Non-compete clauses have largely become a frequent feature across employment contracts of mid to large sized organisations which essentially understood, are restrictive covenants which prohibit or limit the extent to which an employee may gain employment with a competing entity or initiate a business in the similar market space, and are ordinarily limited in their scope and purport within a particular territorial jurisdiction or time period. The intent behind the introduction of such clauses is largely to refrain confidential and proprietary information from being used by a competitor which results in loss of business, which becomes particularly crucial and merger and acquisition deals, among others.
However, the enforceability of such agreements has been contentious with Indian Courts rulings in relation to negative covenants. The larger legal principle while determining the enforceability of non-compete clauses has remained to be reasonability of such restraints, which ought not to be violative of the provisions under the Indian Contract Act.
Section 27, Indian Contract Act & Restrictive Covenants
While restrictive covenants are not expressly impermissible under the Indian legal landscape, they must remain compliant with the provisions under the India Contract Act for their legal enforceability. Section 27 of the Act holds any agreement which is restrictive of any individual from practicing a profession or carrying out a lawful trade or business of any nature as void under law. While the rationale with which such provision has been introduced is with the intention to maintain freedom and liberty of profession and performing any trade or vocation, such provision disallows parties to even wilfully enter into restrictive contracts.
Test of Reasonableness
While section 27 renders all agreements which are restrictive of the freedom to profess a trade or business of one’s volition as void, negative covenants have been recognised as enforceable by Indian Courts subject to fulfilling certain criterion. The larger approach towards recognizing such agreements as enforceable or not has been to determine the reasonableness of the restrictions in the given facts and circumstances. Till the time such clauses and agreements are of a nature which can be said to be in furtherance of fulfilment of the employment terms and ends thereof, they are not considered as a restrain. By way of example, conditions which require an employee to remain exclusively employed with employer and not attain gainful employment during such term of employment are generally not considered as restrictive covenants.
Another reasonable ground which enables the enforceability of restrictive covenants is when the same are limited in their purport and extent to a limited geographical area which are covered under their scope.
Clauses that apply in Perpetuity Impermissible
Insofar as the non-compete clauses that are limited in their purport to the period of the contract and do not essentially bind the employee beyond such time, they continue to remain enforceable, broadly speaking. It is when their applicability surpasses the period of employment that their enforceability remains under question and largely upon their interpretation by the Courts as per the facts and circumstances of the case at hand.
The Supreme Court of India has ruled in a plethora of cases that non-compete clauses which are limited upto the period of employment is not violative of the provisions under the Indian Contract Act, however, clauses which exceed such term shall be hit by the limitations under Section 27 of the said Act.
It is in this background that several contractual obligations envisage a period of ‘garden leave’ which is essentially a period within which an employee while being compensated with the full salary benefits, is restricted from joining or initiating any business which can be considered as a competing business by the employer.
Safeguarding Proprietary Interests
Indian Courts while considering the enforceability of restrictive covenants are conscious of safeguarding the proprietary rights and interests of a business and seek to strike a balance between ensuring that confidential information, database and other trade knowledge and know-how remain protected, while at the same time such protection of interests does not impinge upon the right of an individual to practice and profess their rightful calling. However, a mere averment to this end shall not suffice for enforcing the validity of a non-compete clause and the aggrieved party must clearly establish the interests that may be at stake.
Non-Disclosure & Non-Solicitation Clauses
Restrictive clauses which aim at protecting the dissemination of proprietary information and database and other such confidential information or preventing unauthorised use thereof have been recognised by Indian courts and are enforceable as such. Further, non-solicitation clauses which aim at preventing non-solicitation of customers and employees of the organisation have also been upheld by Indian Courts and such restricts have not been held to in fact with the provisions of Section 27 of the Contract Act. However, in matter pertaining to non-solicitation, it would not be sufficient to produce and document which may reflect that the clients/customers may have been approached, but the aggrieved party must explicitly establish that any business generation was solely attributable to such solicitation.
Non-Compete clauses in Employment Agreements Vis-À-Vis Commercial Agreements
While employment contracts are individual centric, commercial contracts have been viewed slightly differently by Indian courts given that the bulk of information exchange is far more extensive and therefore such clauses have been acknowledged by the courts as being critical for protection of legitimate business interests of an organisation. In cases of partnerships or contracts between vendors and buyers, the courts have a rather liberal approach and often upheld restrictive covenants as being reasonable.
In a matter before the Supreme Court titled
Gujarat Bottling Co. Ltd. and Ors v. Coca Cola and Ors., pertaining to enforceability of a clause which restricted a franchisee from performing similar functions as that of a competitor, it was held that the same is not hit by the doctrine of restraint of trade, since it was critical to the successful execution of the contract and for achieving distribution of goods belonging to the franchisor.
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