A non-compete clause or a covenant not to compete is a term used in
contracts under which the employee agrees to not pursue a similar
profession, trade or business in competition against the employer. Apart
from the regular employment agreements, such covenants are also at
times included in the agreements relating to sale of goodwill of
business or professional practice, employment exit and other exclusive
dealings and service arrangements.
The Indian Contract Act, 1872, which provides a framework of rules and
regulations, governing the formation and performance of a contract in
India deals with the legality of such non-compete covenants. It
stipulates that an agreement, which restrains anyone from carrying on a
lawful profession, trade or business, is void to that extent. Under
section 27 of the Indian Contract Act, 1872 agreements in restraint of
trade are void.
Agreement in restraint of trade is defined as the one in which a
party agrees with any other party to restrict his liberty in the present
or the future to carry on a specified trade or profession with other
persons not parties to the contract without the express permission of
the latter party in such a manner as he chooses. Providing for restraint
on employment in the employment contracts of the employees in the form
of confidentiality requirement or in the form of restraint on employment
with competitors has become a part of the corporate culture.
Section 27
Every agreement by which anyone is restrained from exercising a lawful
profession or trade or business of any kind, is to that extent void.
Exception: One who sells goodwill of a business with a buyer to refrain
from carrying on a similar business, within specified local limits so
long as the buyer, or any person deriving title to the goodwill from
him, carries on a like business therein provided that such limits appear
to the Court reasonable, regard being had to the nature of business.
Although the section states that all agreements in restraint of any
profession, trade or business are void, the current trend as per various
judicial pronouncements leads to the conclusion that reasonable
restraint is permitted and does not render the contract void ab initio.
Reasonableness of restraint depends upon various factors, and the
restraint in order to prevent divulgence of trade secrets or business
connections has to be reasonable in the interest of the parties to
ensure adequate protection to the covenantee. The above section implies
that to be valid an agreement in restraint of trade must be reasonable
as between the parties and consistent with the interest of the public.
Therefore two terms need to be defined:
1. What is public policy?
2. What is “reasonable”?
PUBLIC POLICY
The concept of public policy is illusive, varying and uncertain. The
term ‘Public Policy ’ is not capable of a precise definition and
whatever tends to injustice of operation, restraint of liberty, commerce
and natural or legal rights; whatever tends to the obstruction of
justice or violation of statutes and whatever is against good morals can
be said to be against public policy.
It has been held that the concept of public policy is capable of expansion and modification.[1]
The Supreme Court observed in in Gherulal Pathak v. Mahadeodas Maiya[2]
“Public policy is a vague and unsatisfactory term and calculated to lead
to uncertainty and error and when applied to decision of legal rights
it is capable of being understood in different senses. It is the
province of the judge to expound this law only. They have become a part
of recognized law, and we are therefore bound by them. There are several
decisions of the courts which lays down a general rule as to what is an
agreement opposed to public policy and what is not. These, though
provide guidelines as to defining ‘public policy’ cannot be used as a
sure shot rule”.
Agreements opposed to public policy:
There are several moral, legal, ethical constraints. Some case laws help
to understand what an agreement in restraint of public policy is.
If an agreement is such that it tends to injure public interest or public welfare it is against public policy [3]
Where there is an agreement between the parties that a certain
consideration should proceed from the accused person to the complainant
in return for the promise of the complainant to discontinue the criminal
proceedings is clearly a transaction as opposed to public policy[4]
Agreements Not Opposed to Public Policy:
A contract for manning, running, operating, repairing and maintenance on
hire for three vehicles was entered into between parties. The contracts
inter alia provided that the employer shall have the right to terminate
the contract after expiry of one year without assigning reasons. It was
held that such a stipulation was not unconscionable or opposed to
public policy[5]
Hence using these guidelines courts can deduce what is public policy as it has not been appropriately defined in any case law.
WHAT IS REASONABLE?
As defined by the dictionary reasonable means – according to reason.
Hence whatever a reasonable man would do, using commonsense and
knowledge, under the given circumstances, will account as reasonable.
Therefore the test of reasonability depends on the facts and
circumstances of each case.
Where services are performed under an agreement that the remuneration
shall be to the discretion of the employer, the question whether the
employer has the right to determine whether any remuneration at all
shall be paid, so that his decision is a condition precedent to any
claim or merely has the right to fix the amount of the remuneration, is a
question of construction and intention in each particular case.[6]
Reasonable restrictions can be placed in the following ways:
1. Distance: suitable restrictions can be placed on employee to not
practice the same profession within a stipulated distance, the
stipulation being reasonable.
2. Time limit: if there is a reasonable time provided in the clause then it will fall under reasonable restrictions.
3. Trade secrets: the employer can put reasonable restrictions on the letting out of trade secrets.
4. Goodwill: There is an exception under section 27 of the Indian Contract Act on the distribution of goodwill.
NON COMPETE CLAUSES UNENFORCEABLE IN INDIA
With the increase in cross-border trade and an enhanced competitive
climate in India, confidentiality, non-compete, and non-solicitation
agreements are becoming increasingly popular, especially in the IT and
technology sectors. An increasing number of outsourcing and IT companies
are including confidentiality, non-compete, and non-solicitation
clauses in agreements with their employees, with terms ranging from a
few months to several years after the employment relationship are
terminated. The companies claim that such restrictions are necessary to
protect their proprietary rights and their confidential information.
Indian courts have consistently refused to enforce post-termination
non-compete clauses in employment contracts, viewing them as "restraint
of trade" impermissible under Section 27 of the Indian Contract Act,
1872, and as void and against public policy because of their potential
to deprive an individual of his or her fundamental right to earn a
livelihood.
There are various case laws that will clear out the situation in India:
Supreme Court of India in Percept D' Mark (India) Pvt. Ltd v Zaheer Khan
[7] observed that under Section 27 of the Act a restrictive covenant
extending beyond the term of the contract is void and not enforceable.
The court also noted that the doctrine of "restraint of trade" is not
confined to contracts of employment only, but is also applicable to all
other contracts with respect to obligations after the contractual
relationship is terminated.
In a 2009 decision by the New Delhi High Court in Desiccant Rotors
International Pvt Ltd v Bappaditya Sarkar & Anr [8] involved a
senior marketing manager at a manufacturer of evaporative cooling
components, products and systems. As part of his employment agreement
with Desiccant, the manager agreed that for two years following the
termination of his employment, he would be bound by a covenant with
Desiccant that would require him to keep Desiccant's matters
confidential, and that would prevent him from competing with Desiccant
and soliciting Desiccant's customers, suppliers and employees. Expressly
embodied in the employment agreement was an acknowledgment by the
manager that he was dealing with confidential material of Desiccant,
including: know-how, technology trade secrets, methods and processes,
market sales, and lists of customers. After a few years of employment,
the manager resigned and-notwithstanding the terms of his old employment
agreement-within three months of his resignation joined a direct
competitor of Desiccant as country manager in charge of marketing and
started contacting customers and suppliers of Desiccant. In injunctive
proceedings against the manager by Desiccant, the High Court reiterated
the principles embodied in Section 27 of the Act and the individual's
fundamental right to earn a living by practicing any trade or profession
of his or her choice. Brushing aside any argument by Desiccant that the
restrictive covenants were primarily designed to protect its
confidential and proprietary information, the High Court ruled that in
the clash between the attempt of employers to protect themselves from
competition and the right of employees to seek employment wherever they
choose, the right of livelihood of employees must prevail. However the
High Court did allow an injunction against the manager prohibiting him
from soliciting Desiccant's customers and suppliers to stand in effect.
Similarly, in a 2007 decision in V.F.S. Global Services Ltd. v. Mr. Suprit Roy [9]
The Bombay High Court held that a fully paid three-month "garden leave"
agreement with a senior manager did not renew the employment contract
and constituted a "restraint of trade" unenforceable by V.F.S. However,
relief for breach of non-solicitation obligations was denied on the
basis of vagueness of the relief claimed.
In Superintendence Company of India vs Krishan Murgai [10]
The Supreme Court held that a contract, which had for its object a
restraint of trade, was prima facie void. The company, with its head
office at Kolkata and branch office at New Delhi, carried on business as
valuers and surveyors. It had established a reputation and goodwill in
its business by developing its own techniques for quality testing and
control and possessed trade secrets in the form of these techniques and
clientele. Mr Murgai was employed as branch manager of the New Delhi
office. One of clauses of the terms and conditions of employment placed
him under a post-service restraint that he would neither serve any other
competitive firm nor carry on business on his own in similar line for
two years at the place of his last posting; and the restriction would
come into operation after he left the company. When he was terminated
from service, the employee started a business on similar lines. When the
matter came for appeal, the Supreme Court held that under Section 27 of
the Indian Contract Act, 1872, a service covenant extended beyond the
termination of the service was void.
In Star India Pvt Ltd. V. Laxmiraj Seetharam Nayak [11],
The Bombay High Court held that an employer has right to terminate the
contract of employment on the ground of misconduct; hence, it cannot be
said that the employee had absolutely no right to resign from the
employment on account of better prospects or other personal reasons. It
was observed by the court that merely because for some time the employer
might face some inconvenience, the employee concerned cannot be forced
to come back for the pleasure of the employer or to satisfy the ego of
the higher-ups of the contemplated competition in the market.
In Sandhya Organic Chemicals P.Ltd v. United Phosphorous [12],
The Gujarat High Court held that a service covenant extended beyond the
termination of the service is void. It was held that an employee could
not be restrained for all times to come to use his knowledge and
experience which he gained during the course of employment either with
the employer or with any other employer. It was also held that the
principles laid down by the English Courts on common law and equity will
not be applicable in view of Section 27 of the Indian Contract Act.
In Lalbhai Dalpatbhai and co. v. Chittaranjan Chandulal Pandya[13],
The Division Bench of the Gujarat High Court consolidated all the
fundamental principles concerning the negative stipulation in the
contract of service during the service period and after the service
period. The Bench dealt with the problem with utmost clarity and great
vision. In fact, this should be a guiding judgment on the point. While
considering the freedom of contract and the freedom of occupation, they
laid down the fundamental principle that the freedom of contract must
yield to the freedom of occupation in public interest.” The Bench said
that it must be seen whether the enforcement of the negative stipulation
is “reasonably necessary for the protection of the legitimate interests
of the employer. If it is not going to benefit the employer in any
legitimate manner, the court would not injunct the employee from
exercising his skill, training and knowledge merely because the employee
has agreed to it.”
In M/S Gujarat Pottling Co.Ltd. & Ors vs The Coca Cola Co. & Ors on 4 August, 1995[14]
The Supreme Court exhaustively reviewed the law relating to the validity
of the contracts containing a negative covenant in commercial
agreements. In paragraph No. 14 of the agreement entered into in the
year 1993 between the parties in Gujrat Bottling Company's case provided
that the Bottler would not manufacture, bottle, sale deed or otherwise
be connected with the products, beverages of any other brands or
trademarks/trade names during the subsistence of the agreement including
the period of one year notice of termination. The 1993 agreement
between the parties in that case was construed by the Supreme Court to
be an agreement of a grant of franchiser by Coca Cola as a franchiser to
Gujarat Botting Co. (GBC) as a franchisee whereby the GBC had been
permitted to manufacture, bottle and sell beverages covered by the trade
marks in the area covered by the agreement. The Supreme Court was
required to consider whether the negative stipulation contained in
paragraph No. 14 of the 1993 agreement being in restraint of trade was
void under provisions of section 27 of the Contract Act. The Supreme
Court noted that in England in earlier times, all contracts in restraint
of relaxed and it became a rule that a partial restraint might be good
if reasonable although a general restraint was void. The distinction
between the general and partial restraint was subsequently repudiated
and the rule, in England, now is that restraints whether general of
partial may be good if they are reasonable and any restraint of freedom
of contract must be shown to be reasonable to be valid. The principle
that agreement in restraint of trade is void is a common law principle
applicable in England while it has a statutory recognition under section
27 of the Indian Contract Act, 1872. While construing the provisions of
section 27 of the Contract Act, the High Courts in India have held that
neither the test of reasonableness nor the principle that the restraint
being partial or reasonable are applicable to a case governed by
section 27 of the Contract Act, unless it falls within the exception.
The Law Commission in its 13th report has recommended that the provision
(section 27 of the Contract Act) should be suitably amended to allow
such restrictions and all contracts in restraint of trade, general or
partial as were reasonable in the interest of the parties as well as
public. No action is, however, been taken by the Parliament on the said
recommendations (See paragraph No. 23).
However the court has upheld the non compete principle where is it reasonable:
In the case The Supreme Court of India in Niranjan Shankar Golikari v.
The Century Spinning and Manufacturing Company Ltd [15]. observed that
restraints or negative covenants in the appointment or contract may be
valid if they are reasonable. A restraint upon freedom of contract must
be shown to be reasonably necessary for the purpose of freedom of trade.
The court held that a person may be restrained from carrying on his
trade by reason of an agreement voluntarily entered into by him with
that object. In such a case the general principle of freedom of trade
must be applied with due regard to the principle that public policy
requires the utmost freedom to the competent parties to enter into a
contract and that it is public policy to allow a trader to dispose of
his business and to afford to an employer an unrestricted choice of able
assistance and the opportunity to instruct them in his trade and its
secrets without fear of their becoming his competitors. Where an
agreement is challenged on the ground of its being in restraint of
trade, the onus is upon the party supporting the contract to show that
the restraint is reasonably necessary to protect his interests. Once,
this onus is discharged by him, the onus of showing that the restrain is
nevertheless injurious to the public is upon the party attacking the
contract.
Hence the non-compete covenants used in agreements can be categorized
into in term and post term covenants. In an employment contract, the
basic interests of the employer which are required to be protected
include trade secrets and business connections and other such
confidential information. In case of restraints in contracts of
employment the nature of business and employment is relevant in
assessing the reasonableness of restraints. An employee owes a duty to
the employer to not disclose to others or use to his own advantage the
trade secrets or confidential information which he had access to during
the course of employment and he could be restrained from or sued for
divulging or utilizing any such information in his new employment. But
once again, he cannot be prevented from taking up the employment. Also,
the employer cannot prevent the use of employee’s knowledge, skill or
experience even if the same is acquired during the course of employment.
Restrictive covenants are different in cases where the restriction is
to apply during the period after termination of the contract than in
those cases where it is to operate during the period of the contract.
Negative covenants operative during the period of contract of employment
when the employee is bound to serve the employer exclusively are
generally not regarded as restraint of trade and do not fall under
Section 27 of the Indian Contract Act,1872. A negative covenant, one
that the employee would not engage himself in a trade or business or
would not get employment under any other employer for whom he/she would
perform similar or substantially similar duties, is not a restraint of
trade unless the contract is unconscionable or excessively harsh or
unreasonable or one sided
CONCLUSION
It is well established by the various case laws decided in the courts of
India that ‘non compete’ clauses that extend after the termination of
employment are not enforceable in India. It is stated clearly in section
27 of the Indian Contract Act, 1872 that agreements in restraint of
trade are void. In the garb of confidentiality, an employer cannot be
allowed to perpetuate forced employment, as it is hit by Section 27.
Even though these clauses are valid in foreign countries, the laws and
judicial interpretations of other countries will hardly have any effect
on Indian courts if the statutory laws of this country are unambiguous.
Post term restrictive covenants have been held invalid through various
judicial pronouncements. An employer is not entitled to protect himself
against competition on the part of an employee after the employment has
ceased. However, a purchaser of a business is entitled to protect
himself against competition per se on the part of the vendor and it has
been upheld that a employer has no legitimate interest in preventing an
employee after he/she leaves his service from entering the service of a
competitor merely on the grounds that the employee has started working
with a competitor, unless the same leads to misuse or an unauthorized
disclosure of confidential information, which has been provided to the
employee during his course of employment
Article 21 of the Constitution of India guarantees the live to
livelihood and since it is a fundamental right it is held to be
inviolable. This makes the enforcing of non compete clauses in India
even more of a difficult task.
[1]P.Rathinam v. Union of India, AIR 1994 SC 1844 (1994) 3 SCC 394
[2]AIR 1959 SC 781: 1959 Supp(2)SCR 406
[3]RattanChand Hira Chand v. Aksar Nawaz Jung , (1991) 3 SCC 67
[4]Ouseph Poulo v. Catholic Union Bank ltd AIR 1965 SC 166: (1964) 7 SCR 745
[5]Oil and Natural Gas Corp. Ltd. V. Streamline Shipping Co., AIR 2002 Bom 420 (DB)
[6]S.Ranjan v. Indian Union AIR 1966 Mad 235: 78 Mad LW 636 (DB)
[7]AIR 2006 SC 3426
[8]I.A. No.5455/2008, I.A. No.5454/2008 & I.A. No.5453/2008 in CS(OS) No.337/2008
[9]2008(2)Bom CR 446, 2007(2) CTLJ 423 Bom
[10]1980 AIR 1717, 1980 SCR(3)1278
[11]2003(3) Bom CR 563, 2003(3)MhLj 726
[12]AIR 1997 Guj 177
[13]AIR 1966 Guj 189, (1966) GLR 493
[14]1995 AIR 2372, 1995 SCC (5) 545
[15]1967 AIR 1098, 1967 SCR (2)378
