India: "Enforceability Of ‘Non-Compete Clause' Under An Employment Agreement"

Last Updated: 26 July 2017
Article by Raunak Singh

In this era of globalization, where the success of any body corporate largely depends upon sensitive processes, technological supremacy, and trade secrets, the employers are keen to take all forms of protective measures for safeguarding such confidential information from any kind of leakage. 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 employment. Though the last few decades witnessed an overwhelming acceptance of the concept of "Non-Compete Clause" by employers, the origin of the concept can be traced back to the mid nineteenth century.
The employers use such contractual provisions as a tool (more often as a condition precedent for employment) in order to impose any one or more of the following restrictions on the employees:

  • Restriction on starting a competing business;
  • Restriction on working with enterprises operating in the relevant market;
  • Restriction on working in the relevant geographic market;
  • Restriction on soliciting the clients of the employer;
  • Restriction and in majority of cases, a complete prohibition on disclosure the trade secrets or confidential information;

Besides the said restrictions, such provisions may also specify the time period for which these restrictions may be applicable after the termination of the employment contract.

ENFORCEABILITY

In India such a clause is governed by the codified provisions of section 27 of the Indian Contract Act, 1872 ("Contract Act"), whereby every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void. The Indian courts have more or less adhered to the letter of the law and have given a consistent view treating such clauses more as a concept of equity than a contract.

It would be pertinent to look into the judicial precedent laid down by the Indian Courts with regard to the enforceability of such non-compete provisions. The Supreme Court of India, while dealing with such a contractual issue in Superintendence Company of India (P) Ltd. v. Sh. Krishan Murgai, raised the question that whether a post-service restrictive covenant would fall within the mischief of section 27 of the Contract Act. The court held that a contract, which had for its object a restraint of trade, was prima facie void. Even the Delhi High Court in Foods Ltd. and Others v. Bharat Coca-cola Holdings Pvt. Ltd. & others observed,

"It is well settled that such post termination restraint, under Indian Law, is in violation of Section 27 of the Contract Act. Such contracts are unenforceable, void and against the public policy. What is prohibited by law cannot be permitted by Court's injunction."

The judgment of the Supreme Court in Percept D'Mark (India) Pvt. Ltd. v. Zaheer Khan and Anr. sheds some light on the legality of such clauses. The Apex Court observed,

"Under Section 27 of the Contract Act (a) a restrictive covenant extending beyond the term of the contract is void and not enforceable. (b) The doctrine of restraint of trade does not apply during the continuance of the contract for employment and it applied only when the contract comes to an end. (c) As held by this Court in Gujarat Bottling v. Coca Cola (supra), this doctrine is not confined only to contracts of employment, but is also applicable to all other contracts."

In view of the aforesaid observations, it can be inferred that while dealing with disputes relating to such non-compete clause under an employment agreement, the Indian courts have considered the pre-termination period of the employment distinct from the post termination period of the employment. Whilst the courts have been tolerant about the application of the non-compete clause, they have walked an extra mile to ensure that such clause do not have an effect after the cessation of employment and have held that such clause would fall within the mischief of section 27 of the Contract Act.

However, the Supreme Court in Niranjan Shankar Golikari v. The Century Spinning and Mfg. Co. Ltd., thereby giving a liberal interpretation to section 27 of the Contract Act further clarified that not all non-compete clause effective after the termination of the employment agreement are prima facie prohibited and held,

"a negative covenant that the employee would not engage himself in a trade or business or would not get himself employed by any other master for whom he would perform similar or substantially similar duties is not therefore a restraint of trade unless the contract as aforesaid is unconscionable or excessively harsh or unreasonable or one-sided".

Therefore, in order to qualify for being enforceable by law, it is important to ensure that restriction imposed by the employer is reasonable and not harsh on the employees. It may not be out of place to specify that the restrictions to the extent of "non-solicitation" and/or "non-disclosure" may be viewed as an exception to this rule. Though the non-solicitation clause may be prima facie viewed as negative in nature, they are valid and enforceable by law. The Delhi High Court in Wipro Limited v. Beckman Coulter International S.A. held that a non-solicitation clause does not amount to a restraint of trade, business or profession and would not be hit by Section 27 of the Contract Act as being void. Similarly, in Mr. Diljeet Titus, Advocate v. Mr. Alfred A. Adebare and Ors., the Delhi High Court clarified that confidential information of the employer can be protected even in the post-employment period.

GARDEN LEAVE CLAUSE

Under a "Garden Leave" clause an employee requires to give a long term notice to the employer in advance of his resignation from employment and the employer in exchange pays him full remuneration during this period when he is restrained from competing. As per this clause, notice required for the employee to terminate his employment could be lengthened to one year with the company having the ability to require him to not attend work for any duration post serving of the aforesaid notice. Hence, the company could, after three months, in effect put him on a garden leave. Though this concept is a common tool used by the employers as a substitution to the non-compete clause in other parts of the world, especially United Kingdom, it still lacks legal backing from the Indian courts. Recently, the Bombay High Court in VFS Global Services Private Limited v. Mr. Suprit Roy laid down that "to obstruct an employee who has left service from obtaining gainful employment elsewhere is not fair or proper". Further the Court also pointed out that the clause is prima facie in restraint of trade and is hit by section 27 of the Contract Act.

CONCLUSION

In India the traditional approach to any covenant in restraint of trade is that it is prima facie void, and may be enforced only if it can be justified as reasonable in the circumstances, by reference both to the public interest and interest of the parties. There are, however, some important differences in the approach of the courts in deciding the question of such reasonableness depending upon whether the covenant has been given in the context of commercial transaction or as a part of an employment contract. However, whether dealing with a non-compete clause in a commercial transaction or any employment contract, there are no defined rules or fixed parameters to decide that what may be the extent of acceptance of such clauses and therefore each case turns on its own facts.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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