By Ding Liang of King & Wood’s Corporate Group

A non-compete clause prohibits one party from competing in the same type of business as the other party for a specified period, within a specified geographical area, and is usually included in joint venture agreements, distribution agreements, OEM contracts, licensing agreements, and many other kinds of commercial agreements.

The non-compete clause is usually termed "covenant not to compete", "restrictive covenant", or "non-compete clause". A specific term may be used to restrict various behaviors by one or more parties. For instance, "non-solicitation of employees" will prevent one party from soliciting, directly or indirectly, the employees of the other party. "Non-solicitation of customers" prohibits one party from soliciting customers of the other party. A "no-shop clause" is an agreement by one party, the owner of a business, to negotiate only with one specific party, the putative purchaser, for the sale of that business, for a specified period of time. The object is to prevent the vendor from "shopping around" for another purchaser. No-shop clauses are only relevant in the context of sale of business agreements.

Such non-compete clauses are treated with suspicion by the Anti-Monopoly Enforcement Agency. Therefore, it is prudent to conduct an in-depth analysis of the non-compete clause before the conclusion of agreements.

As China is a fairly young competition regime, there are few competition precedent cases regarding the validity of non-compete clauses. Further, we note that there are no guidelines or regulations accompanying the Anti-Monopoly Law (the "AML")(1) . Thus, this article will only explore the possibility of the treatment of non-compete clauses under the AML. It will be subject to further revision after detailed guidelines are issued.

I. The AML Provisions

In general, the AML contains no specific rules on non-compete clauses and does not provide explicit guidance on the legality of non-compete clauses. However, an agreement containing a non-compete clause would fall within the scope of a monopoly agreement and so would be subject to the AML.

According to Article 13 of the AML, monopoly agreements are agreements, decisions or some concert of action that eliminates or restricts competition. If an agreement reached between two or more operators containing a non-compete clause has the object or effect of eliminating or restricting competition, then it will be considered a monopoly agreement under the AML.

Monopolistic conduct involving horizontal agreements includes: (1) fixing or changing the price of commodities; (2) limiting the outputs or sales volume of commodities; (3) segmenting the sales markets or the raw material purchasing markets; (4) limiting the purchase of new technology, new facilities or limiting the development of new technology or new products; (5) jointly boycotting transactions; or (6) other monopoly agreements as determined by the AML Enforcement Agency. Monopolistic conduct involving vertical agreements includes: (1) fixing the resale prices of commodities to third parties; (2) restricting the minimum resale prices of commodities to third parties; or (3) other monopoly agreements determined by the AML Enforcement Agency.

Moreover, several provisions in other current legislation may provide examples as to how non-compete clauses will be treated. Article 7(2) of Measures for the Administration of Fair Trading for Retailers and Suppliers (the "Measures") provides, "retailers shall not engage in the following acts that impede fair competition: …(2) restricting suppliers from supplying products or providing services to other retailers." Article 18(2) of the Measures provides, "the suppliers shall not, in the course of supply, engage in the following acts that impede fair competition: … (2) restricting retailers from selling the commodities of other suppliers."

II. Non-Compete Clauses in Horizontal Monopoly Agreements

Horizontal monopoly agreements are, in general, subject to the per se rule. Article 13 of the AML prohibits horizontal monopoly agreements segmenting sales markets or raw material purchasing markets among competing operators. Thus, a horizontal monopoly agreement containing a non-compete clause is, in general, prohibited under the AML.

However, a horizontal agreement can be exempted in certain circumstances if it meets the standards specified in Article 15 of the AML. Article 15 enumerates a number of specific exempted situations and then provides additional substantive requirements.? According to Article 15 of the AML, an exemption is available if it is proven that the agreement in question was (1) to improve technology, R&D or new product development; (2) to upgrade quality, reduce costs, enhance efficiency, or introduce standardization; (3) improve efficiency or enhance the competitive ability of small and medium operators; (4) promote the public interest; (5) mitigate sales decreases during economic downturns; (6) ensure legitimate foreign trade and economic cooperation; and (7) other circumstances stipulated by the State Council. For situations (1) to (5), the following substantive standards must also be met: (1) the monopoly agreement will not substantially restrict competition in the relevant market; and (2) consumers will share the benefits derived from the agreement. As a restriction on competition, the non-compete clause is unlikely to be exempted under Article 15.

III. Non-Compete Clause in a Vertical Monopoly Agreement

It is increasingly accepted that vertical agreements which are not related to price often have positive effects. Broadly, non-price vertical arrangements may have the effect of: (1) promoting non-price competition (such as the quality of services); and (2) optimizing a firm’s distribution processes.

However, a non-compete clause in a vertical monopoly agreement is likely to raise the following competition concerns: (1) where other suppliers in the relevant market cannot sell to the distributor directly, this may lead to a foreclosure of the market; (2) market shares may become more rigid and this may facilitate collusion when similar conduct is engaged in by several suppliers; and (3) inter and intra brand competition may be limited.

Typically, vertical arrangements will only give rise to competition concerns where the supplier is dominant or has substantial market power and where the supplier or distributor possesses market power in the relevant market and places restrictions (such as exclusive distribution) which materially lessens competition between suppliers/distributors.

For instance, the Measures for the Administration of Fair Trading for Retailers and Suppliers are only applicable to retailers whose annual sales volume is at least RMB10 million (2) and suppliers of such retailers. Thus, retailers that do not meet this threshold will be exempted from the Measures.

Therefore, if the parties to a vertical monopoly agreement with a non-compete clause do not possess a dominant market position, it generally will not raise competition concerns.

IV. Non-Compete Clause in an Acquisition Agreement

During negotiations for an acquisition of a Chinese business (the "target company"), foreign buyers may insist that sellers enter into a non-compete covenant with the buyer and the target company for a specified period. The aim of such non-compete clauses is to protect and preserve the value of the target company and to obtain certainty that the seller does not re-enter the market soon after the acquisition has been completed.

According to the AML, operators must notify the Anti-Monopoly Law Enforcement Agency in advance where the concentration of operators reaches the threshold for notification prescribed by the State Council. Until they have done so, they may not proceed with the proposed acquisition.

The non-compete clause contained in an acquisition agreement may be allowed by the Anti-Monopoly Law Enforcement Agency, after its anti-competitive effects is weighted against any pro-competitive effects of concentration. According to Article 28 of the AML, "if the operators concerned can prove either that the favorable impact of the concentration on competition obviously exceeds the adverse impact, or that the concentration is in harmony with the public interests, the Anti-monopoly Law Enforcement Agency under the State Council may decide not to prohibit the concentration."

Once the notification is approved by the Anti-Monopoly Law Enforcement Agency, the proposed acquisition can proceed. However, in certain cases, the Anti-Monopoly Law Enforcement Agency may decide to impose restrictive conditions, such as removal of the non-compete clause, in order to reduce the adverse impact of such acquisition on competition.

V. Conclusion

In conclusion, it is apparent that non-compete clauses protect the interests of parties in different types of agreement. Since these clauses involve the balancing of interests between promoting competition and protecting the interests of suppliers, retailers and investors, their interpretation and application can be quite complex.

The article was originally written in English, the Chinese version is a translation. This article was first published in the firm’s periodical China Bulletin April Issue, 2008, Vol.32)

Notes:

(1) The AML will come into effect on August 1, 2008.

(2) See Article 3 of the Measures for Administration of Fair Trading for Retailers and Suppliers, which provides, "A retailer herein refers to an enterprise and its establishments that have handled the registration with the administrative authorities for industry and commerce and with direct sales of their products to consumers and with annual sale turnover (for an enterprise engaged in chain operations, the sale turnover includes the sale turnover of its chain stores) no less than RMB10 million."