By Apoorva Mandhani, Symbiosis Law School, Pune.
A clause in an employment agreement that restrains an employee from working with a competitor or carrying out a competing business is called a Non-Compete clause. An agreement in restraint of trade has been defined as “one in which a party agrees with any other party to restrict his liberty in the future to carry on trade with other persons who are not parties to the contract in such a manner as he chooses.”
Vis-à-vis Indian Contract Act
The non-compete covenants used in agreements can be categorized into in term and post term covenants. Non-compete clauses are valid only to a very limited extent in India, because of the rider under Section 27 of the India Contract Act, which reads as follows:
“27. Agreement in restraint of trade void – Every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void. Saving of agreement not to carry on business of which good-will is sold.”
The legal position with respect to Indian Contract Act is that restrictive clauses pertaining to post employment period are null and void, while the ones imposed on employees during employment are legally enforceable.
In the case of V.V. Sivaram and others v. FOSECO India Limited, an employee was restrained from using secrets and confidential information, which he gained during job, even after moving out of the job. The employee had access to confidential information pertaining to several products including the patent ‘Turbostop’. He left under voluntary retirement scheme. Injunction restraining him from manufacturing and marketing a product similar to ‘Turbostop’ was held to be not violating Section 27.
The principles of Section 27 were aptly summarized by the Supreme Court of India in Percept D’ Mark (India) Pvt. Ltd v. Zaheer Khan, in which the Supreme Court 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.
This long-standing stance was clearly reaffirmed recently in a 2009 decision by the New Delhi High Court in Desiccant Rotors International Pvt. Ltd. v. Bappaditya Sarkar & Anr, wherein the Delhi High Court ruled that in a 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.
On similar lines, in V.F.S. Global Services Ltd. v. Mr. Suprit Roy 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.
Indian Courts have refused to enforce post-termination non-compete clauses in employment contracts, viewing them as violative of Section 27 of the Indian Contract Act, as being in “restraint of trade”.
In the case of Gujarat Bottling Company Limited (GBC) vs. Coca Cola Company, the Supreme Court said any non-disclosure clause shall be applicable only during the period of service and any restraint beyond the service is violative of Section 27.
However, the Court in the case of Nilanjan Golokari v. The Century Spinning and Mfg. ruled that non-compete clauses cannot be considered as restraint of trade against the employee, if they are operating during the course of employment.
The reasoning given by the Court was that such a restriction imposed on the employee cannot be regarded as a restraint of trade due to the apprehension of the employer that his trade secrets and confidential information acquired by the employee throughout the time of employment can be disclosed.
In the case of Dr. S. Gobu vs. The State of Tamil Nadu, the High Court refused to let the employee have the benefit of Section 27, ruling that “the agreement executed by him does not suffer from any arbitrariness or it was not done due to any unequal bargaining power”, in the light of the fact that the petitioner was the beneficiary of three years leave period together with salary paid and he was treated as service candidate and not as a direct candidate. The Court ruled that, he cannot have best of both Worlds.
Vis-à-vis Competition Law
Competition Act is wider in scope compared to Contract Act. While Contract Act relates to contracts only, the Competition Act relates to any “agreement”. The term “agreement” is much more extensive than a contract.
According to the Competition Act,
“an agreement includes any arrangement or understanding or action in concert-
- Whether or not, such arrangement, understanding or action is formal or in writing; or
- Whether or not such arrangement, understanding or action is intended to be enforceable by legal proceedings;”
Further, under Indian Contract Act, the Court can only declare the contract void, while under the Competition Act, penalties can be imposed on such employers. It may also be possible to initiate class-action suits or proceedings under the Competition Act on behalf of employees in sectors where such agreements are common.
It was recently clarified by the Competition Commission of India in the case of Mr. Larry Lee Mccallister v. M/s. Pangea3 Legal Database Systems Pvt. Ltd. & Ors., that a non-compete clause in an employment contract between an employee and a company does not breach Sections 3 and 4 of the Competition Act, 2002.
Section 3 of the Act prohibits an enterprise, person or association of enterprises or persons from entering into agreements which cause an adverse effect on competition within India, while Section 4 prohibits an enterprise from abusing its dominant position in the market.
While examining whether a post-termination non-compete clause would amount to abuse of dominance under the Act, the CIC observed that the relevant dominant position enjoyed by the company is with respect to its competitors, not its employees, and that an employment contract has nothing to do with the market of the company.
The CCI further observed that an employee who enters into an employment contract restraining him from providing services to a competitor of the employer, post termination of his employment, negotiates his salary/pay package accordingly and takes into calculation even the period for which he would not be able to provide his expertise to competitors. The CCI therefore held that a clause in a service contract restricting an employee from taking employment with its competitors does not raise any competition issue.
Vis-à-vis the Constitution of Indian
Article 19 1 (g) of the Indian constitution guarantees that all the citizens shall have the right:
“to practice any profession, or to carry on any occupation, trade or business.”
In the case of Pepsi Foods Ltd. & Others v. Bharat Coca-Cola Holdings Pvt. Ltd. and Ors. the enforceability of a negative covenant restraining employees from engaging or undertaking employment in other company has been treated as economic terrorism. Post employment restrictions were held to be invalid and violative of Article 19 (1) (g) of the Constitution
As a general rule, non-compete clauses will be enforceable during the term of the employment relationship. After termination of employment, however, many provisions of these agreements will be struck down and deemed unenforceable by Indian courts in enforcement proceedings, even if the provisions are reasonable in scope and duration, subject to certain exceptions.
One of the few instances in which non-compete clauses will be enforceable is in the circumstance of the sale of a business, where the owners of the business will agree to a non-compete in exchange for consideration for the goodwill associated with the business.
The legal conclusion now being clear, it is of utmost importance that foreign investors in India need to be aware about the consequences of Section 27 and the Competition Act, as they structure their employment relationships and incentives with local management.
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