An inspirational message that is doing the rounds these days goes somewhat on the lines that a flower does not think of competing with another, it just blooms! and as motivating as this may sound, things take a different turn when we enter the more technical and less idealistic world of corporate. For a world that essentially thrives on competition, which plays a crucial in the success or failure of any company or business, the ‘non-compete clause’ consequently becomes an important part of the contracts between the employees and the employers. Thus, whether these clauses are legally enforceable is the question of the hour.
What is a Non-Compete Clause-
Generally, the non-compete clause is made out in the contractual laws wherein an employee agrees not to compete with the employer in any way after his/her employment has ended. In this type of agreement, an employee or a contracting party is prohibited from disclosing proprietary information, secrets, or sensitive information or any confidential information to any other party or if it is related to the employer’s business during or after employment. Thus, Non-Compete Clause/Agreements can be used by a business to retain valuable employees, protect its confidential information and customers, and prevent unfair competition
The employer uses this clause as a precondition in a contract of employment in order to impose certain restrictions on employees. This is done to safeguard the employer’s confidential information and protect it from all forms of leakages or secrets that can be shared by an employee, which includes information about clients, the company's future plans about products, investments, customers' databases, etc. In India, a non-compete clause is governed by the codified provisions of § 27 of the Indian Contract Act, 1872 in which it states that “Every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.”[1]
The non-compete clause prohibits the employees from competing with their previous places of employment for a fair length of time, so that they cannot compete by founding a comparable business or by working with a competitor firm.
What is the need for Non-compete Clauses-
The need for non-compete clauses arise out of the essential fact of a highly competitive world that we live in. The rationale behind this ever-increasing practice is that the success of any corporate body or any business is mostly dependent on the sensitive procedures, technical superiority, and trade secrets that the said business uses and therefore, the employers are anxious to adopt all forms of protective measures in order to shield such confidential information from any type of leakages.
Consequently, these concerns have resulted in common acceptance of the "Non-Compete Clause" in various employment agreements and other forms of agreements for restricting the employees and/or former employees from pursuing similar profession or trade with the competitor of the employer after the cessation of the employment.[2]
Thus, these non-compete clauses, as can be seen, are primarily restrictive in nature as it stops the employees from doing an action; that action per se being that of either pursuing a similar profession or sharing of trade secrets with the competitor of the employer. This allows the employee not to participate with the employer’s rival or act as a rival during or after his period of employment.
Types of non-compete clauses-
1. Pre-termination non-compete clause- where the restraint is only applicable during the subsistence of the employment of contract, for instance, if a worker entered into a contract of 10 years with the company, so during the term of the contract i.e. 10 years, the employee cannot join any other rival company of the employer.[3]
2. Post-termination non-compete clause- where the restraint clause is added in the contract that prohibits an employee from working in a rival industry or profession for a set length of time or in a defined geographic region, with the goal of protecting the employer's company after the term of employment has ended.[4]
Position of the non-compete clause in India-
In India, such a non-compete clause is governed under Section 27 of the Indian Contract Act, 1872.[5] The non-compete clause is also known as 'doctrine of restraint covenants' or negative covenants due to its restrictive nature. There are other restraint covenants, for instance- non-solicitation clause, garden leave clause, etc.[6] According to Section 27 of the Indian Contract Act, it would seem that the non-compete clauses as long as it restricts a person from carrying on a lawful profession, trade, or business of any kind would be void, but there are some exceptions to it. Further, not just this, the non-compete clause also prima facie seem to restrict a fundamental right guaranteed under the Indian Constitution that being of the freedom to carry on a trade or profession.[7]
The exceptions to these laws are as follows-
Firstly, in the Indian Partnership Act, 1932 under §36 it says that if the existing partner forms an agreement with the remaining partners that he would not carry on a comparable company for an already decided amount of time then such an arrangement is lawful, providing the limits are fair. Also, §11 of this Act[8] says that the partners shall not carry a competitive company throughout the existence of the partnership.
Secondly, in the Limited Liability Partnership Act, 2008 under §24 of the Act deals with cessation of partnership interest so that former partners may also be consulted during inspection.
The legal position in India, in accordance with the Indian Contract Act, 1872, is that the provisions of restraint imposed on employees during the course of employment (pre-termination) are reasonable and enforceable, whereas, the ones that apply to post-termination period are void. At the same time, Courts are obligated to take into consideration the terms of the contract in each individual case and assess the case based on reasonableness, nature of circumstances, and even the nature and relation of the parties in this context.
For a Non-Complete clause or agreement to be enforceable, the same should be reasonable in both duration and geographic scope. The scope is the geographic area where the employee or contractor is restricted from working from the company’s principal place of business. One of the main reasons a non-compete is found unenforceable is when the terms listed are wholly unreasonable. This would make the contract “unconscionable”, i.e., having in place too many restrictions on the employee.
For example, restricting an individual from working in direct competition with your company for five years could be considered an unreasonable length of time. Most non-competes restrict an individual’s competition to a time period of 12 to 24 months. The non-compete should also be reasonable in scope. The agreement should not be overly burdensome to the employee or contractor. This simply means that a company should not restrict an employee or contractor’s ability to find work at the end of the working relationship.
Judicial Precedents pertaining to the enforceability of non-compete clauses-
To get a better understanding when it comes to the question of enforceability of these clauses, one must also take a look at the judicial precedents. Even though, courts follow the language of the law and have consistently seen such clauses as more of an equity idea than a contract.
Now, the question comes whether the post-termination clauses would fall within the ambit of §27 of the Contract Act, this matter was decided in the case of Superintendence Company of India (P) Ltd. v. Sh. Krishan Murgai (1980) [9], the Supreme Court ruled that such a contract with a restraint clause as its goal will primarily be considered invalid. Again in the year of 1999, the Hon’ble Delhi High Court ruled in favour of employees in Foods Ltd. and Others v. Bharat Coca-Cola Holdings Pvt. Ltd.[10] and further it was stated that "It is well established that such a post-termination constraint violated §27 of the Contract Act under Indian law. Contracts of this nature are unenforceable, void, and contrary to public policy. What is illegal under the law cannot be permitted by a court order."[11]
The concept of the legality of such restraint clauses was clarified in Niranjan Shankar Golikari v. The Century Spinning and Mfg. Co.,[12] where the Supreme Court declared unequivocally stated that the approach to restrictive covenants like as non-compete and non-solicitation provisions are different in circumstances where the restriction is to apply after the contract is terminated than in circumstances where it is to operate during the contract time. Furthermore, the court added that the restrictive covenants that are judged to be in effect throughout the term of the employment contract when the employee is expected to serve his employer are rarely regarded restraints on commerce, and so do not violate §27 of the Act.[13]
A similar approach came in 2006 in the case of Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan and Anr. (2006) [14], where the Supreme Court clarified more on the position of legality of such non-compete clause by giving three important points:
(a) The non-compete clause that extends beyond the contract's duration is unlawful and unenforceable under §27 of the Contract Act and does not apply throughout the term of an employment contract,
(b) Such terms cannot be used once the period has ended,
(c) This doctrine, as stated by this Court in Gujarat Bottling v. Coca-Cola[15] is not limited to employment contracts but also applies to all other transactions.[16]
Given the findings made in the above cases, it is reasonable to assume that the Indian courts have clearly distinguished between pre-termination and post-termination periods of employment when dealing with disputes over non-compete clauses in employment contracts. Despite the fact that the courts have not been appreciative of such clauses, they have gone out of their way in some cases to ensure that they are followed.
Likewise, the Supreme Court made more liberal interpretation of §27 of the Contract Act in the matter of Niranjan Shankar Golikari case, where the court said that “unless the contract as stated is unconscionable, unreasonably serious, irrational, or one-sided, a negative covenant that the employee would not participate in a trade or business or would not get himself engaged by any other master for whom he would perform comparable or substantially identical responsibilities, is not a restriction of trade”.[17]
This explains that in order to qualify to be legally enforceable in contractual agreements, it is critical to ensure that restrictions imposed by the employers are fair and not harsh on the employees. However, non-solicitation and non-disclosure would be exception to this rule.[18] This was clarified in the judgment of Wipro Limited v. Beckman Coulter International S.A, where the Delhi High court held that “A non-solicitation clause cannot be deemed to represent a restraint of trade, business, or profession, and hence cannot be viewed as a violation of Section 27”.[19]
Similar clarification sought by the same court on non-disclosure in the matter of Mr. Diljeet Titus, Advocate v. Mr. Alfred A. Adebare and Ors.[20] A non-disclosure agreement (NDA) is also known as a confidentiality agreement, non-use agreement, or trade secret agreement.[21]
In essence, an NDA is a legally enforceable agreement between two parties that requires them to keep specific information private. In India, non-disclosure agreements can be enforced. While registration is not required under the Registration Act of 1908, it does provide legitimacy to the document and improves its enforcement.[22]
Conclusion-
In India, any trade restraint covenant is presumed to be void, and may only be enforced if it can be justified as reasonable in the circumstances, taking into account both the public interest and the parties' interests. On account of fundamental rights under Article 19(1)(g) and the narrow interpretation of Section 27, the courts in India have always been cautious of upholding restrictions given under non-compete clauses.
However, depending on whether the covenant was issued in the context of a commercial transaction or as part of an employment contract, the methodology of the courts in resolving the question of reasonableness differs significantly. Nevertheless, whether dealing with a non-compete provision in a business transaction or any employment contract, there are no set guidelines or limits to determine the extent to which such terms can be accepted, therefore each instance is unique.
To have a clear understanding, the reasonableness of these terms can be judged based on a variety of circumstances, and clauses that go beyond the limit of reasonableness are declared void. While it is a settled position of law that non-compete provisions bind employees during the term of their employment, the position of laws regarding the validity of such restraints on employees after termination of the employment contract is more contentious and adjudicated before the courts.
[1] The Indian Contract Act (1872), §27 (India). [2] Ranauk Lal, Mondaq, India: "Enforceability Of ‘Non-Compete Clause' Under An Employment Agreement" (July 26, 2017), https://www.mondaq.com/india/contract-of-employment/614370/enforceability-of-non-compete-clause39-under-an-employment-agreement [3] Anshika Vashishtha and Damini Chouhan, The ICLRAP Blog, Enforceability of Non-Compete Clause in India (January 15, 2021), http://iclrap.in/enforceability-of-non-compete-clause-in-india/ [4] Supra at 3. [5] The Indian Contract Act, 1872. [6] Akila Agrawal, Money Today, Restrictive Clauses (February 2013), https://www.businesstoday.in/moneytoday/cover-story/non-compete-provisions-in-employment-contract-validity/story/192009.html [7] Article 19 (g) of the Indian Constitution, 1950 [8] Indian Partnership Act,1932. [9] Superintendence Company of India (P) Ltd. v. Sh. Krishan Murgai (1980) (1981) S.C.C. 246 2 (India). [10] Foods Ltd. and Others v Bharat Coca-Cola Holdings Pvt. Ltd. 1999 VAD Delhi 93 (India). [11] Supra at 10. [12] Niranjan Shankar Golikari v Century Spinning Mfg Co. Ltd A.I.R. 1967 S.C. 1098 (India). [13] Supra at 12. [14] Zaheer khan v Percept Mark India ltd. A.I.R. 2006 S.C. 3426 (India). [15] M/S Gujarat Bottling Co.Ltd. & Ors vs The Coca-Cola Co. & Ors 1995 AIR 2372, 1995 SCC (5) 545. [16] Zaheer khan v Percept Mark India ltd. A.I.R. 2006 S.C. 3426. [17] Supra at 12. [18] Supra at 12. [19] Wipro Ltd v. Beckman International S.A (2006) Arb. LR 118 (Del). [20] Mr. Diljeet Titus, Advocate v Mr. Alfred A. Adebare And Ors. 130 (2006) DLT 330, 2006 (32) PTC 609 Del. [21] Supra at 3. [22] Supra at 3.
Author: Somya Kumari, Intern at S&D Legal Associates.
[Image Source: The Economist]