Non-compete clauses and should they be allowed in India
Author: Harkaran Singh Kochar
College- School of Law, Christ
Abstract:
Non-Compete clause is a clause in an employment agreement by virtue of which an employee is restrained from, either working with a competitor or carrying out a competing business. In the case of Petrofina (Great Britain) Ltd v Martin, Lord Justice Diplock LJ defined restraint of trade as “a contract in restraint of trade is one in which a party agrees with any other party to restrict his liberty in the future to carry on trade with other persons not party to the contract in such manner as he chooses.” What has to be realized that this definition is not an exhaustive one i.e. it is still open to various different kinds of interpretations. Section 27 of the Indian Contract Act, 1872 has defined it as- “Every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void”. The only exception that is made to this rule is the attachment of goodwill of a person to the firm which he joins. What this paper has tried to Put forth is the idea that these provisions are perhaps too restrictive with their application. In today’s world specially in the technology and auditing industries, these provisions shouldn’t so restrictive. It is the right of an employer to protect his investment i.e. the intellectual property they have worked towards. It is envisaged through this paper that the restrictions of the 1872 legislation be relaxed so that any work performed by an employee under contract is not subjected to the scrutiny of the courts if there is a breach. What means through this is that there is a vigil mechanism already in place which ensures the protection of workers and the employers at the same time. The remedies offered are more often than not aren’t able to cover the losses incurred as once the damage has been done it spreads over a period of time. Along with this there is also a the tedious and often expensive litigation which the party has to go through. A degree of reasonability has to be exercised however, to ensure rights of the employee are protected and he isn’t hamstrung if he decides to leave the firm and join a competitor.
Part I- Introduction
To put the definition of a non-compete agreement (hereinafter referred to as an NCA) in a very simple manner, is an agreement an employer might require an employee to enter into that prevents him from going to the competition after his term with the current employer comes to an end for a certain amount of time.[1] In order to fully understand this concept we also need to look into why they are enforced. The basic concept behind this clause is to protect any sort of:
- Privileged information.
- An intellectual property.
- Other Trade Secrets that come under the definition as adopted by the court under the case of Tata Motors Limited v State of West Bengal[2].
Non-compete vs Non-Disclosure Agreements- What’s the Difference
When talking in layman’s terms, a there is little difference between the two. However, the Indian legislature and the Judiciary has drawn a line. A Non-Disclosure Agreement is one where one party agrees to not reveal any information that has been shared with them by the client.[3] This
is something commonly found when the work being performed involves information which can be detrimental to the concerned party like an auditor for a company or even a profession like that of an Advocate.
is something commonly found when the work being performed involves information which can be detrimental to the concerned party like an auditor for a company or even a profession like that of an Advocate.
The key point of difference between the two is the fact that an NDA doesn’t prohibit an employee from going to work for a rival right after the termination of his employment while an NCA does the same. The way the Indian Courts have interpreted the concept of an NCA is very flawed. This is highlighted through the Section 27 of the Indian Contract Act which provides the following:
“Agreement in restraint of trade, void – Every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void [4]”
How does one determine a stable/just NCA?
Seeing as the main objective of this agreement is ensure the restraint of business, it can easily be considered as a direct violation of Article 19(1)(g) of the Constitution.[5] There are 5 main factors which need to be considered while an NCA is being drafted[6]:
- Is the restriction reasonably necessary to protect the employer?
- Is the restriction reasonable in terms of time limitation?
- Is the restriction reasonable in geographic scope?
- Is the restriction unduly hard on the employee?
- Does the restriction violate public policy?
The above requirements are looked into by some states in the US while determining a valid non-compete agreement. The validity of these agreements is also a debated topic since because of the model of Federation that is followed by the United States allows for different jurisdictions to have contradicting laws for the state. In India as well these requisites can be applied by the courts since they operate on principles justice and equity. The fact that there might be a temporary restraint of trade can’t be ignored. But along with that there also needs to exist a requirement to observe the rights of the employers to ensure that an employee who joins them and receives any sort of specialized training or even the fact that he is made privy to information that is highly sensitive to a client and he can exercise it to his advantage has to be curtailed. This is stems from the fact that any unpublished IP for instance can be mis-appropriated and the actual owner (the employer in this case) can lose the rights to his work before he is able to publish because of the non-existence of this clause.
Thus, although many employers are aware of the potentially contested enforceability of post-employment non-compete agreements and ‘garden leave’ clauses, these boilerplates remain popular in the employment agreements of several firms operating in India. The main reason behind their continuity is more psychological than legal. Since, a majority of employees in India remain unaware or unsure about the legalities of their employment agreements and are generally reluctant to initiate time-consuming legal proceedings against their employers. Consequently, they perceive the non-compete clause as binding; many abide by it fearing legal repercussions. Therefore, although not legally binding, such clauses in employment agreements often serve their intended purpose by exploiting the psyche of employees.
Part II- Stance of the Indian Judiciary vis-à-vis NCAs
As stated before, the stance of the courts of India is very clear on the validity of the NCAs. Indian courts have always considered the specific facts and circumstances of the case and the conflicting interests and rights of the involved parties while determining legal validity.
Section 27 of the Indian Contract Act, 1872, provides for an agreement in restraint of trade. It 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. The Supreme Court of India in the landmark case of Percept D’ Mark (India) Pvt. Ltd v. Zaheer Khan[7], discussed Section 27[8], and laid down that if a restrictive covenant in the agreement is framed in such a way that it extends even after the term of the contract has expired then such a covenant in the contract will not be enforceable. Further, the Apex Court had also noted
that this principle also applies to all contracts and not just employment contracts with respect to obligations continuing after termination of contract. This view is something that seen to be uniform under not just the Contract Act but also under competition laws. This was highlighted by the supreme court in Mr. Larry Lee McAllister v. M/s. Pangea3 Legal Database Systems Pvt. Ltd. & Ors.[9] It was observed in this case that a non-compete clause in an employment contract is not in violation of Sections 3 and 4 of the Competition Act, 2002.
that this principle also applies to all contracts and not just employment contracts with respect to obligations continuing after termination of contract. This view is something that seen to be uniform under not just the Contract Act but also under competition laws. This was highlighted by the supreme court in Mr. Larry Lee McAllister v. M/s. Pangea3 Legal Database Systems Pvt. Ltd. & Ors.[9] It was observed in this case that a non-compete clause in an employment contract is not in violation of Sections 3 and 4 of the Competition Act, 2002.
It is made clear that in India these restrictive covenants are thought to be fully against the spirit of Article 19(1)(g)[10] and are considered void-ab-initio.
Part III- What would be the impact of having the restrictive covenants allowed in India- A benefit or means of exploitation?
Now that there is a fundamental knowledge of what NCAs are and what are the pitfalls to one along with the benefits of having one signed before an employee joins an organisation. The next task that comes up is whether there needs to be a change in the interpretation of Section 27[11] to allow for such a clause in an employment contract. If the parameters for the clause are made clear and precise, then such a provision would be very beneficial. The main requisites of an NCA are:
- Time of restraint.
- Geographical area.
- Nature of the work being performed.
- Scope of the agreement.
If we assume a situation wherein an amendment is made to the Indian Contract Act, 1872 which removes the restrictiveness of Section 27 and allows for the NCAs to be formed while keeping in mind the above 4 factors so as to ensure un-exploitation of the employees in the organised sector, these are the following pitfalls one might face in such a scenario[12]:
- Employees may feel themselves to be locked into one employer since everyone would try and enforce them.
- High performing employees and in-demand candidates do not prefer a restrictive covenant. This stems more from the fact that they know their worth in the industry and as such they can expect a better offer to come their way at any point in time. They may prefer instead to work for an employer that won’t impose this type of restriction, so the requirement of a non-compete can sometimes lose you potential and existing employees.
- In order to enforce any contract, you have to sue the breaching party. If the former employee cannot pay a judgment, or you cannot establish damages, you may expend a great deal of time and energy to obtain a worthless judgment. It is important to weigh the costs against the benefits before you begin litigation with your attorney.
- If the contract is formed by a competent attorney, the employees may try to find loopholes around the agreement which would allow them to “break the non-compete” and open a competing business.
An example of an employee opening up a competing firm is the classic Gloucester Grammar School Case[13] which demonstrates how the former employer will not have any recourse if an employee opens up a competing firm to run the other out of business. It is a well-founded principle of common law that intent of opening a rival form is of no consequence since because of the fact that no legal right has been breached. This is also highlighted through the legal principle of ‘Injuria Sine Damno’ which literally translates to ‘injury suffered without an actual loss’. Although the above case never did have a restrictive clause but the essence being drawn is the fact that a lack of it allow for the rival school to come up right next to it.
Conclusion:
The disadvantages of this covenant are completely offset by its benefits which in a nutshell are summarised asunder[14]:
- The most obvious perk of having a non-compete agreement is that it can prevent your valuable employees from leaving to work with a competitor. If an employee should leave or start their own competing business, a non-compete can also save you from the loss of key customers.
- A “trade secret” can be a formula, pattern, compilation, program, device, method, technique, or p
rocess, that has value because it is not generally known and because it is being kept secret. When a business owner shares this kind of information, it is important to try to maintain its confidentiality by using a non-disclosure agreement. But practically speaking, if a former employee goes to work with a competitor, a non-disclosure agreement is not enough. By combining a non-disclosure with a non-compete agreement, you can be certain that former employees cannot exploit information you gave them for the benefit of another. - They can help retain employees. With a non-compete agreement in place, employees may be less likely to leave. You can even put a payback clause in the agreement, which will require your employees to reimburse your training costs if they leave before a prescribed period of time has passed. As an employer, you might find these tools useful to protect the investment you’ve put in your people.
In summation, if the provisions of the Contract Act are amended, it would provide for a greater influence of human capital for the firms as they will have the capabilities to ensure that their interests are protected. Moreover, it would also ensure that any protected IP that is worked on by a person doesn’t get stolen by a disgruntled employee. An indirect effect of this would be that it would allow for more start-ups to emerge in niche areas of business where the innovations are so few and far between that protection becomes effectively mandatory for them.
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[1] Kenton, Will, Non-Compete Agreement, https://www.investopedia.com/terms/n/noncompete-agreement.asp
[2] G.A. No. 3876 of 2008 in W.P. No. 1773 of 2008.
[3] Twin, Alexandra, Non-Disclosure Agreement, https://www.investopedia.com/terms/n/nda.asp
[4] Indian Contract Act, 1972.
[5] Constitution of India.
[6] Cohen, J, Michael, 5 Key Factors in Determining Enforceability of Non-Compete Agreements in Wisconsin
[7] (2006) 5 CompLJ 271 Bom
[8] Indian Contract Act, 1872
[9] Case No.66 of 2013, https://www.cci.gov.in/sites/default/files/662013_0.pdf
[10] Constitution of India
[11] Indian Contract Act, 1872
[12] Muir, Jane, The Advantages and Disadvantages of Non-Compete Agreements, https://jmuirandassociates.com/non-compete-agreement-florida/
[13] (1410) YB 11 Hen IV, fo. pl. 201, 23
[14] Muir, Jane, The Advantages and Disadvantages of Non-Compete Agreements, https://jmuirandassociates.com/non-compete-agreement-florida/