Enforcing non-compete clause

Introduction

With the escalating cross-border transactions and improved competitive environment in India, a clause of non-compete is increasingly becoming necessary for companies executing contracts to safeguard its business interests, profitability, future prospects, and goodwill. This is essentially aimed at protecting the proprietary and confidential information of the companies. Under Indian law, an agreement with a “Non- Compete Clause” is referred to as “Agreement in Restraint of Trade”. This article analyses the statutory basis of non-compete provisions generally and with reference to employment agreements, the nature and scope of such non-compete restrictions.

1.0 Statutory Provisions

Under section 27¹ of the Indian Contract Act, 1872, every agreement in restrain of trade is void to the extent the agreement not to carry on business of which good will is sold is entered. The exception provides that “One who sells the goodwill of a business may agree with the buyer to refrain from carrying on a similar business, within specified local limits, so long as the buyer, or any person deriving title to the goodwill from him, carries on a like business therein: Provided that such limits appear to the court reasonable, regard being had to the nature of the business.” Section 27 aims at contracts by which a party precludes altogether for a limited time or area from exercising profession, trade or business and not at contracts by which in exercise of his profession, he enters into ordinary agreements with persons dealing with him for carrying on his business. Also, the reasonableness of non-compete contractual terms/provisions of contracts should not be against the public policy.²

In case of employment agreements, usually the appointment letter serves as a contract for employment and usually includes a non-compete clause. A non-compete clause is essentially a term used in contracts under which the employee agrees to not pursue a similar profession, trade or business in competition against the employer. Apart from the regular employment agreements, such covenants are also at times included in the agreements relating to sale of goodwill of business or professional practice, employment exit and other exclusive dealings and service arrangements.

A stipulation in an agreement whereby a party agrees not to sell to others for a certain period any goods of the same description they were selling to the other contractual

party is not in restraint of trade. Further, section 42 of the Specific Relief Act, 1963 prescribes that court can 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.

Finally, 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. The negative covenant in an agreement applies for the period of the agreement and sometimes even after the agreement. During the subsistence of an employment agreement any restrictive covenant is enforceable, however, beyond such term it constitutes a restraint of trade. A contract which is in restraint of trade cannot be enforced unless (a) it is reasonable as between parties and (b) it is consistent with the interest of the public.

2.0 Judicial view

The judicial view over the years has been confirmed in a landmark judgment of Gujarat Bottling Co Ltd. vs. Coca Cola Co³, wherein the Supreme Court (“SC”) held that a negative stipulation like the one contained in franchise agreements restraining the franchisee from dealing with competing goods were for facilitating the distribution of goods of the franchiser and could not be regarded as a restraint on the right to trade. The SC further held that neither the test of reasonableness nor the principle that the restraint being partial or reasonable will apply to a case governed by section 27 of the Contract Act, unless it falls within the exception.

The SC, in Percept D’Mark India Pvt Ltd vs. Zaheer Khan and Others,⁴ observed that if the negative covenant or obligation in the contract is sought to be enforced beyond the term, then it constitutes an unlawful restriction on an individual‟s freedom. In the instant case, Zaheer Khan entered into an agreement with an event management and marketing company Percept which upon expiry was not renewed by him. However, Percept tried to restrict Zaheer Khan to enter into fiduciary relationships with persons of his choice, and tried to forcibly enter into a fresh contract with him even though he had fully performed the previous contract. The court held any restriction extending beyond the term of agreement is a restraint of trade which is void under section 27. The SC 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) as held in Gujarat Bottling case, this doctrine is not confined only to contracts of employment, but is also applicable to all other contracts.

In Sunilchand C Mazumdar vs. Aryodaya Spg and Wvg Mills Co Ltd,⁵ the question whether a particular covenant in an agreement of service is unreasonably wide depends upon the nature of the agreement, the service to be rendered, the place of employment and availability of service of the same nature.

In the case of V.V. Sivaram and others v. FOSECO India Limited⁶, an employee was restrained from using secrets and confidential information, which he gained during job, even after moving out of the job. The employee had access to confidential information pertaining to several products including the patent „Turbostop‟. He left under voluntary retirement scheme. Injunction restraining him from manufacturing and marketing a product similar to

„Turbostop‟ was held to be not violating section 27.

In a 2009 decision by the New Delhi High Court in Desiccant Rotors International Pvt Ltd v. Bappaditya Sarkar & Anr⁷, as part of his employment agreement, a senior marketing manager at a manufacturer of evaporative cooling components, products and system with Desiccant, agreed that for two years following the termination of his employment, he would be bound by a covenant with Desiccant that would require him to keep Desiccant‟s matters confidential as he was dealing with confidential material in the nature of know-how, technology, trade secrets, market sales, etc of the company. Further, he agreed to not compete with Desiccant and solicit its customers, suppliers and employees. However, three months after resignation, he joined a competitor of Desiccant. In injunctive proceedings against the manager by Desiccant, the Delhi High Court reiterated the principles embodied in section 27 of the Act and the individual‟s fundamental right to earn a living by practicing any trade or profession of his or her choice. Brushing aside any argument by Desiccant that the restrictive covenants were primarily designed to protect its confidential and proprietary information, the High Court ruled that in the clash between the attempt of employers to protect themselves from competition and the right of employees to seek employment wherever they choose, the right of livelihood of employees must prevail.

Conclusion

In deciding whether a restraint of trade is reasonable, regard must be had to the “interests” whom the restraint is designed to protect. 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 of trade 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. 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. It is a good practice for the entity which wants to impose a restriction to insert non-compete clauses in agreements, as it might at least dissuade the other party not to disregard it. Negative covenant which restricts the employee beyond the period of employment are considered to be unreasonable. The exception being extended to confidential information and non-solicitation agreement to a reasonable period of time are valid.

Authored by:
Neeraj Dubey

1 Section 27 of the Contract Act, states: “Every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void”
2 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
3 AIR 1995 SC 2372
4 AIR 2006 SC 3426
5 AIR 1964 Guj 115
6 [2006]133CompCas160(Kar)
7 (I.A. No.5455/2008, I.A. No.5454/2008 & I.A. No.5453/2008 in CS(OS) No.337/2008)