Taiwan Restricts Enforceability of Noncompetes

Paul J. Cassingham, a senior legal consultant at Eiger, is a former chairman of AmCham Taipei and is currently chairman of its Government Relations Committee.

BY PAUL J. CASSINGHAM AND JEFFREY LIEN

Like many jurisdictions, Taiwan has long imposed restrictions on the enforceability of employee post-termination noncompetition agreements.  For many years, Taiwan courts have enforced such agreements only if the employer had a business interest worthy of protection, and only if the scope and duration of the noncompetition obligation were reasonable.

In December 2015, this policy restriction was codified and expanded in Article 9-1 of Taiwan’s Labor Standards Act, which states that a noncompete must meet the following requirements:

(1) the employer must have a proper business interest that requires protection;

(2) the employee must have been entitled to access to or have been able to use the employer’s trade secrets;

(3) the period, area, and scope of the competing activities and the prospective employers covered by the noncompetition obligation must be reasonable; and

(4) the employer must compensate the employee reasonably after termination for losses incurred as result of compliance with the noncompetition obligation.

If the duration of the noncompete exceeds two years, it must be shortened to two years. If it violates any other requirement in Article 9-1, it is null and void.

Amended Enforcement Rules

In October 2016, Taiwan’s Ministry of Labor announced an amendment to the Enforcement Rules of the Labor Standards Act (the “Rules”) which amplifies and further tightens the restrictions in Article 9-1. Under the amended Rules, a noncompete also must meet the following additional requirements:

(1)   the agreement must be in writing, must state the period, area, and scope of the noncompetition obligation and the amount of compensation the employer will pay the employee, and must be signed by the employer and employee;

(2)   the duration of the noncompetition obligation may not exceed the life cycle of the employer’s trade secret or technical information, to a maximum of two years;

(3)   the geographical area covered by the noncompete may not exceed the area where the employer conducts business;

(4)   the scope of prohibited competitive activities may not exceed the scope of the employee’s activities during the period of employment;

(5)   future employment may be prohibited only by competitors of the employer in the same line of business;

(6)   the compensation paid to the employee must be at least 50% of the employee’s average monthly salary at the time the employment terminated; and

(7)   the compensation must be sufficient to maintain the employee’s “life needs.”

The amended Rules apply to all post-termination noncompetition agreements entered into after October 7, 2016.

Areas of Uncertainty

The amended Rules clarify certain terminology in Article 9-1, but they leave other terminology undefined, and in some areas add to the existing uncertainty of Article 9-1. Areas of continuing uncertainty include:

Definition of Trade Secret: Taiwan’s Trade Secrets Act defines a trade secret as a “method, technique, process, formula, program, design, or other information that may be used in the course of production, sales, or operations” which is not generally known, which has economic value due to its secrecy, and which the employer has taken reasonable measures to keep secret. The amended Rules do not state whether Article 9-1 implicitly incorporates the definition of “trade secret” from the Trade Secrets Act.

Unlike Article 9-1, the amended Rules refer to “technical information” as well as trade secrets, hinting that at least in technical areas the term “trade secret” in Article 9-1 may be broader than that in the Trade Secrets Act. Officials of the Ministry of Labor have informally expressed the view that a trade secret for purposes of Article 9-1 includes a broader range of confidential business information than in the Trade Secrets Act. For now, however, it is not clear how Taiwan courts will apply this term.

Definition of Life Cycle: The amended Rules appear to assume that a trade secret has a determinable “life cycle,” but that often is not true. Some trade secrets, for example the formula for Coca-Cola, retain economic value indefinitely, as long as they remain secret. Other technical secrets are tied to a particular product which eventually will be rendered obsolete by future innovation, but it frequently is impossible to determine in advance when a product will become obsolete.

This “life cycle” limitation is even more difficult to apply to non-technical information, such as the terms of a licensing agreement, a list of the employer’s customers with product prices and purchasing volumes, etc. It is clear under Article 9-1 that a noncompetition obligation may not be enforced for more than two years, but under the amended Rules even two years (or less) could be found to exceed the life cycle of the relevant “trade secrets.”

Employee’s Life Needs: The amended Rules require the employer to pay compensation sufficient to support the employee’s life needs during the noncompetition period, apparently on the assumption that the employee will remain unemployed for the duration of that period. In many cases, however, that assumption will not hold true. The amended Rules prohibit employment only by a competitor of the employer in the same line of business.

Many employees with technical, financial, or sales expertise and sufficient experience to be entrusted with the employer’s trade secrets are likely to find new work with an entity that does not compete directly with the employer, giving the employee a windfall of 50% or more of the employee’s salary rather than just compensating the employee’s losses. In addition, the amended Rules do not explain how an employee’s life needs should be measured, or how the employer or employee should proceed if the agreed compensation amount turns out in retrospect to be insufficient.

Status of “Blue Pencil” Doctrine: In general, Taiwan’s Civil Code allows courts to follow the “blue pencil” doctrine. That is, if a court finds a contractual obligation too broad or too lengthy to be enforceable, the court may narrow or shorten the obligation, then enforce the narrowed or shortened obligation. Article 9-1 varies this general principle. Under Article 9-1, a noncompetition obligation longer than two years is deemed shortened to two years, but an obligation that exceeds any of the other requirements of Article 9-1 renders the obligation null and void.

The amended Rules do not state how a noncompete that exceeds the limitations in the amended Rules should be interpreted. If courts follow Article 9-1, they will find such agreements null and void. On the other hand, if they follow the general “blue pencil” doctrine in the Civil Code, they may enforce such agreements against competitive activities that would have violated a more narrowly drafted agreement.

For now, it is not clear how courts will handle noncompetes that exceed the limitations in the amended Rules, or whether in some cases they will apply the Civil Code rule even to agreements that exceed the Article 9-1 requirements.

Application to Employer’s Affiliates: Neither Article 9-1 nor the amended Rules explains how these limitations apply to an employer which is a member of a group of affiliated companies. Under Taiwan employment laws, the “employer” normally refers only to the legal entity that hires an employee, not that legal entity’s affiliates.

On the other hand, a “proper business interest” or “trade secret” may   belong to another member of the employer’s corporate group, and the area where a corporate group conducts business and the scope of the group’s competitors will often be more extensive than those of the legal entity that hired the employee.  As with the other areas of uncertainty described above, it remains to be seen how Taiwan courts will apply Article 9-1 or the amended Rules to affiliated corporate groups.

Conclusions

Article 9-1 and the amended Rules only restrict noncompetition agreements with employees subject to the Labor Standards Act. Certain very senior staff members – for example, directors, supervisors, and managerial officers – are not covered by the Labor Standards Act even if they are considered “employees” for labor pension, national health insurance, or other statutory purposes. For these senior employees, a broader noncompetition agreement will often be enforceable.

On the other hand, for employees covered by the Labor Standards Act, the scope of an enforceable noncompete has become increasingly narrow. In the future, this difference may increase employer interest in a “bright line” test to distinguish these two groups of employees.

Paul J. Cassingham is a senior legal consultant and Jeffrey Lien an associate with the Taipei-based law firm Eiger.

Leave a Reply

Your email address will not be published. Required fields are marked *