Viability of Non-Poaching Agreement

Introduction

One of the critical problems faced by Human Resources (“HR”) managers these days is employee attrition, which, in a broad term, is a situation faced by an employer when his employees leave due to job dissatisfaction, new opportunities in the market, better compensation etc. This is a problem faced by companies all over the world, and Information Technology (“IT”) companies in India are no strangers to employee attrition.

Human talent, being the epitome of business growth, makes it imperative for companies to deal with their employee attrition. Keeping this in mind many HR teams of major IT companies keenly explored a “Non-Poaching” agreement (“NPA”). The present bulletin focuses upon the reasons for the need of NPA, its viability and enforceability under the Indian Contract Act, 1872 (“Act”) and the Competition Act, 2002.

1.0 Need for NPA

In India, as the talent pool in the IT sector is limited, IT companies have to shell out huge sums of money to train fresh recruits in order to make them employable,¹ which is why IT companies prefer hiring people who have already been groomed in their previous jobs so that they (the hiring company) can start reaping rewards immediately. On the contrary, many argue that the amount spent in training a fresh recruit (inclusive of wage and client costs) turns out to be cheaper than what is paid to an experienced employee, for the same work.

As this is a common problem being faced by the IT sector in India, the HR teams of these companies have been trying to come up with a solution on their own to cut down on attrition of employees, and to prevent their employees from joining competitors. In July 2010, the HR teams of the IT companies located in the Hinjewadi IT Park, Pune got together to try and formulate a pact for reducing or minimizing the employee attrition rates. They proposed NPA which in essence is a code of ethics on lateral hiring in the same industry.

From a business perspective, this may seem logical, however, it will be equally crucial to examine the viability of the NPA from a pure legal standpoint and also see if such agreements will be enforceable and doable in India.

2.0 NPA: Viability of contractual provisions

Under Indian law, an agreement, in order to be considered a contract, must be made by the (a) free consent of the parties² and (b) parties competent to contract.³ Further, the objects and considerations of the contract must be lawful and must not be declared void⁴ or unlawful under the Act. The section 27 of the Act provides that, barring a few exceptions, any agreement in restraint of trade is considered as a void agreement. It will be worthwhile examining if NPA falls within the exception under section 27 of the Act.

The enforceability of the NPA can be tested under the provisions laid down under section 27 of the Act which holds any agreement restraining an individual from exercising a lawful profession, trade or business of any kind to be void.⁵ The Act considers restraint to be reasonable if it affords fair protection to the parties and does not interfere with the public interest. The reasonableness of NPA contractual terms/provisions of contracts should not be against the public policy.⁶ Thus, a stipulation in an agreement whereby a party agrees not to hire HR from other companies for a certain period and in exchange gets a similar confirmation from the other company to not hire their HR is not in restraint of trade.

The negative covenant in such an agreement generally applies for the period of the agreement and sometimes even after the agreement. Often companies enter into agreements like non-compete (“NCA”) with their employees, restricting them (the employee) from entering into a relationship with another employer, even after the fulfillment of contract or agreement, to protect their (company’s) interest. Companies share client information, trade secrets, etc, with the employees of the company and when an employee leaves the company there is a threat of divulgence of the aforementioned secrets. Agreements which extend beyond the contractual period, i.e. after the employee has left the employment of the employer, are in restraint of trade and void. However, an agreement which restricts an employee from divulging the secrets of a company has been held by the Supreme Court to be a valid restriction.⁷

In Gujarat Bottling vs. Coca Cola Company,⁸ the Supreme Court held that a man is entitled to exercise any lawful trade or calling as and where he wills, as long as it is not against public policy or interest. It further held that under section 27 (a) a restrictive covenant extending beyond the term of the contract is void and not enforceable, (b) the doctrine of restraint of trade does not apply during the continuance of the contract for employment and it applied only when the contract comes to an end, and (c) this doctrine (section 27) is not confined only to contracts of employment, but is also applicable to all other contracts.

As per section 42 of the Specific Relief Act, 1963, a court may grant an injunction to perform a negative covenant even if due to certain circumstances it is unable to compel

specific performance of the affirmative part of the same agreement. This situation arises when a contract comprises both an affirmative agreement to do a certain act, coupled with a negative agreement, express or implied, not to do a certain act. This proposition is, however, subject to the proviso that the plaintiff has not failed to perform the contract so far as it is binding on him. The principal concern regarding enforceability of a negative covenant in an agreement is that if an agreement is challenged on the ground of it being a restraint of trade, the onus is upon the party supporting the contract to show that the restraint is reasonably to protect their interests. Once this onus is discharged, the onus of showing that the restraint is nevertheless injurious to the public is upon the party attacking the contract.

Often the NPA has been confused with the NCA. The NPA is different from the NCA. Unlike the NCA, which is between an employer and an employee, the NPA is between two employers. A NCA restricts the employee from seeking employment with a rival or other company, whereas, on the other hand, NPA refrain’s other companies from poaching into each other’s talent pools. A NPA confers fair protection upon the parties to the agreement by setting out guidelines to be followed in case of lateral hiring. Furthermore, it does not restrain an individual from exercising a lawful profession, nor does it restrict an individual from joining another company, or carrying out the same profession. It simply requires a company to first take permission of the company from which it wants to recruit. This is in conformity with law, as (a) it is not in restraint of trade and (b) it also protects the interest of the company from which the employee is being recruited as it gives time to a company to find replacement, which would be difficult in case of poaching.

3.0 Viability under the Competition laws

The Competition laws aim to (a) prevent practices that would have an adverse effect on competition, (b) promote and sustain competition in the market, (c) protect the interest of the consumer⁹ and (d) ensure freedom of trade.¹⁰ Section 3 of the Competition Act prohibits agreements which are anti-competitive in nature. It restricts enterprises, association of enterprises or persons from entering into agreements which cause or may cause adverse affect on competition within India. Further, agreements which contravene the above are considered void ab initio, i.e. void since inception.¹¹ NPA does not fall under the ambit of this section, as it does not ban lateral hiring, but instead sets guidelines to be followed in case of lateral hiring.¹² Thus making the NPA in conformity with the competition act as it (a) does not have an adverse effect on competition, (b) does not in any way un-promote competition, and (c) ensures freedom of trade as it does not restrict an employee from working for another employer.¹³

Conclusion

In deciding whether a restraint of trade is reasonable, the “interests” which the restraint is designed to protect must be kept in mind. The principle is that it is valid if, and only if, it is reasonably necessary to protect the legitimate interests of the promisee. The validity of such a restraint depends on the proprietary interest, reasonableness, and public interest. Therefore, a covenant in restraint must be reasonable in reference to the parties and in reference to the interest of public, so framed and so guarded as to afford adequate protection to the party in whose favor it is imposed and at the same time it is no way injurious to the public.

Though the IT companies could not come to an agreement over the NPA and concluded that such an agreement is not viable, the companies did agree to hire from rivals only after candidates have fully served out notice periods. Earlier, it was common practice for the hiring companies to pay salary in lieu of the notice period, which worked well for the hirer, but caused problems for the previous employer who would not have enough time to find replacement. India, though, may seem to be the best breeding ground for NPAs, it still has a long way to go. As held in Gujarat Bottling case, restrictive clause must be ancillary to main transaction and necessary in interest of both parties and also should be clear and definite. This would be a good practice for the IT companies which want to execute NPA as it might at least keep the attrition rate under check to some extent.

Authored by: Divij Kumar

1 The Hindu, Business Line, “IT industry spends Rs 3,000 every year on training fresh graduates” (July 05, 2010), please see http://www.thehindubusinessline.com/2010/07/06/stories/2010070651070700.htm, visited on August 28, 2010
2 Section 13 of the Act
3 Section 11 of the Act underlines the parties competent to contract and Section 12 of the Act defines what a sound mind is for the purpose of contracting
4 Section 24 to section 30 of the Act
5 Section 27 of the Act
6 The law has always opposed any interference with freedom of the contract and all restraints upon the liberty of an individual action unless injurious to the interest of the state and public is said to be the public policy. Black’s law dictionary defines “public policy” as principles and standards regarded by the legislature or by the courts as being of fundamental concern to the state and the whole of society. And more narrowly, a person should not be allowed to do anything that would tend to injure the public at large
7 Shankar Golikari v. Century Spinning and Manufacturing Co. Ltd. (1967)ILLJ 740 SC
8 AIR 1995 SC 2372
9 Defined under clause (f) of section 2 of the Competition Act, 2002
10 Preamble to Competition Act, 200
11 Sub-clause (2) of section (3) of the Competition Act, 2002
12 Example- Company A wants to hire from Company B. As per the NPA, Company A can hire from Company B after obtaining the consent of Company B. Further, the employees of Company B may have to serve the notice period. This gives Company B adequate time to find replacement for the employees to be hired by Company A
13 It is to be noted that an employee can only work for another employer after fulfilling the contractual obligations with the current employer