This article is written by Suchandra Mukherjee, pursuing Diploma in Law Firm Practice: Research, Drafting, Briefing and Client Management from LawSikho. The article has been edited by Amitabh Ranjan (Associate, LawSikho) and Dipshi Swara (Senior Associate, LawSikho).
Have you recently joined a company and are wondering whether you should be signing the non-compete agreement? Most employers ask the new employees to sign the non-compete agreement, wherein they agree not to start a business similar to the company or work for a competitor for a stated period of time after the relationship ends. In order to understand how such an agreement works, we need to understand the importance of entering into a non-compete agreement, major clauses, and its enforceability.
What is a non-compete agreement?
A non-compete agreement is a legal agreement or clause in a contract stating that an employee should not compete with an employer once the period of employment ends. These agreements also prohibit the employee from disclosure to any third party during or after employment of proprietary information or secrets.
Let’s understand non-compete agreement by taking a simple example;
Let us consider a business with a particular number of employees and partners; in order to convert an employee to an asset to the business, training is required so that the employee is familiar with the business structure. However, after working for 3-6 months, the employee learns all of the trade secrets and moves on to another company that offers more packages than the first.
So, how can we constrain the knowledge and strategies provided to the employee so that he doesn’t pass them on to the organization’s competitor?
Here, the non-compete agreement comes into action. According to the terms of the non-competing agreement, an employee cannot enter into a competition or disclose any business secrets of the organization within the employment period and post-employment for a reasonable amount of time after the employment is over.
There is also another bond that an employee needs to accept while entering any organization known as the Employee Bond which requires an employee to work for a fixed amount of period within that company and if that employee breaks the bond before that period, then he/she would have to pay a fixed amount as compensation to that organization.
Key pointers of a non-compete agreement
- The non-compete agreement ensures that the employee DOES NOT ENGAGE in any kind of direct or indirect competition with the organization during a specified term.
- It basically binds a working or former employee of an organization legally from COMPETING WITH AN EMPLOYER for some period of time after the employment ceases.
- The employer MUST NOT REVEAL any trade secrets learned during the period of employment.
- The non-compete agreement LIMITS THE TIME PERIOD during which the employee shall not work with a competitor, geographical location, or market.
- Non-compete agreement PREVENTS AN EMPLOYEE FROM GETTING A JOB in their field if they leave a position.
The functionality of a non-compete agreement
A non-compete agreement is operative during:
- The period of employment.
- After the termination of the offer.
In the Indian system, the courts in most cases have refused to enforce the POST-TERMINATION clauses of a non-compete contract in the restraint of trade and have held such agreement to be void-ab-initio as it is not permissible under Section 27 of the Indian Contract Act, 1872, and such contract was always held as against the public policy (discussed in the next section of this article) as it deprives a man/women of his/her fundamental right to earn through a way of living.
But with the development of social, legal, and corporate circumstances the employment is required to be confidential and the integrity of the employees has become a prime requirement therefore certain regards have also been made to the non-compete agreements.
Significant case laws
The Hon’ble Supreme Court observed in the matter of Niranjan Shankar Golikari Vs the Century Spinning and Manufacturing Company Ltd that restraints or negative covenants in the appointment or contracts may be legal if they are justified.
In another case V.F.S. Global Services Pvt. Ltd vs Mr. Suprit Roy where the Bombay High Court established the precedent that a restriction on the use of trade secrets during or after the termination of employment does not constitute a “restraint on trade” under section 27 of the Act and can thus be enforced in certain situations.
In the case of Mr. Diljeet Titus Adv vs Mr. Alfred, A Adebare & Ors where the Delhi High Court held that the real test was the degree of employment control to decide whether it constituted a contract of service.
From these all judgments, we can clearly understand that our Judiciary has laid down certain tests through which the validity of the impositions of a non-compete agreement can be examined so that in certain circumstances the confidentiality of an organization and proprietary rights such as the patent and trademarks can be protected.
Industries that use non-compete majorly are the sectors of Information Technology and Media Industries where there is considerable risk of leakage of intellectual property.
Clauses in a non-compete agreement
The clauses present in the non-competing agreement are:
- Parties – Introduction of the parties (here employee) to the contract, address details
- Duration/Term– For how much duration the non-compete agreement will be enforceable as it cannot be implemented for a lifetime, a reasonable duration has to be mentioned.
- Non-compete clause which includes:
- Work- Specify all the work that cannot be done by the employee.
- Damages- If still the employer breaks the contract and opens his own business/goes to some other company.
- Dispute resolution- Through arbitration or by the court?
- Signature of the parties.
Constitutionality and enforceability of the non-compete agreement
Is non-competent agreement violative of the fundamental rights of individuals?
Section 27 of the Indian Contract Act, 1872 – “Every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.”
Explanation– Any agreement that restricts anybody from engaging in a lawful profession, trade, or business of any type is null and void.
Such an agreement shall not be binding and be considered null and void and such clauses of the agreement will be beyond consideration.
There is an exception to this section that says –“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.” [see]
If we examine the implications of Section 27 in relation to the exception specified, we can conclude that in order for such trade restrictions to be enforceable, the parties’ agreement must be reasonable and consistent with the interest of the public.
So, now what do we understand by the two terms public policy and reasonable restriction?
- Public Policy – The term public policy itself is very uncertain, it is totally the functionality of the judiciary to define what is ‘public policy’ and what is not. Therefore, to decide upon what all agreements are against public policy and what agreements are not, will totally depend upon the judiciary. In general, any agreement which is intending to injure the public interest or public welfare is against public policy. It can also include any such injustice of operation, restraint of liberty, trade, and commerce and natural or legal rights, that is simply whatever tends to the injustice of operation, restraint of liberty, commerce and natural or legal rights, whatever tends to the obstruction of injustice or violation of statutes and whatever is against good morals can be said to be against Public Policy.
- Reasonable restrictions – Reasonable basically means as per the reasons, that is, whatever an ordinary person would do or restraint from doing using his common sense and knowledge. The test of reasonability depends on the facts and circumstances of each case.
Certain non-compete contracts with reasonable restrictions may be imposed like the following:
- Distance – Restrictions on employees to practice the same profession within a given distance, such that the given distance is reasonable.
- Time limit – If a reasonable time period is mentioned in the clause, then such restriction will be considered reasonable.
- Trade Secrets – An employer can definitely put reasonable restrictions on revealing trade secrets or sensitive information.
Certain legislations have also been made for ensuring confidentiality and privacy of such sensitive information especially Section 72 of The Information Act 2000, and breach of such confidentiality can even lead to imprisonment and a fine up to 1 Lakh rupees.
- Goodwill – According to Section 27 of The Indian Contract Act 1872, distribution of goodwill will be considered as a reasonable restriction.
Along with these above stated the judiciary can also put reasonable restrictions through CERTAIN REMEDIES in order to prevent a third party from compromising sensitive and confidential information are—
- Injunction — A court order that forces a person to perform or refrain from performing an act that is necessary for the interests of justice and whose absence would be contrary to good faith and good conscience.
- Compensation – This remedy is provided by the court to compensate for the losses and damages.
In this age of globalization and industrialization non-compete agreement is very essential for an organization and is valid during the employment period and after the termination of that offer also.
The enforceability of a non-compete agreement is a contentious issue. The enforceability of the Indian judiciary system is not as broad as in other countries. As a result, non-compete clauses have become a matter of disagreement in a number of cases. Unless it is coupled by certain reasonable restrictions, a non-compete is totally valid during employment and afterward.
With the evolution of social, legal, and business circumstances, employment is necessary to be discreet, and employee integrity has become a primary demand; consequently, consideration has been given to non-compete agreements. The present trends of the Indian judiciary i.e to recognize fair and justifiable non-compete clauses in the different agreements listed above are notable initiatives in that regard.
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