Employment LawNavigating the Legality of Non-Compete Agreements

INTRODUCTION

In India’s rapidly growing and ever-changing dynamic employment landscape, the presence of non-compete clauses has become a common feature in employment contracts. ​Non-compete clauses are contractual provisions that restrict employees from engaging in competing businesses or professions after the termination of their employment.

These clauses are typically included in employment contracts to protect the employer’s legitimate business interests, such as trade secrets, confidential information, and customer relationships. While employers argue that non-compete clauses are essential to safeguard their business interests, employees often view them as restrictive covenants that hinder their right to work and earn a livelihood.

In India, the enforceability of non-compete clauses is primarily governed by Section 27 of the Indian Contract Act, 1872 (hereinafter referred to as “ICA”)

LEGAL FRAMEWORK, JUDICIAL INTERPRETATIONS AND KEY PRECEDENTS

 Section 27 of the ICA, states:​

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

This provision establishes a general prohibition against agreements that restrain trade, rendering most non-compete clauses unenforceable, especially those extending beyond the term of employment.

The rationale behind this provision is to uphold an individual’s fundamental right to earn a livelihood and to prevent undue restrictions on trade and commerce.

The Indian Courts have consistently held that while non-compete clauses during the term of employment may be valid, post-employment restrictions are generally void.​

• Niranjan Shankar Golikari v. Century Spinning and Manufacturing Co. Ltd., 1967 AIR 1098:

The Hon’ble Supreme Court upheld a non-compete clause operative during the period of employment, emphasizing that such restrictions are not in restraint of trade if they are reasonable and necessary to protect the employer’s interests.​

• Superintendence Company of India (P) Ltd. v. Krishan Murgai, 1980 AIR 1717:

The Hon’ble Supreme Court declared a post-employment non-compete clause void, reiterating that any agreement restraining a person from practicing a lawful profession, trade, or business is void under Section 27 of the ICA,1872.

• Gujarat Bottling Co. Ltd. v. Coca-Cola Co., 1995 AIR 2372:

The Hon’ble Supreme Court distinguished between restraints during the term of the contract and those post-termination, holding that while in-term restraints might be valid, post-termination non-compete clauses are generally unenforceable.​

• Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan, AIR 2006 SUPREME COURT 3426:

The Hon’ble Supreme Court ruled that no agreement restraining a person from pursuing their profession can be enforced, emphasizing the fundamental right to livelihood.​

These cases underscore the Indian judiciary’s inclination to protect employees’ rights to work and earn a livelihood, especially after the termination of employment.

 Exceptions to Section 27

​Section 27 of the ICA, generally renders agreements restraining lawful professions, trades, or businesses void. However, Indian jurisprudence has carved out specific exceptions where non-compete clauses are enforceable. These exceptions primarily revolve around the sale of goodwill, partnership dissolution, and franchise agreements.​

1. Sale of Goodwill: Safeguarding the Buyer’s Interests

When an individual sells the goodwill of their business, they may agree not to engage in a similar trade within specified local limits and for a reasonable duration. This exception ensures that the buyer can fully benefit from the acquired goodwill without immediate competition from the seller. The courts assess the reasonableness of such restraints based on factors like geographical scope and time frame. ​

2. Partnership Dissolution: Ensuring Fair Competition Post-Dissolution

Partners may agree not to compete after the dissolution of the partnership, provided the restrictions are reasonable in scope and duration. Such agreements aim to prevent immediate competition that could harm each other’s prospects and ensure a fair transition. ​

3. Franchise Agreements: Maintaining Brand Integrity

In franchise agreements, non-compete clauses may be enforceable if they are narrowly drafted and reasonable in scope. These clauses help maintain brand integrity and prevent conflicts of interest by ensuring that franchisees do not engage in competing businesses during the term of the franchise and for a specified period afterward.

IMPLICATIONS FOR EMPLOYERS AND EMPLOYEES

For employers, the legal position necessitates a strategic approach to protect business interests without relying on unenforceable non-compete clauses. Alternative mechanisms include:​

1. Non-Disclosure Agreements (NDAs):

NDAs are contractual instruments entered into by parties to safeguard proprietary and confidential information from unauthorized disclosure or use. In the context of employment, NDAs serve to protect sensitive business information including but not limited to trade secrets, client lists, financial records, technical data, and strategic plans from dissemination by current or former employees, contractors, or business affiliates. A breach of such agreement may give rise to claims for injunctive relief and/or monetary damages, depending on the nature and extent of the disclosure. The enforceability of NDAs is contingent upon the reasonableness of the scope, duration, and the legitimate business interests being protected.

2. Garden Leave Clauses:

A Garden Leave Clause constitutes a contractual provision whereby an employee, following resignation or termination, is required to serve a notice period during which they remain an employee and continue to receive salary and benefits, yet are relieved of active duties and are precluded from commencing alternative employment. The primary function of such a clause is to protect the employer’s business interests by restricting the departing employee’s immediate access to sensitive information and client interactions, thereby mitigating competitive risks. The law generally upholds such provisions provided they are reasonable in duration and do not operate in restraint of trade beyond what is necessary to protect legitimate business interests.

3. Non-Solicitation Clauses:

Non-Solicitation clauses are restrictive covenants designed to prevent former employees from soliciting or inducing the employer’s clients, customers, suppliers, or employees to terminate or alter their relationship with the employer. These clauses aim to protect the employer’s goodwill and proprietary relationships developed over the course of employment. Unlike broader non-compete covenants, non-solicitation clauses are more likely to be enforced by courts, provided they are narrowly tailored in scope, geographic application, and duration, and are necessary to protect the employer’s legitimate business interests without imposing undue hardship on the former employee.

Employees, on the other hand, should be aware of their rights and the limited enforceability of non-compete clauses in India. Understanding that such clauses are generally void post-employment can empower them to make informed decisions about career transitions without undue fear of legal repercussions.

AMLEGALS REMARKS

The non-compete clauses, though not fully enforceable in India, have a lot of significance in employment contracts. They ensure that the invaluable intellectual property, as well as the operating strategy of the firms, which play a crucial role in providing them an advantage over their competitors in this highly competitive market, is not lost.

However, there should be a fine balance between occupational freedom of the employees and the security of the valuable assets and the competitive advantage of the firms, and it is critical to ensure that this balance continues to exist.

– Team AMLEGALS assisted by Mr. Ashish Singh (Intern)