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Building a Trade Secret Barrier through a Non-Competition Agreement

Published on 11 Jan 2023 | 8 minute read
A Review of China’s Leading Battery Maker’s Suits Against Former Employees

Earlier in 2022, CATL (宁德时代), the global leading power battery manufacturer in China, sued its competitor Hive Energy Technology Co Ltd (“Hive”) (world’s 10th largest market share) for trade secret infringement. The defendants in the case also included Wuxi Tianhong Enterprise Management Consulting Co., Ltd. (“Wuxi Tianhong”) and Baoding Yixin Consulting Service Co., Ltd. (“ Baoding Yixin” ), which the court  found to be related to Hive. In July, Hive accepted and paid RMB 5 million (approx. USD 700,000) to CATL and settled the case.[1]

However, related to, and preceeding this law suit, was a series of suits brought by CATL against nine of its former employees for breach of their Confidentiality and Non-Competition Agreements (“NCA”)[2]Between 2018 and 2019, these former employees left CATL and, while still within the non-competition restriction period, joined Wuxi Tianhong or Baoding Yixin, companies which in fact were related to, and provided services to, Hive.  In  2020 and 2021, Ningde City Intermediate People’s Court of Fujian Province issued final judgements respectively supporting CATL’s claim for  granting liquidated damages of RMB1 million (approx. USD 140,000) against each employee, which was the full amount stipulated in the NCA. It is notable that these awards were identical, and did not account for the differences in seniority of positions, for example, of the chief engineer, assistant engineer, and marketing specialist, or their duration of employment. One of the employees had worked at CATL for barely 3 months.

The decision was criticized by some commentators for unreasonably applying a “one-size-fits-all” ruling that strictly upheld the literal wording of the NCA without regard to the circumstances of each employee or the relative harm to the company, and which appeared, to be inhibiting the free flow of talent.  However, with the soaring growth of new energy vehicles and the white-hot lithium-ion battery industry at its centre, the war for talent and the technical know-how it brings has become intense. While China’s trade secrets protection regime has strengthened in recent years[3], it is more suited to addressing compensation after infringement has occurred, when the damage may be irrevocable.  CATL have made full use of the law in relation to post-employment restrictions to provide further deterrent at the point of departure of employees. 

This article reviews how CATL was able to use China’s legal framework for NCA’s to apply broad restrictions and obtain hefty damages awards against its former employees. 

 

What is a Non-competition Agreement (“NCA”)?

China’s Labor Contract Law[4] Art. 23 and 24 recognize the right of an employer to prevent a departing employee from working for a competitor for up to two years. The NCA is limited to senior management or technical staff and compensation must be paid to the employee during the restriction period. 

According to a Supreme Court’s Judicial Interpretation[5], the monthly compensation paid to the departing employee should not be less than 30% of the employees average salary in the twelve months prior to the termination of the labor contract.

In case of breach of the NCA, the departing employee shall pay liquidated damages to the former employer to the amount as stipulated in the NCA, or according to the circumstances of the breach. Art.585 of the Civil Code allows the courts to increase the liquidated damages if the actual damage caused exceeds the amount provided for in the NCA, or reduce them if the NCA’s provisions are excessively high.

 

Focal disputes in the CALT vs Former Employee lawsuits

While the factual background for all the nine cases are similar, we examine one in particular, Zhang Heng vs CATL[6]. This case covers a number of interesting factors and, given that it was appealed, the key arguments were given thorough consideration.  They are as follows:

 

Was the scope of CATL’s non-competition restriction too wide?

In CATL’s NCA, competing businesses were defined broadly, including not only the “scope of business” of CATL (which must be listed on every company’s business registration) but also all actual fields of business engaged in, which means CATL could cover any business activities not formally listed in their business scope. The definition included any new fields of business added by CATL or its affiliates after signing the NCA and up to date of expiration of the NCA period. The NCA also included a list of competitor companies which was clearly stated as non-exclusive.

Zhang Heng challenged the scope of the NCA in regard to the definition of competitors.  He asserted that the NCA imposed an unfair obligation on him to investigate and know all of CATL’s business activities and all the competitors and their affiliates before accepting employment.  Zhang argued that this violated a mandatory provisions of Article 52 and 53 of the Contract Law[7] relating to unfair contract terms in standardized contracts.   

The court held that both parties voluntarily entered into the NCA under the standard terms provided by CATL.  The court noted that the NCA’s terms are based on the wording of Art. 23 and Art. 24 of the Labor Contract Law and that the allocation of rights and obligations imposed in the NCA does not  deviate from the provisions of the law. Moreover, the court noted that Zhang Heng had a high level of education and professional work experience, and should have an above-average ability to understand the contract terms, so the grounds on which he was trying to rely to declare those terms of the NCA invalid were not applicable.

Upon publication of the result of the lawsuits, some CATL employees were interviewed by media. They reiterated their arguments that CATL’s NCA was unfairly broad. For example, they revealed that CATL requires all new employees at Grade 7 or above to sign an NCA upon joining. An employee with a bachelor degree will be at Grade 5 upon joining and in 2-3 years can be promoted to Grade 7 or above, while a new joiner with a master’s degree is immediately at Grade 7 or above upon joining.  They also argued that the scope of competing companies as defined by the NCA almost covers the entire upstream and downstream value chain of new energy vehicles and their related parties. More than 100 companies are listed in the NCA, including both the obvious direct competitors, but also smaller companies rarely heard of, even by industry insiders. Their point was that such companies could hardly be defined as commercial competitors to CATL.

It is worth noting that the Labor Contract Law expressly limits NCAs to “senior management” and “senior technical” personnel. In CATL’s case, NCAs were required as standard from any employee reaching a certain pay grade, which could include fresh recruits. While this appears to be a very blanket use of NCAs, it does not appear to have been challenged by the defendants, and the court was clearly satisfied that all those covered by the NCA fell within the definition of “senior” personnel.

Regarding the scope of competitors, the Labor Contract Law defines competitors that may be covered under an NCA as those engaged in the “same type” of goods and services as the employer (Art.24), but otherwise leaves the scope of the NCA to be agreed between the parties. The court was satisfied that CATL was engaged in a range of activities in the battery value chain and thus upheld CATL’s very broad definition of competitor.

One key issue in this regard is that, after leaving CATL, during the restriction period, Zhang Heng joined Baoding Yixin, which he claimed was a consulting company. Zheng Heng argued that this was a non-competing business and therefore he did not breach the NCA. However, CATL provided evidence that the company registration addresses of Hive and Baoding Yixin were the same, and that Hive’s Baoding branch manager was the same legal representative as Baoding Yixin. As Baoding Yixin seemed to have very little independent trading history, the court agreed with CATL’s contention that Baoding Yixin was a front company created to circumvent the NCA. Although Hive was not listed on CATL’s non-exclusive list of competitors, there was no dispute that Hive was a competitor to CATL, and the obvious connection between Hive and Baoding Yixin meant that Zheng Heng had breached the NCA. 

It should also be noted that a company which hires a employee in contravention of their NCA risks being held liable for inducement to acquire trade secrets[8]. For this reason, Baoding Yixin, Hive and Wuxi Tianhong, another “consulting” company which was a front created by Hive, were all sued in the subsequent trade secrets case, resulting in a settlement to CATL.


Was CATL’s claim of liquidated damages excessively high?

Another disputed issue was the liquidated damages, which Zhang Heng argued was too high. He had only worked at CATL for less than 3 months, so his total remuneration there, on a monthly salary of RMB 20,000, was less than RMB 60,000 (approx. USD8,695). The non-compete period after employment was 12 months, and during this time his compensation for that period was only RMB 6,843 per month or RMB 82,116 (approx. USD 13,000), which is around 33% of his salary, whereas the liquidated damages sum demanded by CATL was RMB 1M (approx. USD 143,400).   Zhang Heng claimed that the liquidated damages in the NCA for its breach were excessively high, which violated the legal principle of fairness and justice, and he requested the court to reduce the amount.

He relied on the Contract Law in force at the time[9] which provides that if a litigant petitions the court to reduce the liquidated damages on the grounds that it is excessively high, the court should take into consideration a range of factors like the actual loss caused, the performance of the contract, degree of fault, balance the principals of fairness and good faith, and make a discretionary decision. Where the liquidated damages stipulated are more than 30% over the actual damages, the court may deem them excessively high.

The court supported CATL by reasoning that the legislative purpose of NCA by the Labor Contract Law is to prevent leakage of trade secrets, and that actual loss should not be the pre-requisite for liquidated damages. The liquidated damages serve a deterrent function, not compensation for actual loss, and aims to give the employer better protection of its trade secrets pre-emptively.  The court stated that CATL is a technology enterprise, and the R&D information Zhang Heng had access to during his employment as Chief Engineer represented the core competitiveness of CATL.  Zhang Heng joining a competing company could mean a severe threat to CATL’s core competitiveness. Moreover, Zhang Heng had knowingly entered into the NCA at the time of his employment, and then wilfully joined a firm he knew to be a competitor. Taking into consideration that CATL had paid the agreed compensation to him there was no abuse of the non-compete restriction.  The court upheld that RMB 1 million was reasonable and not too high and should be maintained. 

 

Is this case representative?

Of course, it should be pointed out that CATL, a world leader in lithium-ion batteries, is by far the largest and most prominent company in the small city of Ningde. To some, the resounding victory for CATL is simply a reflection of a sympathetic home court and not representative of how other courts would treat such cases .

While “home court” advantage is definitely a factor that can come into play in China’s courts, two other points are worth noting here:

Firstly, cases involving breach of NCA, as with other labor related cases, are more likely to be handled by the court in the employer’s domicile. Since most labor disputes start with the Labor and Personnel Dispute Arbitration Commission in the employer’s domicile, appeals of arbitration decisions will be to a court same jurisdiction. So employers everywhere are more likely to enjoy the home court advantage like CATL.

Secondly, there are other instances of courts awarding the exact amount of liquidated damages as stipulated in the NCA[10]. However, there are more cases where the courts have found the liquidated damages excessive and adjusted them downwards.  Employers should therefore understand that excessively high liquidated damages in NCAs are likely to be challenged. However, employers may find that there is still value in setting a high figure for liquidated damages, even if it may be reduced in a trial.

 

Conclusion

The outcomes obtained by CATL in these cases demonstrate the potential power of NCAs for IP owners to prevent leakage of valuable confidential information and trade secrets via departing employees. Given the rarity of preliminary injunctions to prevent damage from trade secret leakage before it happens, NCAs can provide an alternative form of deterrent, albeit a temporary one, aimed at departing employees themselves. IP owners should look at building NCAs into their employment terms for key personnel as part of their trade secrets management processes.

 

 

 

[1] (2021)闽09民初74号;

[2] The 9 cases are: (1) (2020)闽09民终1016号; (2) (2020)闽09民终1017号 ; (3) (2020)闽09民终1018号; (4) (2020)闽09民终1019号; (5) (2020)闽09民终1020号; (6) 2021)闽09民终1351号; (7)  2021)闽09民终1352号; (8) (2021)闽09民终1353号 ; (9) 2021)闽09民终1354号;

[3] See https://rouse.com/insights/news/2022/rouse-launches-china-trade-secret-litigation-report; and https://www.iam-media.com/report/special-reports/q4-2022/article/chinas-trade-secret-landscape-in-2022 [subscription only].

[4] 中华人民共和国劳动合同法 (2012 修正) “Labor Contract Law of the PRC” (Amended 2012)

[5] 最高人民法院关于审理劳动争议案件适用法律若干问题的解释(四)法释(2013)4号. “Interpretations of Supreme People's Court on Several Issues Relating to Laws Applicable for Trial of Labour Dispute Cases” (2013) No.4, now replaced by a new JI of the same name,  最高人民法院关于审理劳动争议案件适用法律问题的解释 (2020) 26号, “Interpretations of Supreme People's Court on Several Issues Relating to Laws Applicable for Trial of Labour Dispute Cases” (2020) No.26, see Art.36.

[6] (2020)闽09民终1016号; (2020) Min 09 Min Zhong Case No.1016

[7] In force at the time, now replaced by the Civil Code

[8] Anti-Unfair Competition Law (2019) Art.9(iv)

[9] Article 114 of the Contract law of China and Article 29 of the Interpretation of the Supreme People's Court on Issues Concerning the Application of the Contract Law of China  (2009) No. 5, both now repealed.

[10] (2015)Yong Dong Min Cu Zi No.476 and (2020) Hu 01 Min Zhong No.13539

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Principal and General Branch Office Manager at Lusheng Law Firm (Rouse's strategic partner)
+86 20 8559 8098
Principal, Rouse Consultancy
+86 21 3251 9966
Principal and General Branch Office Manager at Lusheng Law Firm (Rouse's strategic partner)
+86 20 8559 8098
Principal, Rouse Consultancy
+86 21 3251 9966