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Validity of Non-Compete Clause

INTRODUCTION

Under the wider ambit of the Contractual law which gives perseverance to different clauses in anAgreement, the non-compete clause stands erect neither leaning nor bending with perpetual sanctity. But enhancing its validity especially in Employment Agreement is a matter of minute scrutinisation.By virtue of this non-compete clause, the employee undertakes and gives his acceptance to the condition of the employer that during the course of the employment or even after the employee leaves the services/job of the employer, and he will not be the competitor of the employer in the form and nature of the employment of the employer. The Non-compete clause finds place under the agreements and contracts throughout the globe.

But the irony that exists with the India legal system that this covenant stands in contradiction with Section 27 of the Indian Contract Act, 1872 which states that an agreement which imposes any kind of restriction on exercising a lawful profession or trade should be declared void.

Here, in this article we will be basically concentrating upon the validity of non-compete agreement under the Indian Contract Act.An attempt has been made in this article to visualize how far negative covenants can be stretched and skillfully drafted vis-à-vis "agreement in restraint of trade" enshrined under the Indian Contract Act. The focus of this article would be more towards delving upon "non-compete agreement". The negative clauses always had an unpleasant time with freedom of contract and were prone to be easily charged as agreement in restraint of trade which is generally considered to be valid during the time of employment and the Courts have been less willing to enforce agreements relating to post-employment restraints on the employee.

SECTION 27 OF THE INDIAN CONTRACT ACT

The Indian Contract Act, 1872 is quite exhaustive “even if it may not be a complete code dealing with all eventualities pertaining to contracts. Under Section 27 of the Indian Contract Act, a service covenant extended beyond the termination of the service is void.”

The section concerned reads: “Every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.

Exception: One who sells goodwill of a business with a 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 business”

In the garb of confidentiality, an employer cannot be allowed to perpetuate forced employment, as it is hit by Section 27.There is nothing in the wording of Section 27 to suggest that the principle stated therein does not apply when the restraint is for a limited period only or is confined to a particular area. Such matters of partial restriction have effect only when the facts fall within the exception to the Section.

Therefore, generally speaking, section 27 of the Indian Contract Act imposes a restriction on all Employment agreement from any negative covenant of non-competition and the test for measuring the validity of such restriction lies on the Indian judiciary.

NON-COMPETE CLAUSE UNDER THE EMPLOYMENT AGREEMENT

Keeping in view, the increase in cross border trade and an enhanced competitive climate in India, confidentiality, non-compete and non solicitation agreements are becoming increasingly popular, especially in the IT and technology sectors. A huge number of out sourcing and IT companies are including confidentiality, non-compete and non solicitation covenants in agreements with their employees, with terms ranging from a few months to several years after the employment relationship is terminated. The companies claim that such restrictions are necessary to protect their proprietary rights and their confidential information. In the same way, foreign companies doing business in India often seek to include confidentiality, non-compete and non solicitation covenants in their agreements with senior management and employees, as is customarily done in certain abroad countries.

Whenever an employment agreement is drafted, there always exist a specific need for non-compete covenant because of one of the major reason for maintaining confidentiality. The non-compete clause in any agreement basically consists of two kinds: 1. Pre-termination clause, and 2. Post-termination clause. Whenever a restriction has been imposed on the employee that within the contract period he cannot start or merge or in any other way compete with the Employer than that is a Pre-termination clause whereas when a covenant put a restriction upon the employee that even after the termination of the Agreement, he cannot compete with him in any manner whatsoever will be termed to be post termination obligation.

JUDICIAL PRONOUNCEMENTS

Whenever a law stands in contradiction with a prevailing custom than the rescue operation is generally taken care by the third and most important pillar of democracy i.e. Judiciary. Therefore here also the contravention between section 27 and the negative covenant is being handled by the Judiciary through different leading cases. Considering the developed social, legal, and corporate circumstances, and the required confidentiality and the integrity of the employments, the judiciary has inclined its view towards giving some regard to the non-compete agreements. In the case of ‘Niranjan Shankar Golikarivs 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 one case - V.F.S. global services Pvt. Ltd Vs Mr. Suprit Roy , 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. In the case of Mr. Diljeet Titus, AdvVs Mr. Alfred A Adebare&Ors Delhi High court held that “The real test was the degree of employment control to determine whether it was a contract of service…”Like these there are several other judgments of various High courts which 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.

In foreign judiciary subject to certain limitations and reasonable boundness, the non-compete agreements are declared to be enforceable to the reasonable extent. For example: In ‘HRX Holdings Pty Ltd Vs Pearson , the Federal Court of Australia upheld a post employment restraint preventing a senior employee from competing with his former employer for two years. The court upheld the two years non-compete clause with consideration. The court held the restraint reasonable because

  1. The employee was the “humanface” of the company and had intimate knowledge of the former employer’s client relationships, pricing arrangements and strategies, and

  2. The employee had received compensation for the restraint in the form of the remuneration and shares for all but three months of the restraint period.

TEST FOR ENFORCING THE COVENANT

The Indian legal system talks about Rights & freedom but no right or freedom exist in its absoluteness, it always co-exist with some kind of restriction. Article 21 of the Indian constitution speaks about freedom but this freedom is also subject to reasonable restrictions, similarly section 27 of the Indian contract act exit with restrictions.

Although section 27 of the Indian Contract Act states that all agreements in restraint of any profession, trade or business are void, the current trend as per various judicial pronouncements leads to the conclusion that reasonable restraint can be permitted to some extent and does not render the contract void abinitio. Reasonable of restraint depends upon various factors, and the restraint in order 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. So the question arises as to

  1. What is public policy and
  2. What is reasonable

It is to be widely discussed regarding the public policy. It is illusive, varying and uncertain. It is difficult to give precise definition of the term public policy. Concept of public policy is capable of expansion and modification. It is the province of the judiciary to expound the term “Public policy”. There are several guidelines given by the judiciary to determine as to what public policy is and what is not. Some of these can be expressed as – any agreement tending to injure the public interest or public welfare is against the public policy. Further it can include as to – whatever tends to injustice of operation, restraint of liberty, commerce and natural or legal rights, whatever tends to the obstruction of injustice or violation of statutes and whatever is against good morals can be said to be against Public Policy. What agreements are actually against the public policy and what are not, is totally the discretion of the courts.

So far as the term “Reasonable” is concerned, simply in general understanding it means- “according to reason”. 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. Whether an agreement containing non-compete clause is valid and suitable to restrain, or not, is also a total discretion of the courts and which is varying based on the facts of the case.

To validate such non-compete clauses certain reasonable restrictions may be imposed like:
  1. Distance: Suitable restrictions on employee prohibiting them to practice same profession within a stipulated distance, the stipulation being reasonable.

  2. Time limit: If there is a reasonable time provided in the clause then it will fall under reasonable restrictions.

  3. Trade secrets: the employer can put reasonable restrictions on the letting out of trade secrets.

  4. Goodwill: Section 27 of the Indian Contract Act provides an exception on the distribution of goodwill.

Therefore the recent trend shows that the Indian Judiciary is not very consistent upon the point of enforcement of any non-compete clause, it vary and depends upon the facts and circumstances of the case, but we could analyze one consistent approach of Indian courts on refusing 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.

CONCLUSION

Although, non-compete clauses are valid in foreign countries, but in regard to the Sphere of the Indian judiciary, it does not find such wider and effective scenario like that in foreign countries. Article 21 of the Constitution of India guarantees the right to livelihood and since it is a fundamental right it is held to be inviolable. This makes the enforcing of non-compete clauses in India even more difficult. At the same time it is also very pertinent to be considered that, the time and the circumstances-socio, legal, economical & corporate, have changed and developed in India and Abroad to a greater extent and in order to fill the lacunas of law and the developed circumstances, social engineering (Social engineering is a beautiful concept propounded by Roscoe Pound – social engineering is a means of trying to control human behaviours with the emphasis of laws. This principle is based upon the thought that laws are a deterrent to future crimes. As written by the Roscoe Pound in the ‘Jural Postulates’, he lays the foundations for assumptions in which a civilized society should be able to live…) is required to be done. The recent trends of the Indian Judiciary tending to validate the non compete clauses to the reasonable and justful extent in the various agreements as discussed above is an attempt to that effect and are commendable.

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