Non-Compete Clauses
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This article is written by Shriya Sehgal, a first year student pursuing BBA.LLB. from Symbiosis Law School, Noida. This article deals with the various aspects of restraint of trade including landmark judgements.

Introduction

Who doesn’t get excited when he/she is hired at a top notch firm? Decent salary, good infrastructure and a lively work environment are the prerequisites for every employee. However, what happens when they get bored with their jobs or want to explore better opportunities? Are they permitted to leave their jobs before the completion of their term of employment? Are there any restrictions on the employees while they are working for a particular organisation/institution?
The above questions would be answered in the following article with respect to Exclusivity and Non-Compete Clauses under Contract of Employment. 

General Rule

Section 27 of Indian Contract Act,1872

Section 27 of ICA,1872 makes the agreements in restraint of trade to be void. This section states that, “Every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.” However, there are certain exceptions to this rule.

Exceptions of Restraint of Trade[1]

Statutory Provisions

  • Sale of Goodwill- It is the only exception that is mentioned in Section 27. It means that the restrictions imposed on the seller should be reasonable. The seller can only be restrained from carrying on a similar business for such period for which the business sold is actually carried on either by the buyer or by any person deriving title to the goodwill from him.
  • Indian Partnership Act, 1932- Under Section 36 of this Act if the outgoing partner makes an agreement with the other partners that he will not carry on a similar business for a specific period of time then such an agreement is valid, provided the restrictions are reasonable. Also, Section 11 of this Act states that the partners should not carry a competing business during the continuance of the partnership.
  • Limited Liability Partnership Act, 2008-  Section 24 of this Act talks about ‘Cessation of partnership interest’. The former partners may also be consulted during inspection. 

Judicial Interpretations

  • Trade Combinations- It’s a universal practice to carry on a trade in an organised way. Regulations as to the opening and closing of business in the market, licensing of traders, supervision and control of dealers and the mode of dealing are not illegal. [2]
  • Service Agreements- These agreements refer to the negative covenants and prevents an employee from working for someone else during the term of employment. This is to prevent leakage of trade secrets etc.
  • Sole or Exclusive Dealing Agreements and Franchise- It refers to a practice where manufacturer markets his goods through a single distributor or agent. 

Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co. Ltd., 1894 AC 535

It is this case that established the concept of restraint of trade in 1890s in England. In this case, the appellants sold their business to the respondent company and agreed to enter into a negative covenant not to work for a rival business for a period of 25 years in an unlimited geographical area. Later he worked for a rival business. Consequently, the respondents brought an action against the appellant to enforce the covenant by injunction.

The appellant argued that the clause was in restraint of trade and the clause of unlimited geographical area was unreasonable. Whereas, the respondent argued that the clauses were imposed to protect the interest of their business. 

The House of Lords upheld that the clause was in restraint of trade and was prima facie unlawful. However, the restraint was reasonable in the interest of the parties as Nordenfelt obtained a huge sum of money for his business. Moreover, the restraint was reasonable in the public interest. Therefore, the clause was upheld.

Superintendence Co. of India v. Krishan Murgai, (1981)

The appellant company carries on business as surveyors undertaking inspection of quality, sampling of merchandise, machinery etc. It has established a reputation and goodwill by developing its own techniques and possess trade secrets in the form of those techniques. They have their head office at Calcutta and a branch at New Delhi.

The appellant company employed the respondent as the Branch Manager of its New Delhi Office on the terms and conditions mentioned in the letter of appointment. Clause 10 of the terms and condition placed the respondent under a post service restraint that he shall neither carry on a business on his own nor serve any other rival firm in similar line as that of the appellant company for two years at the place of his last posting.

When the appellant company terminated the respondent’s service, he started his own business in New Delhi on lines identical with the appellant company. Thus a suit was filed by the appellant company and they also sought an interim injunction.

The court granted them an interim injunction which was converted into a permanent injunction after listening to the respondent. The restraint was considered to be reasonable with respect to time and place however the clause contained the expression ‘leave’ which was susceptible.The clause was considered unreasonable as the term of employment was terminated. 

On an appeal by the respondent, a Division Bench of the High Court reversed the order of the learned Single judge holding that the negative covenant operating post service was in restraint of trade and void under Section 27 of the Indian Contract Act, 1872. 

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Rationale for Rule Against Restraint of Trade

An employment contract generally includes restraint of trade clause to protect the interest of the employer after an employee leaves their organisation or business. The various restraint of trade clauses are imposed due to the following reasons:

  • Non-compete clause prevent the employees from competing with their former employer for a reasonable period of time the employees can compete by opening a similar business or working with a rival business.
  • Non-solicitation clause prevents the employee to solicit his former employer’s clients for a reasonable period of time.
  • Non-recruitment clause prevents the employee to hire the former employer’s employee for a reasonable period of time.
  • Confidentiality clause prevents the employee from disclosing the former employer’s confidential information.

Here, the word ‘reasonable’ is of significant importance. For a contract to be enforceable, the restraint of trade clause must be reasonable. Reasonability can be ascertained on the basis of the following grounds:

  1. Time period
  2. Geographical location
  3. Scope of work 

Conflict of Laws

Conflict of law refers to relations among various legal jurisdictions. Something valid under the jurisdiction of X may be invalid or illegal under the jurisdiction of Y. 

For instance, Conflict of Laws took place in the famous case, Taprogge Gesellschaft Mbh vs Iaec India Ltd.[5]. In this case, the Bombay High Court held that a restraint operating after termination of the contract to secure freedom from competition from a person who no longer worked within the contract was void. The court refused to enforce the negative covenant and held that, even if such a covenant was valid under German law, it could not be enforced in India. [3]

Doctrine of Restraint of Trade not applicable during the subsistence of the Contract

A contract of employment which is operative during the employment doesn’t attract the provisions of Section 27 of the Indian Contract Act, 1872. The main purpose for restraining an employee from joining a competing business or profession is to fulfil the legal terms of the contract that are binding on the employee. This also encourages better performance on the part of the employee.

The clauses of restraint of trade are imposed after the conclusion of term of employment to prevent the employee to benefit from the skills that he/she has acquired during the term from the employer. In other words, the employer prevents his competition to a certain extent. Whereas, when restrictions are imposed during the term of employment, the motive is to ensure performance of employees and the fulfillment of legal terms of the employment contract.

Thus, when the purpose of restraints imposed is transparent and lawful it is considered to be valid by the court. However, when the purpose of restraints imposed is unclear or unlawful it is considered to be void by the court. In other words, only reasonable clauses of restraints of trade can be imposed by the employer.

For instance, an employee of a company during the contract of employment or prior to termination of contract of employment should not join another company carrying on similar business or shouldn’t establish his own business of similar nature.

In case of a franchise, the franchise agreement prohibits the franchisee from dealing with competitors goods during the subsistence of the contract. In this way the franchiser can promote his/her own goods and prevent the competition to a certain extent. It will also lead to ease of distribution of goods.

It was stated in a case that, “There is a growing trend to regulate the distribution of goods and services through franchise agreements providing for the grant of franchise by the franchiser on certain terms and conditions to the franchisee. Such agreements often incorporate a condition that the franchisee shall not deal with competing goods. Such a condition restricting the right of the franchisee to deal with competing goods is for facilitating the distribution of the goods of the franchiser and it cannot be regarded as in restraint of trade.” [4]

Judicial Precedents

Niranjan Shankar Golikari v Century Spg. & Mfg. Co. Ltd., (1967) 

The respondent company is the manufacturer of tyre cord yarn and other things. Their plant is located at Kalyan known as the Century Reyo entered into an agreement with Algemene Kunstzijde Unie of Holland (AKU) and Vereinigte Clanzstoff Fabrikan AG of West Germany (VCF) to transfer their technical know-how to the respondent company for consideration of 1,40,000 Deutsche Marks(currency). It was to be used exclusively for the respondent company’s tyre cord yarn plant at Kalyan.

Clause 4 of that agreement provided that the respondent company should keep secret until the termination of the agreement and during three years when all technical information, know-how, data and documents would be passed on by the AKU and VCF then, the Century Rayon should enter into corresponding secrecy arrangements with its employees.

The respondent company then invited applications for appointments in said plant. The appellant was hired as a Shift supervisor in the tyre cord division and entered into a contract of standard form for a term of 5 years. After obtaining training for 9 months the appellant started absenting himself and then informed the company that he has resigned. The company rejected his resignation and asked him to join back but he had already obtained another employment. The appellant’s services were considered essential for the respondent company as his employment with rival company would cause him damage because they had undertaken to obtain secrecy undertakings from its employees.

Therefore they wanted an injunction restraining the appellant to obtain employment with the rival company. Whereas the appellant said that the agreement was a restraint on trade and against public policy.

Both the trial court and the High Court found that the negative covenant in the present case were reasonable and necessary for the protection of the company’s interest. 

BLB Institute of Financial Markets Ltd. v. Ramakar Jha (2008)

The petitioner company is one of the leading institutes in imparting education and knowledge in the field of financial services. In the course of its business, the petitioner appointed the respondent as a faculty member who was to be responsible for the development of the petitioner’s study material and teaching methodology. Consequently, they entered into an employment agreement including various terms and conditions.

The respondent realised his value to the organisation and asked for a hike in his salary multiple times. One day he sent his resignation via email and stopped coming to work because his demands were not accepted. The petitioner returned the resignation unaccepted and asked him to resume work as his unauthorized absence was in breach of the terms and conditions of the employment agreement.

According to the terms and conditions of the agreement the respondent cannot resign before the compulsory period of 3 years and in case he wants to resign before the completion of 5 years he has to give 6 months notice of the same. Moreover he cannot join a rival business. The same was ordered by the court until the arbitrator independently evaluated the observations made.

Bluedart Aviation Ltd. v Captain Puneet Shankta (2006)

In this case, the defendant, a qualified pilot was trained at the behest of the plaintiff. It was done to enable him to be released as a Senior First Officer for an aircraft and thereafter to serve the plaintiff. But the defendant has abandoned the services of the plaintiff without giving him a written notice of three months or payment for the same. 

Consequently a suit was filed and during it’s pendency an interim injunction was filed for restraining the defendant from taking employment as pilot of any other company. The defendant was made liable to pay a sum of Rs. 10,00,000 with 15% interest from the date of filing the suit for committing a breach of contract. The plaintiff also claimed a permanent injunction restraining the defendant for taking up employment as pilot of any other company or airline or corporation for a period of three years. 

Since injunction is a discretionary relief, the court can grant an injunction for a reasonable period as it is difficult for the airline to make an alternate arrangement. Due to their inability to make the arrangements they will have to minimise their operations which will cause them damages. 

Thus, in the appeal it was held that the learned single judge was was not correct in not granting the injunction at least for a period of notice. In the given circumstances the court desist from directing restoration of status quo ante. However, it is open to the plaintiff to claim any compensation by amending the plaint. Thus, the appeal was disposed of with the aforesaid observations.

Wipro Ltd. v Beckman Coulter International S.A., (2006)

In this case, Wipro worked as a sole and exclusive canvassing representative for Beckman Coulter International, S.A. They worked together for a span of 17 years. Beckman Coulter decided to undertake direct operations in India and issued advertisement seeking employment from people and giving preference to candidates having experience in having handled respondent’s product or similar products. Wipro Limited alleged that such advertisement was in violation of non-solicitation clause and approached the court for prohibiting solicitation and claiming damages.

It was held that the restrictions had not been imposed on the employees but on Wipro and Beckman Coulter and therefore Section 27 would not be attracted and the agreement was held not in restraint of trade.

Conclusion

There is a legal assumption that a restraint of trade is legally unenforceable. However, there are certain exceptions to the same. The various types of clauses mentioned in employment agreement aims to protect the interest of the employer and are not against public policy. The reasonability of these clauses can be determined on the basis of various factors and the clauses beyond the scope reasonability are considered to be void.

References 

  1. https://resource.cdn.icai.org/46634bosfnd-p2-seca-cp1-u2.pdf 
  2. http://www.legalservicesindia.com/article/1753/Exceptions-of-agreement-in-restraints-of-trade-with-reference-to-Indian-and-English-case-laws.html 
  3. https://www.majmudarindia.com/pdf/Validity%20of%20agreements%20in%20restraint%20of%20trade%20in%20India.pdf 
  4. Gujarat Bottling Company Ltd and Ors. v. Coca Cola Co. and Ors. 1995 (5) SCC 545
  5. https://indiankanoon.org/doc/1495448/ 

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