Non-Compete Agreements

- Rahul Aggarwal (Practicing Advocate at Punjab & Haryana High Court)

Definition

A Non-Compete clause is a legal instrument or a negative covenant, which is commonly used in employment contracts. Under this, certain restrictions are imposed on the person (employee) to not engage in the same business as his employer, or to not engage with the employer's competitor. These restrictions are often in a certain geographical ambit and a limited time period. The main rationale behind such negative covenants is to protect confidentiality, and to prevent solicitation, in turn preventing any unfair advantage to the person leaving the place.

There has been an ample amount of controversy surrounding the legality of the non-compete agreements in India, especially, when they extend to the term after the termination of the employment. 

Section 27 of the Indian Contract Act, 1872

Section 27 of the Indian Contract Act, 1872 (“Contract Act”), renders agreements which restrict trade, business, or any lawful possession void. There has been an expectation carved out under the same, that relates to selling of a goodwill of a company. However, the exception is archaic and very narrow to include non-compete agreements within its ambit. A bare reading of the Section 27 of the Contract Act is not at all sufficient to establish the legality of non-compete agreements. However, courts on many occasions have clarified that such agreements are valid and legal if they are reasonable and not exploitative. Now I shall analyse the arguments in favour and in against such agreements with help of prevailing case laws.

Observations

The often used argument while terming non-compete agreements as void is that of Section 27 of the Contract Act, and right to free trade and occupation. The main aim of an employer to make such agreements is the maintenance of confidentiality, to keep its clients and to protect its trade secrets. Further, it could be argued that if agreements if a contract can contain clauses such as non-solicitation and non-disclosure, then why is there a need to restrain a person altogether from working in that domain. 

Against this these companies often claim that just stopping someone from sharing trade secrets isn't enough to keep their confidential information safe. They argue that since the person now works in a similar role at a different company, it's almost certain they'll end up revealing the secrets anyway. 

The former argument has always compelled and convinced the courts because in the modern economy, such agreements are necessary to maintain a healthy and fair competition, and to prevent disclosures of sensitive information and secrets of a company. However, courts have always attempted to keep a check on such agreements, and have placed emphasis on “reasonability” of such agreements. 

Legal Position

The legal position of the enforcement of non-compete clauses is pretty clear when it comes to the period of employment, however the same is dwindling when concerning the post-employment period.

The Hon’ble  Apex Court in Niranjan Shankar Golikari vs The Century Spinning And Mfg. Co. Ltd, (“Niranjan”) while citing Brahmaputra Tea Co. Ltd. v. Scarth held that: “An agreement to serve a person exclusively for a definite term is a lawful agreement, and it is difficult to see how that can be unlawful which is essential to its fulfilment, and to the due protection of the interests of the employer, while the agreement is in force.”. There are many more cases regarding the same stating that a non-compete clause is enforceable, provided it is only till the term of the employment. However, there has always been ambiguity when it comes to enforcement of such clauses in post-employment cases.

Legal Position of Post-Employment Non-Compete clauses

When concerning the enforceability of non-compete clauses post-employment period, the courts have pretty much ruled against the same. For instance the Hon’ble Supreme Court (“SC”) in Superintendence Company Of India (P) vs Krishan Murgai has reasoned that any restrictive covenant post-service period is not enforceable. Further in Percept D'Markr (India) Pvt. Ltd vs Zaheer Khan & Anr, the SC stated a restrictive covenant post-employment as non-enforceable, on the ground of it being barred under section 27 of the Contract Act. 

Reasonable Restrictions

The Indian Jurisprudence also provides some reasonable restrictions (although scattered throughout the case laws), which can be included under a non-compete clause, which can be enforceable. These restrictions include protection of trade secrets, protection of goodwill (exception under section 27), a reasonable time period and a reasonable geographical restriction. For instance in Niranjan, the court reasoned that the restrictive covenant should not go beyond protecting actual business interests of a company. The Delhi High Court in Ozone Spa Private Limited vs Pure Fitness & Ors (“Ozone Spa”), took a liberal approach and restricted the Defendants from starting, operating, or establishing any competing business in the vicinity of the plaintiff's premises. However, the Bombay High Court in Tapas Kanti Mandal v. Cosmos Films Ltd (“Tapas Kanti”), refused to hear any argument of reasonable restrictions and held that such clauses are not enforceable in the post-employment period, and took a confined approach. 

The contradicting decisions of the various High courts like in Ozone Spa and Tapas Kanti, show that there is not an ironclad criteria of reasonable restrictions and the same depends on case to case circumstances.

Conclusion

It can be inferred from the existing jurisprudence, that non-compete clauses in the post-employment period are non-enforceable under the Indian Regime. There exist some reasonable exceptions, however such are considered by the court when they fall under the narrow exception given under section 27 of the Contract Act. There are some foreign laws under which such clauses are enforceable, discussion on which will be further taken upon in upcoming blogs. 

Despite being non-enforceable, non-compete clauses extending to the post-employment period is a common practice in the corporate culture. These types of agreements are not illegal, but merely non-enforceable. Larger firms use it to their advantage, as the employees tend to follow these agreements as they are not willing to delve into extensive litigation regarding the same. This is a huge concern in today’s corporate culture and more debate is required on the same. There is a need for courts to formulate an exhaustive criteria regarding such agreements, and to streamline their approach regarding the enforceability and legality of the same.