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All you need to know about the enforceability of the non-compete clause in Employment Contracts

Introduction

In the highly competitive world, as it is today, an employer would most certainly attempt to take all the preventive steps for any anticipated threats that they are likely to face from their competitors. However, more often , the highest anticipated threats for the employers may turn out to be the ones by their employees.

In this era of globalization, any corporate body depends largely upon its sensitive processes, technology, trade secrets, technological supremacy, and its employees, who have all such crucial information about the company. For the security and survival of the company, an employer is required to ensure that the necessary measures be taken up for safeguarding such confidential information from any kind of leakage. As a consequence of the same, the ‘Non-competence clause’ has come to be commonly accepted in almost all employment contracts.

What is a Non-compete clause?

A well known law under the Contractual Laws in India, a Non-compete Clause is an agreement between two parties, one being the employer and the other an employee. Because of the non-competence clause, the employee undertakes and accepts a condition precedent to his/her employment contract which says that during employment or even after the employee leaves the service/job of the employer, he/she would not work with the company’s competitor in the form and nature of the employment of the employer.

The non-competence clause, therefore, is used as a tool by employers to impose any of the following restrictions on an employer:-

  • 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 the majority of cases, a complete prohibition on disclosure of the trade secrets or confidential information;
  • It may also specify the period for which these restrictions may be applicable after the termination of the employment contract.

There are two types of non-compete clauses; one with the pre-termination condition and another with the post-termination condition.

Pre-termination non-compete clause

In the pre-termination non-compete clause, restrain is imposed on the employee for only the time of the subsistence of the employment contract. The Indian Law enforces pre-termination breach of the non-competence clause as upheld as a legal injury in various judicial pronouncements.

Post-termination non-compete clause

In the post-termination non-compete clause, the restraint(s) is positioned in a way to bar the employees from entering into a similar business or profession for a specified period/area limits to safeguard the employer’s interests even after termination of the employment. The Indian Law prohibits post-termination non-compete clauses per se. However, it might also vary from case to case when that is deemed necessary.

Practical Implications of the Non-compete Clause :

Non-competence agreements, also known as restrictive covenants, have become quite common in employment agreements, employment applications, and contracts for the sale of businesses. It has come to be seen as really important for the employers, so much so that not agreeing to a non-compete clause may cost any person, their current/potential job.

To answer as to whether it would be legal to deny a job opportunity only based on not accepting the non-compete clause, it can be said that it would depend upon the reasonableness of the proposed covenant for not to compete.

To determine such reasonableness, the courts consider multiple factors. Some of the considerations can be :

  1. Legitimate Interest :- The courts consider if there is some legitimate Interest that the employer is protecting and when found so, the clause can be enforced.
  2. Distance :- Suitable restrictions as to prohibiting the employee from practicing the same profession within a stipulated distance from the place of the original employer.
  3. Time Limit :- A reasonably stipulated time can be provided in the clause, after which, the non-compete clause terminates automatically.
  4. Trade Secrets :- The employer may put restrictions on the letting out of trade secrets depending upon the company, its nature of work and industry standing.
  5. Goodwill :- As per the exception under Section 27 of the Indian Contract Act, 1872, the non-compete restrictions can be imposed for the matter of goodwill.

Position under the Indian Legal System

  • Essentials to a valid non-competence clause

The Internet and social media have made it easier for recruiters to approach employees and allure them to work for other companies. With the hopes of actually getting the higher incentives as offered by such recruiters, it is understandable why any company would want to have a non-compete clause as a condition in every or most of its employment contracts.

However, any non-compete clause should not include anything that is too broad to prevent someone from making their living. Therefore, it should be ensured that the terms listed in the clause are fair for everyone involved.

The three terms that are to be made sure to have not been added to a non-compete clause to prevent it from getting unreasonable are :

Unspecified Time Period :

A non-compete cannot last forever. There has to be a reasonable time restriction in the agreement. Depending upon the employee, his/her nature of work, the industry, etc., the employer would be necessitated to choose a reasonable amount of time (could be anywhere between 6 months and 2 years).

Unreasonable Geographic Restrictions :

A geographic restriction implies that no employee can compete with their previous employer or solicit clients from that employer within the specified area. It is seen as necessary to specify a reasonable geographic area to be restricted, just so that the moving employee does not solicit/poach clientele from the previous company.

  • Unreasonable, Vague or Ambiguous Activity Restricted :

If the non-compete clause includes activity restrictions, it has to be ensured by the drafter to specify the nature and type of activity restricted in a pointed, specified, clear manner. Moreover, the restriction such placed must be with the sole intent of protecting their legitimate business interests and should not deprive one of their livelihood.

  • Enforceability of the Non-competence clause in India :

As per the Indian legal scenario, the non-competence clause is prohibited under the Law of contracts , as it reads;

‘ “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”.

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 reasoned, regard being had to the nature of business.’[1]

A non-compete clause therefore, directly contravenes the aforementioned section of the Indian Contract Act, 1872. Moreover, the non-compete clause also is in infringement of the Fundamental Right to carry on any profession, trade or occupation of choice, as guaranteed under Article 19(1)(g) of the Indian Constitution.

However, by looking at some of the judicial precedents laid down by the Indian courts concerning the enforceability of such non-compete provisions, it can be said that such agreements have been held valid insofar as the clause does not restrict the employee.

To sum up India’s position concerning the non-compete agreements, it has been largely settled now that these restrictive covenants are binding on the undertaking employee during the employment. On the lines of the non-compete clause being binding post-termination, a lot of judicial deliberation has been happening, leading to various opinions on the same.

  • Judicial Trend in India

Gaining precedence from previous judicial pronouncements, it can be taken that such constraints , about the non-competence and the non-solicitation clauses, are deemed to operate during the period of the contract of employment and are not generally considered as a restraint to trade and therefore, cannot be said to necessarily fall foul of Section 27 of the Indian Contract Act, 1872.

While dealing with such a contractual issue as that of the non-competence clause, the Supreme Court in the Superintendence Company of India (P) Ltd. v. Sh. Krishan Murgai, answered the question as to whether a post-service restrictive covenant would fall within the mischief of section 27 of the Contract Act. It was held that a contract, which had for its object a restraint of trade, was prima facie void.

On similar lines, the Delhi High Court in Foods Ltd. And Others v. Bharat Coca-cola Holdings Pvt. Ltd. & others observed that a post termination restraint would violate Section 27 of the Indian Contract Act, 1872. Such contracts would thus be unenforceable, void and against public policy.

Moreover, in the case of Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr. The Apex Court shed some light on the legality of such clauses and observed that “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.”[2]

In the Niranjan Shankar Golikari v. The Century Spinning And Mfg. Co., the Supreme Court categorically stated that non-compete and non-solicitation clauses are different in cases where the restriction is applied during the term of employment and the cases where such restrictions are imposed after the termination of the employment.

Validity of the Non-compete Clause

Defenders of the Non-compete clause put forward certain reasons as arguments for its validity. The arguments majorly revolve around the employer’s disinterest in investing in workers (if skilled employees would take their skills to the competitors), the non-competence clause would prevent the rival companies from dancing off with trade secrets and thereby encourage innovation, and that people should be free to contract.

Based on these arguments, the Law Commission of India, in its 13th Report (1959, Para 55) mentioned that at the time when The Indian Contract Act was enacted, i.e., in 1872, and Section 27 therein was formulated, trade was not developed. However, in the contemporary world, a liberal attitude should be adopted.

It is because of the precedents like the Niranjan Shankar Golikari v. The Century Spinning And Mfg. Co. and Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr., that the Indian courts are bound against enforcing non-compete clauses, as reasonably restricted and even otherwise.

Non-compete clauses have become technically included in most of the employment agreements and worldwide. Though any company could have a Non-compete agreement, media, information technology, sales positions, financial industry, and the corporate world are the most common industries that require their employees to sign a Non-compete agreement.

Conclusion

It can therefore be concluded that courts in India have taken up a rather restrictive approach towards the enforceability of the non-compete clause. Even though such non-compete clauses are commonly valid in foreign countries. The enforceability of the pre-termination non-compete clause is very well accepted in the Indian Jurisprudence. On the other hand, the law regarding the post-termination non-compete clause has no settled position in the Indian legal scenario.

However, while dealing with a Non-compete Clause, there are no defined rules or parameters to determine the acceptance of such clauses and therefore, it is subjectively dependent on the facts of every case. What is important to be noted is that, non-competes must be reasonable and should not prevent someone from making their living.

References

  1. https://www.barandbench.com/columns/the-case-for-non-compete-clauses

What is non-compete clause?

The employee undertakes and accepts a condition precedent to his/her employment contract which says that during employment or even after the employee leaves the service/job of the employer, he/she would not work with the company’s competitor in the form and nature of the employment of the employer.

What is pre-termination non-compete clause?

In the pre-termination non-compete clause, restrain is imposed on the employee for only the time of the subsistence of the employment contract. 

What is post-termination non-compete clause?

In the post-termination non-compete clause, the restraint(s) is positioned in a way to bar the employees from entering into a similar business or profession for a specified period/area limits to safeguard the employer’s interests even after termination of the employment. The Indian Law prohibits post-termination non-compete clauses per se.

Is the non-compete clause valid under Section 27 of the Contracts Act?

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.

What will happen if one does not abide by the non-compete clause?

The employer has the option to sue the employee if he/she breaches the clause.

Author

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    Tanisha Agarwal is a second year B.A. LLB (Hons.) student at Institute of Law, Nirma University, Ahmedabad, Gujarat. She is inclined towards professional litigation and has researching skills.

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