are highly consistent with the functions of the original position, and some of the trade secrets are of personal nature, or the use of trade secrets cannot be avoided in the performance of specific functions under normal circumstances.
For example, let's say an employee has mastered a confidential coffee roasting process, and this technology becomes the employee's most valuable skill. Then, as long as the employees are engaged in baking work, they will not abandon their martial arts and completely give up the use.
The most influential cases in the U.S. judicial history on the unavoidable disclosure rule are the Kodak Eastman v. Paul Film case ("Kodak") in the New York State Court and the PepsiCo v. Raymond and Quaker case ("PepsiCo") in the Federal Court for the Seventh Circuit.
The Kodak case, handed down by a New York State court, involved Kodak suing the court to prevent Harry Warren, a former employee who had mastered the core technology of film, from switching to rival Paul Film, seeking to prevent Harry Warren from joining the defendant within two years of leaving the company. The court of first instance upheld Kodak's claim that Warren had an obligation to perform the non-compete agreement and that it would inevitably use and disclose Kodak's trade secrets if he joined the defendant.
However, in 1919, the Fourth Branch of the New York State Court, which was in charge of the second instance, reversed the judgment of the first instance, prohibiting Warren from divulging Kodak's trade secrets to Paul Film on the grounds that the non-compete prohibition not only protected Kodak's trade secrets, but also restricted Warren's freedom to use his own skills and experience, but rejected Kodak's claim to enforce the non-compete restriction.
While the Kodak case is a prime example of the early development of the Inevitable Disclosure Rule, the district court's decision did not receive much support and invocation in the U.S. federal government. By contrast, the PepsiCo case decided by the Federal Seventh Circuit in 1995 had a much greater impact and citation rate on the legal profession.
PepsiCo, the plaintiff in the PepsiCo case, and Remond, a former executive, did not sign a non-compete agreement, but PepsiCo asked the federal court to prohibit Raymond from joining Quaker for six months after leaving PepsiCo on the grounds that Raymond would inevitably disclose trade secrets to competitors at the time of Raymond's defection to another food giant, Quaker.
The court of second instance upheld PepsiCo's claim in this case, which was purely concerned with the unavoidable disclosure rule. In addition to the fact that Raymond concealed from the plaintiff that he held a position that corresponded to his position in a competitor and PepsiCo, it was found that he lacked integrity and found it difficult to believe that he would perform the confidentiality agreement. The most noteworthy point is that it fully supports PepsiCo's argument that the production, packaging, profits, costs, marketing, sales, competition, strategic and tactical arrangements of the products controlled by the plaintiff in the course of the plaintiff's management constitute trade secrets as a whole, and that it is impossible for Raymond to ...... In the management of competing products for Quaker, he detached from using the trade secrets obtained by the plaintiff.
The Seventh Circuit's elaboration and application of the doctrine of unavoidable disclosure in the PepsiCo case has had a significant impact on U.S. and global justice. Judging from the unavoidable disclosure rule explained in the Pepsi-Cola case, the court has the right to exclude the departing employee from engaging in direct competition with the plaintiff on the grounds of trade secret protection if the parties have not entered into a non-compete agreement, which is far more lethal than the non-compete in this regard.
Mr. Sun Yuanzhao pointed out that there are currently 17 states in the United States that recognize the "inevitable disclosure doctrine". In fact, unless the application of the unavoidable disclosure rule is explicitly excluded under the California legislative model, the courts can determine whether the unavoidable disclosure rule applies by precedent, so there are far more state courts in the United States that actually enforce the rule.
3. How to improve the non-compete restriction
1. Resolve non-competition or abuse
The FTC has set a global precedent by halting non-compete. However, regardless of whether the FTC's new rules can withstand a large number of opposition and legality lawsuits in the United States, Japan allows courts to determine the legality of non-compete restrictions on a case-by-case basis in major jurisdictions around the world, and the United Kingdom (Restrictive Covenants), Germany (Wettbewerbsverbot) and France (Clause de Non-concurrence) have also regulated but not prohibited non-compete restrictions, and there is no sign of following up with the FTC's new policy.
While there are some issues that need to be resolved in non-compete practices, including in China, such as the ongoing controversy over Pinduoduo and the abuse of a major gaming company's requirement for all technical and project employees, regardless of rank, to enforce the non-compete after leaving the company. However, the problem that we urgently need to solve is whether the non-compete itself or the abuse of the non-compete restriction is worth seriously summarizing in light of practice.
The non-compete is similar in nature to the declassification period system often adopted by government departments and R&D institutions. The key to whether the non-compete is reasonable is whether the compensation for the non-compete employee is truly reasonable, not whether the non-compete is reasonable or feasible in the system design.
If we compare the non-compete and unavoidable disclosure rules, it is difficult for the latter to uniformly apply the standards, so that the specific discretion of the court is greatly relied on in individual cases, and the judicial outcome will almost inevitably become a thousand judgments. This will not only make the application of the law overly complicated and costly, but also change the public's belief in the law to praying for the comfort of judges.
On the contrary, if the non-compete restriction is recognized, in accordance with the principle that the trade secret right holder should actively protect it, only a valid non-compete agreement should be implemented, and the application of the unavoidable disclosure rule in the absence of an agreement can be greatly eliminated.
2. Adequate compensation is reasonable compensation
The non-compete restriction is based on the protection of the company's trade secrets, and the restriction on the scope of employment within a specific period of time after the employee leaves the company, the employee who has lost his or her employment interests should of course be compensated. Article 36 of the new version of the Supreme People's Court's Interpretation (I) on Issues Concerning the Application of Law in the Trial of Labor Dispute Cases promulgated in 2020 inherits the content of Article 6 of the repealed Interpretation (4), which stipulates that the employer shall pay severance at the rate of 30% of the employee's average salary for the 12 months prior to the termination or termination of the labor contract.
Refer to Article 9 of the Labor Standards Act of Taiwan, China: "...... Unless there is a reasonable compensation under the contract...... The reasonable compensation provided for in the preceding paragraph refers to the cash compensation paid monthly during the non-compete period stipulated in the contract, and shall not be less than 50% of the average monthly wage of the employee during that period."
Article 24 of the Regulations on the Protection of Technical Secrets of Enterprises in the Shenzhen Special Economic Zone, as amended for the second time in 2019, stipulates that "the compensation agreed in the non-compete agreement shall not be less than one-half of the average monthly salary of the employee in the last 12 months before leaving the enterprise......
Considering the current unsatisfactory employment situation and the ubiquitous age discrimination, as well as the shortening of the depreciation period of employees' experience and skills due to the acceleration of technological iteration, the negative impact of non-compete restrictions on the re-employment of departing employees has been significantly amplified. Relative to the employment loss of employees, the 30% stipulated by the Supreme People's Court, or even 50% of the Shenzhen Special Economic Zone Regulations, is hardly sufficient.
On the other hand, the low cost of non-compete compensation allows large enterprises to monopolize talent at a low cost, and cut off employment opportunities for employees in the first two years after leaving the company with 30% of their wages. As we all know, talent is the greatest resource, and it is reasonable to infer that the monopoly of talent is the most anti-competitive and obstructive form of monopoly of the market mechanism.
Anti-monopoly has always been a hot topic in various administrative legislation and academic circles, but there is little research on the monopoly of talents caused by excessively low non-compete compensation, and this kind of monopoly with obvious anti-competitive consequences is also reflected in the fault line between theory and practice to a certain extent.
It is worth mentioning that the U.S. Chamber of Commerce, in its statement against the FTC's new policy, put forward a contrary proposition - that is, it believes that small enterprises also have the desire to prevent large enterprises from siphoning talents through capital advantages through non-compete restrictions. It seems that the practical consequences of non-compete restrictions are complex enough to accommodate the contradictory phenomenon.
Another issue related to non-compete compensation is the payment method of the corporate side. Article 8 of the original Interpretation (IV) on Several Issues Concerning the Application of Law in the Trial of Labor Dispute Cases (repealed) provides: "...... After the termination or termination of the labor contract, if the employee fails to pay economic compensation for three months due to reasons attributable to the employer, and the employee requests to terminate the non-compete agreement, the people's court shall support it."
On October 22, 2019, the Beijing No. 1 Intermediate People's Court released the eighth case of the Top 10 Typical Cases of Labor Disputes Involving Non-Competition, ruling that "only if the employer fails to pay the non-compete compensation for three months can the employee have the right to unilaterally terminate the non-compete agreement".
The aforesaid provisions seem to only involve a unilateral election period of three months for the enterprise, but in fact it will put a lot of pressure on employees. In practice, it is found that this provision will put the employee in a blind spot within three months after resignation, even if he does not receive any compensation from the original employer, and cannot judge whether the non-competition is effective, and he will have no income, no job, and no effective job search. During these three months, the employee and the original employer were in a clear legal asymmetry, because the employee was in a position of strict liquidated damages and continued performance of the liability for breach of contract, and the company's risk was only to pay back plus bank interest for the same period.
Based on the above analysis, it can be considered that the system design in line with the current situation in China is to retain but strictly limit the scope of application of non-compete restrictions, increase the cost of non-compete on the part of enterprises, and protect employees from excessive economic and employment losses due to unemployment. In addition to changing the payment clause to one month for non-payment, i.e., employees should be allowed to file for the removal of the non-compete restriction, there are two feasible options for the overall reform of non-compete compensation:
- First, the non-compete compensation will be increased to at least 50%, and the non-compete period will be shortened from two years after leaving the company to one year.
- Second, the non-compete period should be retained for a maximum of two years, and the non-compete compensation should be at least 50% in the first year and at least 75% in the second year, which not only guarantees the compensation for long-term unemployment of employees but also increases the monopoly cost of enterprises.
This article is from the WeChat public account: Lin Hua (ID: gh_4d992808ffdf), author: Lin Hua
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