This article has been written by Kshitij Pandey pursuing the Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from LawSikho.
A restraint of trade agreement is an agreement in which a party agrees with the other party to restrict his choice and liberty to carry on a trade or choose similar jobs in rival firms. In these agreements, negative covenants or restraints are direct. Negative covenants are often found in contracts between employees and employers so as not to set up business on their own account on poach leaving employees or to enter into a rival firm.
A balance needs to be struck between the rights of the employee and the employer in employment contracts while determining the negative covenants of the contract. The agreement should be read jointly and primacy shall be given to the rights of the employees since the employer has greater bargaining power. Through this article, the author seeks to analyse if employment contracts with unenforceable terms are unethical by taking a look at the various negative covenants in such contracts.
Validity of negative covenants
The validity of negative covenants can be assessed in 3 stages;
- Whether the agreement amounts to total restraint.
- Whether the restraint protects a legitimate interest of the employer or the covenantee
- Whether the restraint is reasonable and not arbitrary.
The last stage involves a two-fold test: – the restraint must be reasonable with reference to both the parties and with reference to the interest of the public.
To test whether the covenant is reasonable, regard shall be given to the interests which the negative covenant is providing restraint and is designed to protect. The test is that it should protect the legitimate interests of the employer and the employee. For example: – a negative covenant on a seller in business not to carry the similar business in the same locality would be reasonable as it protects the interests of the businessman. Similarly, an employer restricting employees from joining rival firms in order to protect sensitive information and trade secrets is reasonable as a covenant brought forth in order to protect the interests of the employer. The validity of such a negative covenant depends on: – proprietary interest, reasonableness and other public interest.
Significance of negative covenants in the employment agreement
For justifying the reasonability of the negative covenant clause, the employer must state the length of time for such a restriction, territory, and make sure altogether that it’s reasonable. The duties, responsibilities and scope of employment at the time of his/her hire should be stated. Due to the non-permanent nature of jobs, the employer must consider whether there is confidential information that if leaked could cause harm or any intellectual property which if revealed could cause a huge loss to the employer. This depends on the post of the employee as well and it is for the employer to see whether the employee is in a junior or senior position along with looking at the specialization the employee brings to the job. The concept of negative covenants is applicable to employment contracts even in the services and labor sector and in real cases most of them have been struck down. Agreements that put complete restrictions on the re-employment of former employees will be struck down. In India, an agreement between members of a trade union is not held void and negative covenants about it will be held invalid.
Balancing of rights
The approach adopted by the Indian courts when it comes to significant decisions regarding negative covenants is to view rights differently and to create a balance between employer rights and employee rights. While adhering to the principle of trade, the prohibition does not apply during the continuance of the contract, the Court prioritizes employer’s rights over workers’ rights. The latter has no choice but to follow the guidelines even if they are committed to the freedom to work in better socio-economic conditions.
A different approach can be seen in the decision of the Supreme Court in the case of Gujarat Bottling Co. Ltd. and others v. Coca Cola Company and Others, where the Court held that there should be a balance between the interests of the employer or covenantor and the rights of the covenantee by laying down that a negative covenant in restraint of trade should be reasonable about public policy and should be necessary to protect the interests of the covenantee and should take into account the interests of the covenanter. The Court further stated that the responsibility rests with the covenantee to provide proof that it is necessary to protect the covenantee’s interests and that if this is done it removes the responsibility to show that the prohibition is detrimental to the public in the attacking party. However, the Supreme Court did not follow this procedure/approach in the case of Percept D’Markr (India) Pvt. V. Zaheer Khan and Another, and held the covenant in a contract to be void as the restriction time limit was extending beyond the validity period of the contract and was therefore struck by Section 27 of the Indian Contract Act.
Delhi High Court in the case of BLB Institute of Financial Markets Ltd. v. Ramakar Jha held that the ease of balance of convenience is in favour of the applicant as the applicant will be compensated monetarily if there are any trade secrets or details relating to courses when course materials and business details are disclosed by the respondent to any other entity conducting business similar to the applicant. Thus, covenants restraining the respondent from seeking employment with any of the businesses similar to the applicant’s business or any organization operating as Stock Market / Capital Market / Financial Market Education Institute were not withheld because they were in the applicant’s interest.
In this case, neither the balance approach is followed nor the doctrine of reasonableness. as there is no limit to the amount of time specified in the agreement which means that he or she will not be able to join another competing organization. So, the High Court did not follow the order of the Supreme Court in the reasonableness test. Therefore, in this case, the primacy is given to the interests of the employer, and the employee has no choice but to work for the same organization, which is limited to the restriction on his trade / freedom to work in any other organization. Had the agreement been given a deadline, the restraint would probably have made sense.
Stages for imposing negative covenants
The Supreme Court, while making a distinction between negative covenants that are operative for the duration of the employment contract and negative covenants that are operative after the termination of the contract of employment said:-
- Covenant during employment
Negative clauses that apply during an employment contract are generally not considered barriers to trade and therefore do not fall under Section 27 of the Contract Act of India 1872. It is a common perception that at the time of employment, an employee is obliged to work for an employer and the exclusive right to the services of the employee are available only to the employer. Covenants during employment may be related to confidentiality, contract performance and the same type of business as other entities at the time of employment. In V.N. Deshpande v. Arvind Mills Company Limited, a contracted employee was to work as a weaver for three years and agreed not to serve anyone else in India at the time. He left the ministry one year later and joined another mill as a weaver. An agreement was reached and an order was issued for the work to be carried out. It was understood that the ban was reserved in the field of weaving and was therefore mandatory.
This principle has also been applied by the Supreme Court in Coke v. Gujarat Bottling Company. In this case the Court held that the agreement between the parties was a trade agreement in which both parties had made mutual obligations. The order, therefore, was sought and was given. Negative covenants are especially important in industries such as the aviation and pharmaceutical industries where the employer has to spend a lot of money to make his work fit for the type of work he has undertaken. Under such circumstances, there may be a restriction because, in his absence, the employee will simply acquire this skill and leave that job, which means that it would result in a huge loss for the employer both financially and professionally.
A similar situation was demonstrated in the case of Jan Peters v. Jet Airways the Supreme Court held that negative covenants during an employment contract where the employee will only work for his or her employer are generally not considered a trade bar and, therefore, do not fall under Section 27. In addition, the defendant was trained by plaintiffs and during the training, the respondent had acquired knowledge of the techniques, procedures, and equipment involved, and other confidential information. Defendant violated the agreement by seeking employment with the plaintiff’s competitors. Therefore, the order was given to protect the plaintiff’s interest.
Covenants related to looks
Indian Airlines and Air India flights have set age restrictions and weight limits for a certain section of their employees and non-compliance may result in termination or suspension. The courts have treated these restrictions as appropriate and non-discriminatory against women. However, this is problematic as male workers are not subjected to the same circumstances. The whole argument leads to the conclusion that women are based on looks in these airlines. Similar problems arise in cases of termination or suspension of female employees during pregnancy. These agreements, although approved by women, are against their well-being and therefore should not be considered as valid as announced, women are left with no other option.
Restraints after employment
Under Indian law, an agreement to prevent an employee from competing with his or her employer after termination of employment is not valid. The Supreme Court ruled that under Section 27 of the Indian Contract Act, 1872, a service covenant that went beyond the termination of service is invalid. In addition to imposing a penalty if questioned, it would prevent the defendant permanently, from using the information and experience gained during his or her employment by the complainant or about the matter to any other employer. Having obtained sufficient information during his or her employment by the complainant or other companies, the experience is his or her property, it is difficult to prevent him or her unless proper proof is provided to disclose or disclose any secret or confidentiality imposed on him or her while he or she was in service with the plaintiff’s company. A similar situation was found in the case of Percept D’Markr (India) Pvt. Ltd. v. Zaheer Khan. In this case, the Court held that the limit exceeding the term of the contract to prevent competition is clearly affected by Section 27 of the Contract Act, 1872, and is thus, prima facie void.
In order to strike a balance between employer and employee rights, the inclusion of negative covenants in employment contracts must be scrutinized and a set of rules or regulations must be set forth by Parliament directly, or by labor authorities empowered by the Parliament, where negative covenants are allowed to the extent that they do not conflict with public policy and are reasonable to the extent of ensuring a balance of rights. These days there have evolved certain covenants that although are restrictive in nature, yet do not fall squarely under the umbrella of Restrictive Employment Covenants read with Section 27 of the ICA like non-poaching agreement, training bonds, and garden leave clauses, etc. The inclusion of such restrictive covenants might appear to be a matter of regularity in today’s legal landscape; however, such restrictions are only enforced by the court keeping in mind the need to strike a balance between the rights of the employer and those of the employee.
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