Kevin Jun Lin, Corporate Lawyer

I. Case Introduction: The Tragedy Triggered by a Partner’s “Defection”

In 2022, three partners of a certain AI startup, “ZY Tech”—Jia (CEO), Yi (CTO), and Bing (CMO)—founded the company, holding 40%, 30%, and 30% of the equity, respectively.

Two years after the company was founded, CMO Bing, due to a divergence in management philosophy with CEO Jia, submitted his resignation. Just one month after leaving, Zhao registered a competitor company, “XZ Tech,” with highly overlapping business, and took away the original company’s customer lists, marketing strategies, and core channel resources.

After discovering this, ZY Tech promptly filed labor arbitration and litigation, demanding that Bing: (1) perform his non-compete obligations and cease operating the competing business; (2) pay RMB 1 million in liquidated damages; and (3) return the company’s trade secrets he had taken.

However, the arbitration commission and the court held that: the company and Bing had not signed a formal non-compete agreement; the only reference was a statement in a shareholders’ resolution that “partners should preserve trade secrets,” which does not constitute a non-compete obligation in the legal sense. In the end, ZY Tech could only rely on the Anti-Unfair Competition Law to claim that Bing had infringed trade secrets, but, due to insufficient evidence, failed to obtain full compensation.

This “defection” caused ZY Tech’s market share to shrink dramatically, its financing plan to stall, and ultimately forced it to accept a low-price acquisition.

This case reveals a key question: when a partner starts a rival business, can the company “restrain” him? The answer depends on whether you have put in place lawful and valid non-compete and confidentiality provisions in advance.

II. Interpretation of Legal Provisions: The Legal Boundaries of Non-Compete

(1) Articles 23–24 of the Labor Contract Law: The Basic Framework of Non-Compete

Article 23 of the Labor Contract Law of the People’s Republic of China

An employer and a worker may agree in a labor contract that the worker shall keep confidential the employer’s trade secrets and confidential matters related to intellectual property.

For a worker subject to confidentiality obligations, the employer may stipulate a non-compete clause with the worker in the labor contract or a confidentiality agreement, and agree to pay the worker economic compensation on a monthly basis during the non-compete period after the labor contract is terminated or ends.

Where a worker violates the non-compete agreement, he shall pay liquidated damages to the employer as agreed.

Article 24 of the Labor Contract Law of the People’s Republic of China

Non-compete personnel are limited to the employer’s senior management, senior technical personnel, and other personnel subject to confidentiality obligations.

The scope, geographic area, and duration of the non-compete shall be agreed upon by the employer and the worker, and such agreement shall not violate the provisions of laws and regulations.

After the termination or ending of the labor contract, the non-compete period during which the personnel referred to in the preceding paragraph may not join another employer that produces or deals in products of the same type or engages in the same business as the unit, or may not open their own business to produce or deal in such products or engage in such business, shall not exceed two years.

(2) The Core Elements of Non-Compete

Under the Labor Contract Law, a lawful non-compete clause must contain the following elements:

1. Applicable personnel are limited to senior management, senior technical personnel, and other personnel subject to confidentiality obligations. Ordinary employees need not sign a non-compete agreement (even if signed, it may be deemed invalid due to lack of qualifying capacity).
2. Compensation During the non-compete period, the company must pay economic compensation on a monthly basis. If no compensation is agreed or actually paid, the non-compete clause is not binding on the worker.
3. Duration limit shall not exceed two years at most. Any portion exceeding two years is invalid.
4. Liquidated damages Where a worker violates his non-compete obligation, he shall pay liquidated damages as agreed. The amount should be reasonable (usually 2–3 times the total compensation); if excessively high, the court may reduce it.
   

⚠️ Important Note:

The non-compete clause under the Labor Contract Law applies to employment relationships (employer and employee). For partner relationships (shareholders and the company), the Labor Contract Law cannot be directly applied; instead, the non-compete obligation should be agreed upon through a confidentiality agreement or shareholders’ agreement under the contract book of the Civil Code.

(3) The Anti-Unfair Competition Law: The Umbrella for Trade Secrets

Article 9 of the Anti-Unfair Competition Law of the People’s Republic of China

Business operators shall not commit any of the following acts of infringing trade secrets:

(1) obtaining the trade secrets of the right holder by theft, bribery, fraud, coercion, electronic intrusion, or other illicit means;

(2) disclosing, using, or allowing others to use the trade secrets of the right holder obtained by the means mentioned in the preceding item;

(3) disclosing, using, or allowing others to use the trade secrets in its possession in violation of the confidentiality obligation or the right holder’s requirements for preserving trade secrets;

(4) instigating, inducing, or assisting others to violate the confidentiality obligation or the right holder’s requirements for preserving trade secrets, so as to obtain, disclose, use, or allow others to use the right holder’s trade secrets.

Where natural persons, legal persons, or unincorporated organizations other than business operators commit the illegal acts listed in the preceding paragraph, such acts shall be deemed an infringement of trade secrets.

Elements of trade secrets:

1. Secrecy not known to the public;
2. Commercial value possessing commercial value;
3. Confidentiality measures the right holder has taken corresponding confidentiality measures.
   

If the customer lists, marketing strategies, technical formulas, etc. taken by the partner meet the above elements, the company may file a lawsuit under the Anti-Unfair Competition Law, demanding that he cease the infringement and compensate for losses (the amount of compensation may be determined by reference to the actual losses suffered by the right holder due to the infringement or the benefits obtained by the infringer from the infringement).

III. Practical Points: How to Design Effective Non-Compete and Confidentiality Clauses?

Point 1: Distinguish “employment relationship” from “shareholder relationship” and sign separate agreements

Founders usually have the dual identity of “shareholder” and “employee.” Therefore, they should sign separately:

• Labor contract + non-compete agreement restricts his non-compete obligations as an employee (governed by the Labor Contract Law);
• Shareholders’ agreement + confidentiality agreement restricts his confidentiality and non-compete obligations as a shareholder (governed by the Civil Code).

Dual protection avoids the risk that a single agreement is insufficient in effect.

Point 2: Clarify the scope and geographic area of the non-compete

The non-compete clause should be specific and clear, avoiding vague language. It is advisable to include:

• Definition of competing business enumerate specific product types, service fields, and technology directions;
• Scope of competitors may enumerate a specific list of competitors, or stipulate “enterprises whose business overlaps with the company by more than X%”;
• Geographic scope such as “within the territory of the People’s Republic of China” or “the Yangtze River Delta region” (which should match the company’s actual areas of operation; an overly broad scope may be deemed invalid).
  

Point 3: Reasonably stipulate the compensation standard

For non-compete under an employment relationship, the compensation standard may be agreed by both parties. If not agreed, according to Article 36 of the Interpretation (I) of the Supreme People’s Court on Several Issues Concerning the Application of Law in the Trial of Labor Dispute Cases, it shall be paid monthly at 30% of the worker’s average monthly wage for the twelve months prior to the termination or ending of the labor contract (if lower than the local minimum wage standard, the minimum wage standard shall apply).

It is recommended to agree on a clear compensation standard in advance (e.g., “pay 50% of the average monthly wage for the 12 months prior to departure each month”) to avoid disputes.

Point 4: Set reasonable liquidated damages

The liquidated damages should be commensurate with the total compensation (usually 2–3 times the total compensation). If set excessively high (e.g., RMB 10 million), the worker may request the court to reduce it; if set too low (e.g., RMB 10,000), it will not serve as a deterrent.

It is recommended to stipulate in the shareholders’ agreement that, upon violation of the non-compete obligation, the party shall return the distributed profits and resell the equity at the ratio of unvested equity, and pay liquidated damages.

Point 5: The independence of the confidentiality obligation

The confidentiality obligation does not terminate upon the termination of the labor contract or shareholder relationship, but remains in force (until the trade secret is made public). Therefore, the confidentiality agreement should expressly provide:

• Confidentiality period: until the date the trade secret is made public;
• Scope of confidentiality: including technical information, business information, customer information, financial information, etc.;
• Confidentiality measures: e.g., no unauthorized copying, transmission, or disclosure of confidential information;
• Liability for breach: including compensation for losses, payment of liquidated damages, return of benefits obtained from the use of confidential information, etc.
  

IV. Common Scenarios of a Partner “Starting a Rival Business” and Response Strategies

(1) Scenario 1: A Partner Operates a Competing Business Directly After Leaving

Response strategy:

1. Immediately send a warning letter demanding that he cease operating the competing business within X days of receiving the letter, or legal liability will be pursued;
2. Apply for an injunction (preliminary injunction) during litigation, applying to the court to order him to cease the infringing act;
3. File a breach-of-contract action based on the shareholders’ agreement or confidentiality agreement, demanding that he bear liability for breach;
4. File an infringement action if he has infringed trade secrets, demanding under the Anti-Unfair Competition Law that he cease the infringement and compensate for losses.
   

(2) Scenario 2: A Partner Joins a Competitor Company After Leaving

Response strategy:

1. Verify the non-compete agreement to confirm whether he falls within the scope of non-compete personnel and whether the non-compete period has expired;
2. Send a letter to the competitor company informing it that the partner is subject to a non-compete obligation and demanding that it not employ the partner, or it will bear joint and several liability;
3. File labor arbitration/litigation demanding that the partner perform the non-compete obligation and pay liquidated damages.
   

(3) Scenario 3: A Partner Discloses the Company’s Trade Secrets

Response strategy:

1. Preserve evidence immediately by notarization, screenshots, audio and video recording, etc. to fix the evidence;
2. Send a letter demanding cessation of infringement requiring that he delete and destroy all confidential information within X days of receiving the letter and provide a written commitment not to disclose it again;
3. File a trade-secret infringement action demanding under the Anti-Unfair Competition Law that he cease the infringement and compensate for losses;
4. Investigate criminal liability if the disclosure of trade secrets causes significant losses, a report may be filed with the public security authority to pursue his criminal liability for the crime of infringing trade secrets.
   

V. Risk Warning: Common Loopholes in Non-Compete Clauses

Risk 1: No compensation agreed or compensation too low

Under the Labor Contract Law, the company must pay compensation during the non-compete period. If no compensation is agreed but the worker has performed the non-compete obligation, the company must still pay compensation (paid monthly at 30% of the worker’s average monthly wage for the twelve months prior to the termination or ending of the labor contract).

Recommendation: expressly stipulate the compensation standard in the non-compete agreement and pay it in full and on time.

Risk 2: The non-compete period exceeds two years

The Labor Contract Law explicitly provides that the non-compete period shall not exceed two years. If a period exceeding two years is agreed, the excess portion is invalid.

Recommendation: strictly comply with the two-year limit and do not attempt to extend it by agreement.

Risk 3: The scope of “competitors” is not defined

If the non-compete clause only generally provides “shall not engage in competing business” without specifying a concrete list of competitors or business scope, the clause may become unenforceable.

Recommendation: in the agreement, enumerate in detail the list of competitors and the specific types of competing business, and stipulate “other enterprises whose business overlaps with the company by more than X%.”

Risk 4: Confidential information is not marked, making it impossible to prove “secrecy”

If the company has not marked confidential information (e.g., affixing a “confidential” stamp or setting access permissions), it may be difficult to prove in a dispute that such information constitutes a “trade secret.”

Recommendation: establish a confidential information management system, mark all confidential documents, and set access permissions.

Risk 5: Only non-compete is agreed, but no confidentiality obligation is stipulated

The non-compete obligation is effective only for a specified period (at most two years), whereas the confidentiality obligation is unlimited in duration. If only non-compete is agreed but no confidentiality obligation is stipulated, after the two-year period expires, the partner may freely use the original company’s trade secrets.

Recommendation: sign both a non-compete agreement and a confidentiality agreement to ensure dual protection.

VI. Action Recommendations: Three Steps to Prevent a Partner from “Starting a Rival Business”

Step 1: Immediately review existing agreements and fill gaps

If you have already established a company but have not signed a non-compete or confidentiality agreement with the partners, it is not too late to remedy it now. You may promptly negotiate with the partners and sign a supplementary agreement.

Note that if the partner has already submitted his resignation or shown signs of “defection,” he may refuse to sign an agreement at that point. Therefore, the earlier you sign, the more initiative you have.

Step 2: Establish a confidential information management system

Merely signing a confidentiality agreement is not enough; an internal management system must also be established to ensure confidential information is not leaked. Recommendations:

• Mark all confidential documents (e.g., affix a “confidential” stamp);
• Set access permissions, allowing only necessary personnel to access confidential information;
• Sign a confidentiality undertaking with employees and partners;
• Regularly inspect the implementation of confidentiality measures.
  

Step 3: Upon discovering signs of “defection,” take legal action immediately

If signs of a partner “starting a rival business” are found (such as privately contacting competitors, transferring customer resources, or copying confidential documents), the following measures should be taken immediately:

• Preserve evidence by notarization, screenshots, etc. to fix the evidence;
• Send a warning letter demanding that he cease the infringing act and informing him that legal liability will be pursued;
• Consult a lawyer to assess the sufficiency of the evidence and formulate litigation or negotiation strategies;
• Apply for an injunction if the situation is urgent, the court may be asked to issue a preliminary injunction to prevent the expansion of losses.
  

Special reminder:

In cases of a partner “starting a rival business,” time is the lifeline. Once a competitor launches a similar product first or customer resources are transferred, the losses will be hard to recover. Therefore, act immediately upon discovering signs, and do not delay.

VII. Conclusion

A partner “starting a rival business” is one of the most painful wounds for a startup. It is not only a loss of commercial interests but also a devastating blow to team trust.

However, the law provides the company with weapons to prevent and counter “defection”: non-compete agreements, confidentiality agreements, and the Anti-Unfair Competition Law. The key is whether you have used these weapons in advance.

For entrepreneurs, “trust” cannot replace an “agreement.” When the partner relationship is harmonious, signing non-compete and confidentiality agreements in advance is not a sign of “distrust” but rather long-term protection of both parties’ interests.

If you are facing a crisis of a partner “starting a rival business,” or need to review and improve your existing non-compete and confidentiality clauses, please contact the legal team of Lawyer Kevin Jun Lin. We will tailor a legal risk prevention plan to your actual situation.

Lawyer Kevin Jun Lin . Company Law Treasure · Focused on corporate legal practice

Disclaimer

This article is for general reference only and does not constitute legal opinion or advice. For specific legal issues, please consult a professional lawyer. The cases in this article are adapted from real events, and the company names and details involved have been anonymized.

Lawyer Kevin Jun Lin

Senior Corporate Lawyer · Industry Legal Practice Expert

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About the Zhenpin Lawyer Team

Lawyer Kevin Jun Lin — Today’s Author

Currently a doctoral candidate in civil and commercial law at China University of Political Science and Law. Combining depth in company law theory with extensive practical experience, he specializes in company law, shareholder disputes, corporate compliance system building, data compliance, and product quality disputes.

Lawyer Yan Ge: founding partner of the firm, with decades of frontline legal experience and hands-on practice in the courts, supervision, judiciary, and enterprise dimensions.

Lawyer Lin Bing: 27 years in practice, with a dual background in law and finance, having handled more than 2,000 litigation and non-litigation matters.

Further Reading

• When a Founder Suddenly Dies, Who Gets the Equity? Without This Clause in the Charter, Everything Changes
• Profit Distribution: How to Divide Profits? No Agreement Means Disaster
• Equity Vesting: What Happens to Equity When a Founder Leaves Early?
• Redemption Rights: What Must Founders Repay When Investors Withdraw?
• Valuation Adjustment Mechanisms (VAM): The Hidden Knife When Investors Hand You Money
• Drag-Along and Tag-Along Rights: What Can Minority Shareholders Do When Majority Shareholders Want to Sell?

If you need professional support in shareholders’ agreements, investment term sheet review, or shareholder disputes, please contact Lawyer Kevin Jun Lin (Shenzhen Corporate Lawyer) for one-on-one consultation.