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Validity and Enforceability of Non-Compete Clauses in Contracts

The author, Danie Joseph, is a 2nd year BBA-LLB student at St. Joseph's College of Law.

INTRODUCTION AND BACKGROUND Contracts of employment tend to contain non-compete provisions and are regarded as standard practice by companies. A non-compete clause prohibits the employee from competing against the employer or joining a competitor company during the period of employment or even after the termination of employment. The sole object for the inclusion of such a provision is to prevent or safeguard confidential information such as trade secrets, sensitive processes from any kind of leakage and to maintain its confidentiality and ensure the competitive advantage of the company. However, whether such a clause is valid and enforceable in the Indian legal context can be proved through the provisions of the Indian Contract Act and the judicial pronouncements made by the Court regarding the matter.

SECTION 27 AND ENFORCEABILITY According to the codified provisions of Section 27 of the Indian Contract Act which lays down that “every agreement by which anyone is restrained from exercising a lawful profession or trade or business of that kind, is to that extent void”. Therefore such a Non-compete clause or also known as “restraint of trade” clause that restrains an employee to exercise a particular profession, trade or business is void as per Section 27. Observance of judicial precedents laid down by the Courts of India regarding the enforceability of Non-compete clauses is therefore necessary. The Hon’ble Supreme Court in the Superintendence Company of India v. Sh. Krishan Murgai [1] poised the question whether a restrictive covenant will fall within Section 27 of the Contract Act, it was held that since the object of the clause is to restrict trade, business it was, therefore, prima facie void. In the case of Pepsi Foods Ltd. and Others v. Bharat Coca-Cola Holdings Pvt. Ltd. & others [2], the Delhi High Court observed that a post-service restrainment clause would be in violation of Section 27 and such clauses will be unenforceable and against the public policy. However, a non-compete clause during the course of employment is held valid and does not attract the provisions of Section 27 of the Contract Act due to the apprehension of the employer of the possibility of the worker to disclose confidential information to a competitor. Therefore it is evident that the Indian Courts have refused to enforce such non-compete clauses and has established a distinction between the pre-termination period of employment and post- termination period of employment and has refused to uphold the validity of restrictive covenants such as non-compete clauses in the post-termination period of employment as it against the provisions of Section 27 and also considered to be against public policy as it deprives the fundamental right of a person to practice a profession and earn a living.

EXCEPTIONS TO RESTRICTIONS On the contrary, such restrictive covenants have been enforced by the Courts of India under certain conditions. The Hon’ble Supreme Court of India in the case of Niranjan Shankar Golikari v. The Century Spinning and Mfg. Co. Ltd. [3], laid down a liberal interpretation of Section 27 of the Contract Act where it held that "a restrictive covenant that the employee would not engage himself in a trade or business or would not get employed by any other employer where he undertakes to perform substantially similar duties is not, therefore, a restraint of trade unless the stipulations of the contract are unreasonable or exorbitantly harsh or unconscionable or one-sided". Therefore the certain restrictions of trade imposed on the employee were to be held as reasonable and not unfair or unconscionable in order for its validation. In another case before the Bombay High Court, V.F.S. global services Pvt. Ltd Vs Mr Suprit Roy [4], it was held that restraint on the use of trade secrets during or after the employment termination was held to be valid and not in violation of the provisions of Section 27 of the Contract Act and enforceable under certain circumstances. A clear inference which could be made from observing the prior cases is that the stance of the judiciary regarding matters relating to restrictive trade covenants or non-compete agreements have altered to an extent. This could be mainly due to the increased need for confidentiality relating to the various intricacies of companies operations and the changing legal and corporate circumstances. Therefore it can be stated that for the enforceability of non-compete clauses, such imposition of restraints must be reasonable in nature and thus does not render the contract void ab initio and therefore does not attract the provisions of Section 27.

REASONABLENESS AND PUBLIC POLICY To determine a valid non-compete clause, it mainly depends on the I) Reasonableness II) Whether it is consistent with the interests of public policy.

From the various judicial pronouncements, courts in India have laid down certain tests and guidelines to determine the reasonableness of the imposition of restriction of trade covenants. A clear definition of reasonableness in this context has to be construed as what a reasonable man would do using common sense and knowledge, placed in similar circumstances. Therefore what is defined as reasonable would differ on a case to case basis. An agreement containing a non- compete clause will be left to the total discretion of the courts to determine its validity and enforceability after consideration of the facts and circumstances of the case. Examples of reasonable restrictions are:

a. Distance - Certain restrictions may be imposed on employees prohibiting the practice of similar trade or profession within a stipulated distance, which should be reasonable in nature.

b. Time period/limit - A particular time period/limit may be imposed on the employee restricting to practice a similar trade or profession, however, such a period should be reasonable in nature.

c. Trade Secrets - Restriction on the disclosure of trade secrets is considered to be a reasonable restriction. d. Goodwill - Section 27 of the Contract Act provides an exception for distribution of goodwill.

An injunction is another tool used by the Judiciary to prevent a party from disclosing certain confidential information or using trade secrets with the object of earning profits.

In the case of the definition of public policy, it has various iterations and a precise definition cannot be attained. It is an illusory, varying and uncertain concept. A concept which is open to expansion and modification. Any agreement which harms or injures the interest or welfare of the public is considered to be against public policy. It includes anything which causes obstruction of justice, infringement of statutes. It is left to the discretion of the courts to determine whether agreements are against public policy.

ALTERNATIVES EMPLOYED IN THE INDUSTRY In the current scenario, Indian companies make a distinction between their employees into ‘key’ and ‘non-key’ employees. The contracts of ‘key’ employees contain non-compete restraint during the period of employment along with either a ‘garden leave’ clause or fixed-term clause. A tool used by most companies as a substitution to the non-compete clause is the ‘Garden Clause’. This clause stipulates that the employee gives advanced notice of resignation to the employer in some cases it could extend to a year and in exchange, the employee receives complete remuneration for the period he/she is restrained from competing or undertaking a similar profession or trade. This system is widely recognized in different parts of the world, especially in the United Kingdom however it has not received the legal recognition from the courts in India. In the case of VFS Global Services Private Limited v. Mr Suprit Roy [5], it was held by the Court that such a clause is prima facie is in restraint of trade and therefore attracts the provisions of Section 27 of the Contract Act. It was laid down by the Bombay High Court that “obstructing an employee who has left service from obtaining lawful employment elsewhere is not fair and proper”. Courts have held even though employees cannot be restrained from undertaking a similar profession, by setting a fixed-term contract employees can be restricted from joining a competitor during the period of employment. Another clause is the employee bond which requires the employee who has undergone training to work with a company for a certain period. If the employee fails to do so then he is liable to pay compensation.

CONCLUSION The scope and enforceability of non-compete agreements concerning India, with regards to the Indian judiciary, has not been found in the same wide and effective ambit as that observed in foreign countries. The provisions of Section 27 of the Contract Act alongside the fundamental rights endowed on citizens under Article 19(1) (g) and Article 21 under the Constitution of India has contributed to the difficulty of enforcing non-compete clauses in India. The factor of “reasonableness” is considered vital for creating equitable terms of understanding between employer and employee meeting the interests of both parties. It is important to maintain the confidential nature of the operations of the business and also ensure the right of the citizens to undertake employment and profession is not violated. Hence restrictive covenants have to be reasonable in nature in order to be validated and enforced. The recent inclination of the Judiciary to uphold non-compete provisions to an equitable and rational degree is a clear indication of improvement. Therefore changes in the legal, corporate, social, economic context in India and other parts of the globe have modified and grown and the courts have accommodated such necessary changes.

[1]1981 SCC (2) 246, 1980 SCR (3) 1278 [2] 81 (1999) DLT 122, 1999 (50) DRJ 656 [3]AIR 1967 SC 1098 [4]2008 (2) BomCR 446 [5]2008 (2) BomCR 446

Picture Credits: The Economist -

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