India: Restrictive Covenants Of Employment & Contract Act

Last Updated: 3 January 2019
Article by AMLEGALS  

INTRODUCTION

In human resource, a restrictive covenant is a clause which limits an employee from seeking placement till a certain time limit after leaving the business/organisation. Some noteworthy restrictive covenants are contracts pertaining to confidentiality, non-disclosure and non-solicitation matters.

Such covenants are usually incorporated and subsequently enforced so that employees can be prevented from disclosing confidential and other important information to which employees are made privy-to during the course of their employment.

These are often considered contentious issues because such provisions seemingly clash with Section 27 of the Indian Contract Act, 1872 (ICA) which provides that:

'Every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.'

Since, the legal framework addressing such conflicts is still at a nascent stage in India, judicial precedents and common law doctrines have played a major role to develop a jurisprudence that balances the conflicting issues and rights, inherent under restrictive covenants and scheme of Section 27 of the ICA.

However, time and again there emerge conflicting interpretations, thus a detailed re-look at developments and validity of restrictive covenants in the light of Section 27 of the ICA is wholly warranted.

disputes between employer & employee

Section 27 Indian Contract Act and Restrictive covenants predominantly finds confluence in issues regarding payment terms, termination of service, breach of confidentiality, non-compete or non-solicitation clauses that gives rise to disputes between an employer and an employee.

For a better grasp, these disputes further can be categorized on the basis of the stage at which they rear-up.

  1. Before Hiring Disputes

Disputes that arise before hiring are actually a subset of Post-Termination disputes. It may happen that a new employer might get involved in a dispute where a new hirer is involved in an issue pertaining to breach of post-termination obligations.

To reduce risk in this regards, employers usually ask for an undertaking from the new employee that the employee has not and will not breach any obligations towards his previous employer, as a result of joining the employment under the new employer.

  1. During Employment Disputes

Although during employment, many disputes can arise between an employer and an employee, however, with respect to restrictive covenants, there are generally governed by two kinds of covenants that subsist during the term of employment.

These are:

  • Non-compete Restriction

In the event of breach of a non-compete restriction, an employee can be prohibited from indulging in any kind of business or activity which is similar to the company's business that is detrimental to the company's business interests.

  • Non-disclosure of Confidential Information Restriction

A non-disclosure restriction on the other hand dictates an employee to not disclose or misuse confidential information or trade secret that the employee is privy to during the course of his employment.

  1. After Employment Cessation/Termination Disputes

The current trend is inclusion of certain covenants to restrain employees from joining competitors after the cessation of employment and such covenants can lead to disputes in the post termination period.

However, a breach of 'after-employment cessation' clauses often requires a detailed legal scrutiny.

In Indian judiciary's perspective, the protection of 'rights of an employee seeking employment' ranks above protection of 'interests of the employer from competition.'

The reasoning being post termination restraints are prevents an employee from using the skills and knowledge gained, to advance further in the industry.

Thus, to be valid, restrictive covenants are tested on the standards of reasonability with due considerations to duration and geographical operating area of the restricting clause.

RESTRICTIVE COVENANTS vis-à-vis S. 27 OF CONTRACT ACT

Restrictive covenants, by the virtue of their very nature, are complicated issues. Such clauses clash with provisions of Section 27 of the ICA. Further, at the outset they are also an antithesis to the rights provided under Article 19 (1) (g) of the Constitution of India i.e. the 'right to practice any profession, trade or business as subject to certain restrictions'.

Now, while the Constitution itself does provide for restrictions to Art 19 (1) (g), but those are not strictly very apt to Employer-Employee relations.

While Section 27 doesn't offer details specifying what kinds of restraints are allowed under the scheme of the ICA, it does provide an exception clause as follows:

Exception:

Saving of agreement not to carry on business of which goodwill is sold.-One who sells the goodwill of a business may agree with the 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 the business.

Thus, on one hand Restrictive Covenants are deemed not enforceable by virtue of Section 27 of the ICA and Art. 19 (1) (g) of Constitution, and on the other hand, both Section 27 of the ICA and Art 19 of Constitution also provide for exception to their respective rules.

This makes incorporation of restrictive covenants by Employers a challenging legal conundrum.

Under such situations, validity and enforceability of Restrictive Covenants have been determined by Courts in tandem with provision of Sec. 27 of the ICA, Art 19 (1) (g) and various doctrines of common law.

Consequently a unique jurisprudence has evolved for determining the legality of various restrictive covenants in Employment contracts in India.

  1. Non-Compete Restrictions

A Non-Compete clause in a contract of employment restricts an employee from competing with ex-employer under same/similar area of business.

These result in some of the most contentious challenges under enforceability of Restrictive Covenants in India, and thus for resolving issues related to Non-Compete clauses.

The Courts pay a close regard to bargaining power of each party involved, reasonableness of restrictions set out, time, place and manner of restriction in the Non-Compete Clause.

Addressing all such issues, the Supreme Court in the case of Niranjan Shankar Golikari vs. Century Spinning Mills AIR 1967 SC 1098 stated that:

"......a negative covenant operating in restraint of trade during the term of employment of the employee is enforceable and such restrictions falling within the term of the contract could be enforceable, provided such clauses are not "unconscionable or excessively harsh or unreasonable or one sided."

However, there should be no confusion that this position is with respect to restrictions during the term of employment.

Reiterating the same principle, Supreme Court has clearly held in Superintendence Company v. Krishnan Murgai AIR 1980 SC 1717 that:

"......a restrictive covenant is valid only during the subsistence of the contract and such covenant extending beyond the term of the agreement was void."

A similar reiteration was made by the Court in Percept D'Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr. AIR 2006 SC 3426, as that

"......a restrictive covenant extending beyond the term of the contract is void and not enforceable". The Supreme Court also held that "the doctrine of restraint of trade does not apply during the continuance of the contract of employment and it applies only when the contract comes to end."

  1. Non-Solicitation (Employees & Customers) Restrictions

Non-solicitation restrictions are incorporated to prevent employees (former or current) from entering in business with the company's employees or customers against the interest of the company.

Disputes regarding enforcement of non-solicitation agreements in India have majorly been decided on the factual matrix of individual cases. In some circumstances, as in Desiccant Rotors International Pvt. Ltd v Bappaditya Sarkar & Anr (CS (OS) No. 337/2008 dated July 14, 2009 non-solicitation agreements have been enforced; whereas in other cases like V.F.S. Global Services Ltd. v. Mr.Suprit Roy 2008 (2) Bom CR 446, relief for breach of non-solicitation obligations have been denied also.

From this, it is clear that solicitation is a question and matter of facts, and facts differ from case to case. This is also reflected in the Madras High Court's judgement given in FL Smidth Pvt. Ltd. v M/s. Secan Invescast (India) Pvt. Ltd. (2013) 1 CTC 886 wherein a standard to establish non-solicitation has been laid down as follows:

"......solicitation is essentially a question of fact. The appellants should prove that the respondents approached their erstwhile customers and only on account of such solicitation, customers placed orders with the respondents. Mere production of quotation would not serve the purpose. It is not that the appellant is left without any remedy. In case the Court ultimately holds that the appellant has got a case on merits, they can be compensated by awarding damages. The supplies made by the respondent to the erstwhile customers of the appellant would be borne out by records. There would be no difficulty to the appellant to prove that in spite of entering into a non-disclosure agreement, respondent has solicited customers and pursuant to such solicitation they have actually supplied castings. When there is such an alternative remedy, question of issuing a prohibitory injunction does not arise."

Thus, non-solicitation obligations post-termination of employment may be enforced in limited circumstances, based upon the facts of each individual case if they pertain to reasonable restrictions such as distance, time limit (reasonable time frame), protection and non-usage of trade secrets and goodwill.

  1. Non-Disclosure (Confidential & Trade Secret) Restrictions

Non-Disclosure covenants, directs an employee to not disclose any trade secrets, business connections and confidential information to any person or entity, unrelated to the employer company.

"Non-Disclosure is not a restraint of trade" is a fairly well settled jurisprudence. Thus, the deciding factor is factual matrix of the individual case. Some important judicial precedents pertaining to Non-Disclosure Restrictions are:

Mr. Diljeet Titus, Advocate v. Alfred A Adebare and Ors 2006 (32) PTC 609 (Del), wherein Delhi High Court restrained the Defendant from misappropriating the information including the lists of clients and other information forming the database of the firm.

Whereas in American Express Bank Limited v. Priya Puri 2006 (110) FLR 2061 upon allegations of sharing of trade secrets, confidential information and possessing intellectual property, the Delhi High Court observed that in order to claim copyrights, the plaintiff should have abridged, arranged and/or done something "which would show that they have done something with the material which is available in public domain so as to claim exclusive rights on that".

  1. Restrictive Covenants: Court's Approach

Judiciary has had occasions where it was asked to consider two or more issues in one case. Such cases are important as they help in establishing an approach for Courts to follow in future disputes.

In Hi-Tech Systems & Services Ltd. v/s. Suprabhat Ray and Ors AIR 2015 Cal 261, the Plaintiff Company had employed the Respondents who were obliged to keep confidential all information and material provided to them during their employment with the Plaintiff, and thereafter until a period of three years from the date of termination vide a code of conduct policy circulated to them during the course of their employment.

Soon after the resignation by the Respondents, the Plaintiff learned that the Respondents had started a competing business and solicited the Plaintiff's clients using valuable data and information illegally procured from the Plaintiff's database.

As a result of such finding, the Plaintiff filed an application before the Hon'ble Kolkata High Court praying for an order of injunction restraining the Respondents from divulging and/or using in any manner the Plaintiff's computer database containing confidential information and trade secrets."

This case involved all three issues i.e. Non-Solicitation, Non-Compete and Non-Disclosure. Thus the decision by the Court is essential to note here:

"The Court restrained the Respondents from utilizing trade secrets and confidential information of the Plaintiff and from acting as a sales agent of the Plaintiff's client for a period of three years from resignation/termination of the employment as stipulated in the said code of conduct/human resource policy."

Further it was held that,

"Although the Court held that its order shall not prevent the Respondents from carrying any business, which maybe same and/or similar to the Plaintiff, it added a condition that the same should be carried out without using and/or utilizing the database and trade secrets of the Plaintiff in course of their business, thus protecting the trade secrets of the Petitioner."

Another important case that determined approach of Courts in disputes concerning Restrictive Covenants vis-à-vis protection of sensitive and confidential information of an employer is Zee Telefilms Ltd. v. Sundial Communications Pvt. Ltd 2003 (27) PTC 457(Bom).

In this case, the Bombay High Court propounded a triple test for situations where a Plaintiff sues, relying upon breach of confidence.

Under the aegis of this test, a Plaintiff must establish three elements in order to establish breach under Restrictive Covenants:

  1. That the information was of a confidential nature;
  1. That the information was communicated in circumstances importing an obligation of confidence, and
  1. That there has been an unauthorized use of the information to the detriment of the person communicating it.

Zee Telefilms' case helped in clearing ambiguity regarding application and extent of a Restrictive Clause in Litigations involving breach of confidential matters during employment.

EMERGING TRENDS

In the modern legal landscape, there have evolved certain covenants that although are restrictive in nature, yet do not fall squarely under the umbrella of Restrictive Employment Covenants read with Section 27 of the ICA.

  1. Non-Poaching Agreements

In the modern market place every profession and trade requires a niche talent. Consequently, employers are spending a substantial amount of time and resources to train their "Human Resources" as per their specific requirements.

When such employees join the competitor's operations by will, or when the competitors poach such trained employees, it causes immense loss to the former employer.

Although not strictly a restrictive covenant, Non-Poaching Agreements are in trend. These agreements are executed between two competitors wherein they agree not to encourage or entice the employees of the other party.

Thus, these agreements simply put an imposition on the contracting parties to refrain from hiring the employees of one another.

  1. Training Bonds

Training Bonds are instruments that empower the employers in ensuring that the employers' interests are shielded and any investment that an employer makes are backed by a security for a particular amount of time period.

A Training Bond ensures this by imposing an obligation on the employee to utilize the training received from the employer for the benefit of the business of the employer for certain specified duration.

The exit clause of a Training Bond provides that if the employee fails to comply with the contractual obligation, the employer can recover compensation for the investments made in the training of that particular employee.

The recovery is only of the amount of investments made and not an imposition of penalty for terminating the employment contract.

Thus, the employment bond is considered reasonable, however, the restraints stipulated upon the employee in the contract should be "reasonable" and "necessary" to safeguard the interests of the employer or validity of bonds comes under scrutiny.

The employee cannot be compelled to work for any employer by enforcing the employment bond. In the event of a breach of contract by the employee, the only remedy available to the employer is to obtain a reasonable compensation amount.

There is fairly straightforward jurisprudence in reference of Training Bonds in India. In Satyam Computer Services Limited v. Ladella Ravichander MANU/AP/0416/2011, the Andhra Pradesh High Court held that,

"the employer must, establish that he had incurred expenses in the training of the employee and the employee has not performed his part of the contract of working for the business of the employer for a stipulated time period."

Further, in Toshnial Brothers (Pvt.) Ltd. v. E. Eswarprasad & Ors 1997 LLR 500, it was held by Madras High Court that:

"......the employer was entitled to recover the stipulated damages, which is a genuine pre-estimate by the parties of the damages incurred. There is no requirement to prove separately any post-breach damages."

"......The employer is required to establish that the employee was the beneficiary of special favor or concession or training at the cost and expense wholly or on the part of the employer and there had been a breach of the undertaking by the beneficiary of the same."

Thus, employment bonds are not inherently void or invalid. Their enforceability depends upon the terms stipulated by them which, if not excessive or unreasonable, are perfectly capable of being legally enforced.

  1. Garden Leave Clauses

Garden leave refers to the period between the employee is given a notice of termination and his actual termination.

During this period, the employee is not allowed to continue working either at the workplace or work from home or any another location.

He is entitled to his salary for the notice period but he is not allowed to work for his current employee or his new or any other employee.

So although Garden Leave is similar to a restrictive covenant but it differs as it does not deprive the employee of his basic remuneration and does not expressly violate the right to livelihood. It provides that the former employee, post the termination of his employment, will be paid his monthly pay.

Any employee with whom a Garden Leave provision is executed is mostly someone who has access and knowledge of the confidential information, which if promulgated to a competitor can cause immense economic damage to the employer.

However, this clause has not been widely accepted by the Indian Courts. It has not received much appreciation since it puts a disguised restraint of trade which goes deep into the root of freedom of contract, which is fundamental to the validity of a contract.

ENFORCEMENT OF RESTRICTIVE COVENANTS

Restrictive Covenants although are specific type of contracts, but in terms of enforcement procedure, they too follow general methods of enforcements for fulling contractual obligations. Some main enforcement procedures are:

  1. Service of Legal Notice to the employee.

The first step in enforcement of any covenant is same in this case also. Employers are advised to follow the due process of enforcement mechanism by giving proper notice to the employee reminding him of his contractual obligations.

  1. Enforcement of Legal instrument specifically provided for.

If the covenant provides for deposit of any instrument against breach of term of covenant, then the said instrument (cheque or undertaking) should be enforced.

  1. Institution of suit against breach of terms of the covenant.

In the event of non-resolution of dispute through above means, Court can be approached by institution of civil suit for specific performance of contract or for seeking damages and remedies as the case may be.

CONCLUSION

It is now a matter of routine to include restrictive covenants in employment contracts. However, restrictive covenant clauses are not enforceable just by the virtue of their presence in the employment contract.

They can be enforced only if their restrictions are held to be reasonable and it strikes a balance between the rights of the employer as well as that of the employee.

Based on the Jurisprudence adopted by Indian Courts, the test for determining reasonableness of the said restrictive covenant along the following points:

  1. The restraint should be no greater than is necessary to protect a legitimate business interest, such as a trade secret;
  2. The restraint should not be unduly harsh or oppressive in restricting the employee's ability to earn a living;
  3. The restrain should not be against the public policy of India; and
  4. The restraint should be limited in accordance with the Time-Space-Locality basis.

As observed above, it may be argued that the approach of using Sec. 27 of the ICA to prevent a restrictive covenant from operating may look too simplistic but is complex and worth a detailed legal look.

This content is purely an academic analysis under "Legal intelligence series".

© Copyright AMLEGALS.

Disclaimer: The information contained in this document is intended for informational purposes only and does not constitute legal opinion, advice or any advertisement. This document is not intended to address the circumstances of any particular individual or corporate body. Reade should not act on the information provided herein without appropriate professional advice after a thorough examination of the facts and circumstances of a particular situation. There can be no assurance that the judicial/quasi-judicial authorities may not take a position contrary to the views mentioned herein.

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