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Validity Of Non-Compete Clause In Employment Agreements In India

What is a non-compete clause?

A non-compete clause under the Contractual Laws is the clause in an employment agreement whereby the employee undertakes and gives his acceptance to the condition of the employer that during the employment or even after the employee leaves the services of the employer, he will not be the competitor of the employer in the form and nature of the employment of the employer.

Section 27 of the Indian Contract Act, 1872

From an Indian legal perspective, the Non-compete clause is prohibited under the Law of Contracts. Section 27 of the Indian Contract Act-1872 provides that - Every agreement by which anyone is restrained from exercising a lawful profession or trade or business of any kind, is to that extent void. Indian courts have also consistently refused to enforce post-termination non-compete clauses in employment contracts as restraint of trade is impermissible under section 27 of the Indian Contract Act-1872, and have held them as void and against the public policy because of their potential to deprive an individual of his or her fundamental right to earn a living.

For any restrictive covenant to fall within the ambit of Section 27 of the Contract Act, the agreement has to be in restraint of trade. Unlike the law in the United Kingdom, the Contract Act does not distinguish between partial and total restraint of trade, if the clause amounts to restraint post-termination of the agreement, then the same is void. Section 27 does not offer insight as to what kinds of restraints are valid; the qualification of reasonable restraints being valid and enforceable has been read into Section 27 by the courts.

What does Article 19(g) of the Constitution of India say?

Article 19(g) of the Constitution of India provides every citizen the right to practice any profession, trade, or business. This is not an absolute right and reasonable restrictions can be placed on this right in the interest of the public, the courts have always been wary of upholding such restrictions and have kept the interpretation of this provision flexible to ensure that principle of justice, morality, and fairness are aptly applied, depending upon facts and circumstances of each case. Considering the required confidentiality and the integrity of the employments, the judiciary has inclined its view towards giving some regard to the non-compete agreements.

Case laws:
In the case of Niranjan Shankar Golikari Vs the Century Spinning and Manufacturing Company Ltd., the Hon'ble Supreme Court observed that-restraints or negative covenants in the appointment or contracts may be valid if they are reasonable.

Further in case:
V.F.S. global services Pvt. Ltd Vs Mr. Suprit Roy, 2008(2) Bom CR 446, the Bombay High court established the principle that a restraint on the use of trade secrets during or after the cessation of employment does not tantamount to a restraint on trade under section 27 of the Act and therefore can be enforceable under certain circumstances.

Like these, there are several other judgments of various High courts that have laid down certain tests or guidelines to check the validity and legality of imposition of restrictions on such non-competing agreements. It shows that Indian courts may in certain circumstances enforce confidentiality agreements intended to protect an employer's proprietary rights.

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, violates Section 27 of the Contract Act. Such contracts are unenforceable, void, and against 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:
  1. A restrictive covenant extending beyond the term of the contract is void and not enforceable.
  2. The doctrine of restraint of trade does not apply during the continuance of the employment contract and is applied only when the contract comes to an end.
  3. 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.

Given 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 does 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 clauses 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, to qualify for being enforceable by law, it is important to ensure that the 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, they are valid and enforceable by law.
The Delhi High Court in Wipro Limited v. Beckman Coulter International S.A. held that bar under Section 27 of the Act will not be attracted in cases where non-solicitation clauses operate between business partner and distributor contracts or similar partnership contracts between two independent entities as opposed to that between an employer and an employee.

Therefore, non-solicitation clauses have more sanctity when part of agreements such as those of partnership where there is a strong implicit presumption that each party had an equal opportunity at the negotiation table and there was an absence of dominance of will of one party over another. This however would be dependent on the facts of each case and the language of each contract. 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.

Reasonableness of restraint depends upon various factors, and the restraint 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. On careful analysis of section 27 keeping in view the exception provided with it, it can be safely concluded that the section implies that, to be valid an agreement in restraint of trade must be reasonable between the parties and consistent with the interest of the public.

Whatever a reasonable man would do using common sense and knowledge, under the given circumstances, will account as reasonable. Therefore the test of reasonability depends on the facts and circumstances of each case.

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