Employment LawEnforceability of Non-Compete Clause in India

INTRODUCTION
Today’s era of competition across organizations has led to the introduction of specific restrictive clauses in the employment agreement seeking to protect the employer’s interests and maintain the confidentiality of information in an organization.

A non-compete clause refers to a clause in the employment agreement by virtue of which an employee has to abide by during, and even after the termination of the employment. Such a clause provides that an employee agrees to not compete with his previous employer by joining some other competitior after the employment period is over.

Even though these clauses are prevalent in the Indian landscape, there is a significant lack of certainty on their enforceability, necessating an urgent solution. This blog post discusses the  grey areas of enforceability of non-compete clauses in India.

LEGAL BACKGROUND
Since non-compete clauses form part of an employment agreement, it is governed by the Indian Contracts Act, 1872 (hereinafter referred to as “the Act”). Section 27 of the Act states that “Every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.”. This provision does not provide any further explanation as to what kind of restraints are valid.

Exceptions to Section 27 have been introduced only by way of judicial precedents. In Wipro Limited v. Beckman Coulter International S.A., 2006 SCC OnLine Del 743 the Delhi High Court held that a non-solicitation clause does not amount to a restraint of trade, business or profession and thus, Section 27 would not be attracted in such a case.

Article 19(1)(g) of the Constitution of India further safeguards an individual’s fundamental right to practice/ carry on any trade, occupation or business. The Courts, in order to ensure that the principles of justice, morality, and fairness are befitted, depending on the facts and circumstances of each case, have always been hesitant of upholding such restrictions and have kept the interpretation of this provision flexible. This is not an absolute right, and reasonable restrictions can be placed on this right in the interest of the public.

However, non-compete clauses being restrictive to the employees is in direct contravention of Section 27 of the Act and Article 19(1)(g) of the Constitution of India. It thus, raises the question of enforceability since the clause is directly in conflict with the legal right as well as the fundamental right of an employee. Thus, the judicial precedents must be analyzed to better understand the current position.

JUDICIAL PRECEDENTS

Pre-Termination vis-à-vis Post Termination
In a pre-termination non-compete clause, a restrain is imposed only during the continuance of the employment period. Courts have upheld the enforceability of such a clause.
In the case of Precept D’ Mark v. Zaheer Khan and Anr., A.I.R. 2006 S.C. 3426, the Supreme Court had opined that Section 27 of the Act deals with the following-

“… 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. This doctrine is not confined only to contracts of employment but is also applicable to all other contracts”

Further, in the case of Niranjan Shankar Golikari v. Century Spinning Mfg Co. Ltd A.I.R. 1967 S.C. 1098, the Supreme Court observed that:
“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”.
On the other hand, a post-termination clause bars the employees from entering into a similar business or profession for a particular period or for a specific geographical area with an objective to guard the employers’ business once the term of employment is concluded.
With regard to post-termination non-compete clauses, in the case of Superintendence Company of India (P) Ltd. v. Krishan Murgai, (1981) S.C.C. 246 2, the Hon’ble Supreme Court has held that a contract which has an object restraining trade is prima facie void. The Court also that under Section 27 of the Act, there could be no post-employment limitation even if the restrictive covenant were to include termination of employment at the employee’s will.
Further in the case of Foods Ltd. and Others v. Bharat Coca-cola Holdings Pvt. Ltd. & others, 1999 V.A.D. Delhi 93, the Delhi High Court has categorically mentioned that post-termination restraint, under Indian Law, is in violation of Section 27 of the Contract Act. Such contracts are invalid, unenforceable, and against public policy.
Given the distinct and contrary interpretations of the Courts in different cases, it can be inferred that the effect of non-compete clauses is different in pre and post-termination. It may be concluded that Indian courts have distinguished between the pre-termination time of employment and the post-termination period of employment when resolving disputes involving a non-compete clause in an employment agreement.
Even though the Courts have been understanding of the application of non-compete clauses, they have gone above and beyond to guarantee that these clauses do not take effect after an employee’s employment ends and have ruled that doing so would violate Section 27 of the Act.
In order to safeguard their business interests, the employers often includes the condition requiring a Garden Leave in the event a non-compete clause might not be upheld once the employment contract is terminated.

GARDEN LEAVE CLAUSES
The garden leave clauses are typically substituted for post-termination non-compete clauses in the agreement. This clause provides employees with remuneration for a specific period of time during which he refrains from working for a rival company or elsewhere.
Garden leave is a prevalent technique used by employers all over the world, but especially in the United Kingdom. This specific clause has not yet been given legal status in India, despite replacing non-compete restrictions in many other countries. The aim behind the introduction of such a clause is to protect the business interests.
In the case of V.S.F. Global Services Pvt. Ltd. v Mr Suprit Roy, 2007 SCC OnLine Bom 1083, even the Bombay High Court categorically held that such clauses are not principally restrictive of any trade activities.

AMLEGALS REMARKS
The Indian approach with regard to pre-termination non-compete clauses is clear, with the Courts upholding its validity. On the other hand, the post-termination non-compete clauses are still in the grey area. Judiciary, from time to time, has stepped in to protect the interest of the employees from harsh and unreasonable employment clauses.
Thus, a fixed set of rules governing such clauses is the need of the hour so that justice is served to all. It should not be necessary to impose severe restrictions on employment after termination because doing so would harm the employee’s interests and result in such clauses being void.
However, for the time being, it should be remembered that when formulating post-termination non-compete terms, whether, for any employment contract or other commercial transaction, the employer’s interest should only be safeguarded to the absolute minimum.

– Team AMLEGALS assisted by Ms. Pritha Lahiri (Intern)