confidentiality
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This article is written by Parth Makarand who is pursuing a Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from Lawsikho.

Introduction

In this day and age, Intellectual Property Rights have turned out to become one of the most valuable assets a business can possess. Therefore, the need for safeguarding these assets gave rise to the evolution of non-disclosure agreements (NDAs).  NDAs ensure the confidentiality of the information and keep it hidden from prying eyes, by preventing parties from divulging such crucial information and trade secrets exchanged in their dealings of the business. However, restrictive covenants such as NDAs can run afoul of Section 27 of the Indian Contract Act, 1872, which declares every agreement which restricts a person from practicing a lawful trade, business or profession as void. This article shall examine the current legal position of the enforceability of an NDA in India, with special regards to Section 27 of the Act.

Taking a closer look at a non-disclosure agreement

A non-disclosure agreement (NDA) can also be referred to by other names such as a confidentiality, non-use, or trade secret agreement. In India, they are governed by the Indian Contract Act, 1872. Essentially, an NDA is a legally binding contract between parties that require them to keep certain information confidential. It is a restrictive or a negative covenant, that is, it either:

  • restricts a party from doing an action; or
  • requires a party to abstain from doing an action;

In this case, the party which is entrusted with confidential information has an obligation to not further disclose such information, except in accordance with the terms of the agreement between the parties involved. For example, in an employment contract between a software company and a software developer:

  • The developer would have intimate knowledge of the software developed by the company. 
  • The company would not want this information to be used for the benefit of its competitors. 
  • Therefore, the company includes a confidentiality clause in the contract that prohibits the developer from divulging confidential information to anyone who he is not supposed to. 

NDAs are commonly used in the following scenarios:

  • When employers are looking to prevent their employees from defecting and selling their confidential information to their rivals;
  • When parties are considering entering into a licensing discussion or agreement with each other;
  • Distribution negotiations and between start-ups and companies who wish to gauge the potential possibility of future commercial joint ventures;
  • When talking to potential investors; and
  • During mergers and acquisitions;

The constituents of confidential information

Depending on how the definition clause is drafted, a large number of details can be construed to be “confidential information.” Some examples include:

  • Client information database;
  • Information about driver’s license of customers;
  • Plans of company regarding future products, investments, etc;
  • Any intellectual property such as copyrights, patents, etc.;

Parties to an NDA

  • Disclosing Party

The Disclosing Party is the party that reveals confidential information.

  • Receiving Party

The Receiving Party is the party that accepts the confidential information from the disclosing party and is bound to keep the said disclosure a secret.

Different kinds of confidentiality agreements will have different types of parties. In fact, a party may be a disclosing party as well as a receiving party in the same agreement. This notion has been explained further ahead in the article.

Types of NDA

Unilateral Confidentiality Agreement

The Recipient of this agreement by signing the document agrees upon safeguarding the confidential information conveyed to them and preventing third parties from getting their hands on it. They must also agree to not use Confidential information for their own benefit. For example, in a software development agreement, the developer receives a significant amount of confidential information about the company, its clients, and its software, so that he can design the software as per the requirements of the company. He is under an obligation to not divulge the same to any third parties.

Bilateral Confidentiality Agreement

Two parties are revealing confidential information to each other in pursuance of an agreement between them. Thus, each party will be disclosing the party and a receiving party with respect to this type of agreement. Example: Two corporate entities are considering a merger. Before the merger can take place, each party agrees to exchange confidential information about their inner workings to the other. Thus, in this case, both parties will be receiving and disclosing confidential information.

Multilateral Confidentiality Agreement

More than two parties are involved in such kinds of agreements. They come into play when one of the parties reveals confidential information to other parties, and desires to prevent that information from further being disclosed by the receiving parties. Thus, in this type of agreement, there is one disclosing party and several receiving parties. Example: A fast food franchise shares the recipe of their signature burger with all the chefs of the franchise. All the receivers of this confidential information are under an obligation to not divulge it to any outsiders.

Enforceability in India

Non-disclosure agreements can be enforced in India. While it is not mandatory to register them under the Registration Act, 1908, doing so lends credibility to the document, thus aiding its enforceability.

Does section 27 of the Contract Act affect the enforceability of NDAs?

In theory, the attempts of employers to maintain their secrecy should clash with Section 27 of the Indian Contract Act, 1872. The section prohibits any agreement which hampers a person from exercising a lawful trade, profession, or business. The only exception stated in the section is regarding the selling of goodwill, which is not applicable to confidentiality agreements. For a contract that is found to be restraining trade, it is essential that such restrictions must be either:

  • Reasonable; and
  • In the nature of public interest.

A confidentiality agreement at its core is a post-contractual restrictive covenant. After the contract of employment has terminated, it restricts the former employee from divulging confidential information related to the employer. Therefore, the question is, are confidentiality agreements liable to be held void under Section 27? The answer is no if the said covenant is carefully drafted so as to not restrain the employee from engaging in his trade or profession, while also protecting the secrets of the former employer. 

In the case of V.F.S. Global Services Ltd. v. Mr. Suprit Roy, the confidentiality agreement sought to be enforced and dictated that a current/ former employee was not permitted to:

  • to undertake employment in a similar business; and/or
  • to commence a similar business two years after.

This restrictive covenant applied to the employee:

  • During the term of his employment; and
  • Two years after his employment with that employer had ended.

The Bombay High Court also mulled over the notion of a ‘Garden Leave Clause’. Such a clause entailed inter alia that:

  • Once an employee has resigned/was terminated, his former employer reserved the right to force him to abstain from seeking work/employment after the end of his employment; and
  • The employee had to yield to any other conditions laid down by his former employer during this period.

The High Court held that the restrictive covenant had two elements:

  • One which applied during the ongoing employment; and
  • One which applied after the termination of employment.

In the landmark case of Niranjan Shankar Golikari v The Century Spinning And Mfg. Co., the Apex Court held that restrictive covenants during the subsistence of employment were not hit by Section 27. Pursuant to this, the Bombay High Court observed that while the first element was not tantamount to restraint of trade as under Section 27, the second element was. It held that post-employment covenants which restrained the exercising a lawful profession, trade, or business of any kind could not be enforced. This was in stark contrast with the UK position, which allowed the enforcement of such covenants, provided they prescribed reasonable limits as to time, place, and other related conditions. 

Understanding the validity of post contractual restrictive covenants 

The position regarding the same was surmised by the High Court in BLB Institute of Financial Markets Ltd. v Ramakar Jha. Referring to the principles laid down by the Supreme Court in Percept D’Markr (India) Pvt. Ltd v Zaheer Khan, it clarified that:

Under Section 27 of the Contract Act: 

  • A restrictive covenant that extends beyond the term of the contract is void and not enforceable.
  • The doctrine of restraint of trade does not apply during the continuance of the contract for employment and it applies only when the contract comes to an end.
  • This doctrine is not confined only to contracts of employment but is also applicable to all other contracts.

Does this entail that confidentiality agreements cannot be enforced? 

As discussed earlier, in V.F.S Global case, the High Court held that a clause that restrained an employee from disclosing commercial/trade secrets would not be hit by Section 27. The reasoning it gave for upholding the enforceability of this clause was that it would not result in the employee being restrained from exercising a lawful profession, trade or business within the scope of Section 27. It can be inferred that restraint on the use of trade secrets during or after cessation of employment is not tantamount to a “restraint on trade” under Section 27 of the Act and therefore can be enforceable under certain circumstances.

Thus, Delhi High Court upheld the enforcement of the post-contractual element of confidentiality agreements.  It went on to give several rulings pursuant to the same.

Conclusion

Thus, we have explored the meaning of confidentiality agreements, and their enforceability within the scope of Section 27 of the Indian Contract Act, 1872. The law is still unclear regarding what reasonable restraints can be enforced in a confidentiality clause after the termination of an agreement. As the necessity to protect trade secrets is rising by the day, it is humbly implored by the author that the courts should settle the law regarding the same.

References

 

 

 


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