This article is written by Preeti Bhandari, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho.com.
Table of Contents
Introduction
Non-compete and Non-solicitation clauses mainly find place in employment agreements however they have equal importance in other business contracts.
Non-compete and non-solicit clauses bind the parties to contract to act in a particular manner during their association with one another or after they have ended their association. The clauses though signed or entered during the term of association with an organization or an employer however comes into effect after the association comes to an end. The exiting party is required to act in a certain manner after he has exited his services or association with such organization or an employer.
Non-compete and Non-solicit clauses are restrictive clauses in nature and put restrictions on the employees or business clients leaving the organization. Both the clauses are a resort to the organization or the employer to restrict the employee or business client in acting in a particular manner or pattern.
Non-Compete and Non-Solicit Clause Meaning
Non-Compete Clause
Non-compete or covenant not to compete restricts the parties to enter into or start a business similar to the business which is in direct competition with the business of its previous business partner or employer for a certain period of time.
A non-compete clause also puts a restriction on the employee to not work or to engage in any business similar to the business of his ex-employer. The clause prohibits an employee to work in a competitive business for a certain period of time and in a certain location.
For example a hotel industry may prohibit its employee to work in any other hotel in the same vicinity for a certain period of time.
Non-Solicit Clause
Non-solicit clause is a more specific term as compared to Non-compete clause. It just restricts an employee or business clients in soliciting other employees in the organization to move with him or them.
A Non-solicit clause restricts an employee or the business partner who is leaving or the client to solicit any business clients, take over other employees or use any confidential information which he acquired due to his association with the employer or organization.
Non-Solicitation of Business Clients
Business Clients are earned after years of hard work and dedication and the employee works equally with the organization to make clients for the organization, So if the employee leaves an organization/employer it may happen that he takes away such clients which were made by him for the organization. So insertion of Non-Solicit clause prevents such loss of the employer/organization.
For example a sales personnel working in a real estate company selling high end apartments switches jobs and joins a competitor company. In this case the personnel have excess to the data of the high end clients and after joining the competitor he is restricted by the non- solicit clause to use the data of the high end clients of the previous employer.
Non-Solicitation of Employees
A non-solicit clause apart from restricting the employee from using the information also restricts against soliciting the current employees. An organization is the result of the people that they have and who work towards a common goal.
So when an employee leaves an organization he/she tries to take his team also along with him in the new organization he is joining. The reason behind is that they have that sync. energy and understanding which is very important for success of any organization.
So the clause prevents a going employee to take the whole team with him/her.
Purpose of the Clauses
Inclusion of such clauses in the contract is to ensure that upon leaving the organization or upon the contract between the parties coming to an end, employee or such business client does not disclose trade secrets to the rival company or start its own business in the same field as he already had excess of information of the employer/organization and can use such information to the advantage of the employer. The Non- Solicitation clause ensures that an employee or business client does not take away with him leading employees thereby affecting the organization.
Legal Position of the Clauses
Applicability of non-compete and non-solicit clauses are subject to section 27 of the Indian Contract Act. Section 27 puts a bar on any agreement that restricts practice of any trade.
Section 27 of the Indian Contract Act-1872 provides that” Every agreement by which anyone is restrained from exercising a lawful profession or trade or business of any kind, is to that extent void”.
Section 27 says that an agreement which is in restraint of a trade and restricts anyone to carry on any business or trade similar to that business which he exited is void. Restraining freedom of a person to trade is against public policy. A person restrained from carrying on a trade is generally to avoid competition and has a monopolistic tendency and this is both against an individual’s interest as well as the interest of the society and on that ground such restraint is discouraged in law.
Courts treat Non-compete and Non-solicitation differently. Approach of the Courts towards non compete clause is strict as compared to non-solicitation clause.
Different Courts have from time to time cleared the air on both the clauses.
The Supreme Court of India in Superintendence Company of India (P) Ltd. v. Sh. Krishan Murgai, raised the question of whether a post-service restrictive covenant would fall within the mischief of section 27 of the Contract Act. The court held that a contract, which had for its object a restraint of trade, was prima facie void. Even the Delhi High Court in Foods Ltd. and Others v. Bharat Coca-cola Holdings Pvt. Ltd. & others observed “It is well settled that such post termination restraint, under Indian Law, is in violation of Section 27 of the Contract Act. Such contracts are unenforceable, void and against the public policy. What is prohibited by law cannot be permitted by Court’s injunction.“
The judgment of the Supreme Court in Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan and Anr. sheds some light on the legality of such clauses. The Apex Court observed,
“Under Section 27 of the Contract Act (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 applies only when the contract comes to an end. (c) As held by this Court in Gujarat Bottling v. Coca Cola (supra), this doctrine is not confined only to contracts of employment, but is also applicable to all other contracts.”
Enforceability of Non-Compete and Solicit Clause
The Clause can be enforceable if they are satisfying the followings conditions-
- Protecting Trade Secrets
The question whether a Non-compete and Non-solicitation clause is void will depend on the fact as to whether if the clause is not made applicable the owner of the business or the employer will lose on important trade secrets of the business. It is applicable in case the employee or the business client was in charge of such information which if leaked will result in the loss to the business.
- Restriction of practicing trade in particular location
If the existing employee or the business client plans to operate in the same area and location and common sense it can be gazed that it will result in loss of the business of the employer or organization and therefore the clause can be made applicable.
Not cause an unfair hardship to the employee/business client- If enforcing the clause does not put the employee or the business client in a position wherein, he finds it difficult to earn a regular income for himself:
- For a limited Duration-If the applicability of the clause is for a limited period of time
- Sale of goodwill- Where a business owner is in the process of selling its goodwill, the seller of the business may enter into an arrangement with the buyer not to carry on the business in competition with the buyer. Exception 1 to Section 27 of the Indian Contract Act reads as under:
Saving of agreement not to carry on business of which goodwill is sold. One who sells the goodwill of a business may agree with the buyer to refrain from carrying the similar business, within specified limits as long as the buyer or any person deriving title to the goodwill from him, carried on a like business therein, provided that such limits appear to the court reasonable, regard being had to the nature of the business”.
Thus, where the parties agree that the Seller of the business will not carry on the same or similar business within a certain location, the restraint is considered valid by the court of law. So where a person who has paid a certain amount for the purchase of the goodwill of the business to the seller, starting of a same business by the seller in competition of the buyer will not be right for him. However, in this it needs to be understood what exactly is the purpose of such restraint. If it is for the purposes of protecting the rights of the buyer who has invested huge sums for purchase of goodwill or if the restraint aims at controlling competition. If its aim is only to curtail competition, then such restraint is invalid.
In Vancouver Malt and Salt Brewing Co vs Vancouver Breweries Ltd., the appellants had a brewer’s license in respect of their premises in Vancouver City under which they could manufacture and sell beer. They never manufactured or sold beer. However, we were dealing with Sake, a Japanese liquor made from rice. The appellants made an agreement with the respondents wherein they purported to sell their brewer’s license and agreed not to engage in the manufacture of beer for a period of fifteen years. The Privy council held the agreement to be void on the basis of two reasons-
- The agreement put a restraint on the appellants to not engage in the sale and manufacture of beer. It was just to avoid competition and not due to purchase of goodwill as the appellants had never manufactured beer.
- Further the agreement put restraint to practice the trade in any part of the world which was considered as unreasonable.
Exceptions under the Indian Partnership Act
Indian Partnership Act,1932 provides an exception to Section 27 of the Indian Contract Act. Under Section 11(2),36(2),54 and 55(3) permit partners of the firm to put restraint on partners for not acting in a specified manner.
Section 11(2) restricts a partner not to carry on any business other than that of the firm during the time he is the partner. The purpose is to ensure that the partner is focusing properly on the business of the firm.
Section 36(2) allows entering into an arrangement with the outgoing partner not to carry on similar business within a specified location and for a reasonable time as he has been paid his share in the goodwill when he is exiting the firm.
Section 54 contain another exception wherein in case of dissolution of the firm wherein the firm is purchased by one of the partners or third party, the partners are restricted to carry on same business within a specified limit and for a specified time period.
Section 55 (3) contains still another exception wherein upon sale of goodwill the outgoing partners are restrained to carry on the similar business however such restraint to be valid should be reasonable.
Firm Daulat Ram vs. Firm Dharm Chand, AIR 1934 Lah 110, where two ice factory owners constituting a partnership agreed that only one factory will be worked at a time and its profits distributed among them. The restraint was held to be justified.
Restraint by a contract of service
An agreement where an employee agrees to work for a particular employer for a certain period of time and not enter into a similar kind of contract with any other employer during that tenure is considered a valid covenant. For eg. A enters into a contract with B to serve him for two years and agrees not to serve anybody during that period. In such condition B is not entitled to a decree for specific performance of the contract.
In Charlesworth vs. Mac Donald the defendant agreed to serve as an assistant to the plaintiff, a physician and a surgeon for a period of three years and not practice during that duration. After one year, he left the plaintiff’s service and started his own practice in Zanzibar. It was held that the plaintiff was entitled to restrain the defendant from practicing during the period of agreement in Zanzibar.
Pepsi Foods Ltd. & ors. vs. Bharat Coca-cola Holdings Pvt. Ltd., post-employment restrictions were held to be invalid and violative of Article 19 (1)(g) of the Indian Constitution. Restraining an employee from engaging or undertaking employment after leaving the services of a plaintiff for a duration of twelve months was held to be contrary and in violation of Section 27 of the Indian Contract Act, 1872 and injunction was declined.
In Wipro Limited Vs. Beckman Coulter International S. A. 131(2006) DLT681 the Hon’ble High Court of Delhi categorically observed that, “the non-solicitation clause does not amount to a restraint of trade, business or profession and would not be hit by Section 27 of the Indian Contract Act 1872 as being void.”
In another case before Madras High Court, it was held that merely approaching customers of a previous employer does not amount to solicitation until orders are placed by such customers based on such approach. The Madras High Court laid down the standard to establish non-solicitation.
However in Calcutta High Court in tis judgement in Embee Software Pvt. Ltd. v. Samir Kumar Shaw it was held that ‘acts of soliciting committed by former employees takes such active form that it induces the customers of the former employer to break their contract with the former employer and enter into a contract with the former employee, or prevents other persons from entering into contracts with the former employer’ cannot be permitted.
The Apex Court in Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr, stated that “a covenant which puts restrictions even beyond the term of the contract is void and not enforceable…the doctrine of restraint of trade applies only when the employment or association comes to an end and not during the term of association.
The Bombay High Court in VFS Global Services Private Limited v. Mr. Suprit Roy laid down that “to obstruct an employee who has left service from obtaining gainful employment elsewhere is not fair or proper“. Further the Court also pointed out that the clause is prima facie in restraint of trade and is hit by section 27 of the Contract Act.
Trade Combinations
In the business it may happen that the parties may come together to evade competition between them and decide to regulate the price, distribute profits between them. Such contracts are valid and do not restrain the right of the person to trade.
In Fraser & Co. vs The Bombay Ice Manufacturing Co. various ice manufacturers agreed between themselves for fixing minimum price for selling the ice manufactured by them. The parties agreed to pool the profit and distribute it between them. Such an arrangement was not considered as violative of trade and was within the ambit of non-compete clauses.
The case of Gujarat Bottling Co. Ltd. v. Coca Cola Co. is considered a landmark case where a contract between the plaintiff and the defendant was not considered to be a contract in restraint of trade since it was a commercial agreement whereunder both the parties had undertaken obligations for promoting the trade in beverages for their mutual benefit. The purpose of the impugned clause was to promote the trade and the negative stipulation under challenge sought to achieve the said purpose.
Solus Agreements
Wherein the Seller and the Buyer of a product agree that the Seller will sell all the products to buyer only and the buyer agrees to purchase the product only from the seller, is not considered against the principle of free trade and such non-compete clause is allowed. However, if the seller has excess of the product and the buyer has not purchased all, the buyer Cannot restrict the seller from selling the surplus to other buyers. However, it should also be for a limited period as was decided in Sheikh Kalu vs Ram Sharan Bhagat.
Conclusion
The Constitution of India guarantees the right to free trade and Article 21 grants the right to livelihood which is a fundamental right. No person can deny others the right to exercise their rights under the constitution. The same is confirmed under Section 27 of the Indian Contract Act. However, with the advent of technology and fierce competition non -compete and non-solicitation clauses find place in the contracts and are validated by the court of law if exercised within the exceptions given under Section 27 of the Indian Contract Act.
References
- https://www.rocketlawyer.com/article/how-does-a-non-compete-clause-work-cb.rl
- https://www.investopedia.com/terms/n/noncompete-agreement.asp
- Indian Contract Act
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