This article has been written by Yadav Mahima Kaushal pursuing a Diploma in US Contract Drafting and Paralegal Studies course from LawSikho.

This article has been edited and published by Shashwat Kaushik.

Introduction

In a world of competitive markets, every employer wants to protect their interests. A non-compete clause is a tool for protecting the legitimate interests of the employer.

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A non-compete clause is a clause in an employment contract that puts restrictions on the action of an employee from working for a competitor or starting a similar business or profession as the employer, either in the course of employment or after employment. In the latter, enforceability depends on various factors.

Non-compete clause is inserted in an employment contract to protect the employer’s legitimate business interests, such as trade secrets , confidential information, customer data, goodwill and market strategies. However, a non-compete clause is not always enforceable in a court of law. The enforceability of a non-compete clause depends on various factors, such as:

  • The reasonableness of the scope, duration, and geographic area of the restriction;
  • The balance between the employer’s interest and the employee’s right to earn a living;
  • The public interest and policy considerations; and
  • The existence of a valid consideration or compensation for the restriction.

History of a non-compete clause

In 1414, while hearing Dyer’s case law, English Common Law rejected the enforcement of non-compete agreements because of their nature. As it put restraint  on the trade, the non enforceability was  continued until 1621. After that restriction that was limited to a specific geographic location was allowed as an exception, the exception became the rule with the 1711 watershed case of Mitchel v. Reynolds, which established the modern framework for the analysis of the enforceability of non-compete agreements.

Historical perspective in the Indian context.

A strict approach by Indian courts towards the non-compete clause has been seen in the past. In most of the cases, honourable judges have refused to acknowledge the legality of non-compete clauses by citing Section 27 of the Indian Contract Act and also Article 19(1) (g) of  the Indian  Constitution.

Section 27 of the Indian Contract Act  1872 prohibits agreements that put  restrictions on  trade. Article 19(1)(g) gives every citizen of India freedom of trade and profession.

However, in the landmark case of Niranjan Shankar Golikar vs. The Century Spinning Company , the Court started acknowledging the non-compete clause by introducing the concept of ‘the rule of reasonableness’. The following factors need to be considered while applying this rule:

  • The duration of the restriction; 
  • The geographical scope;
  • The nature of the employee’s position;
  • The availability of alternative employment  opportunities.

What is a non-compete clause

A non-compete clause is a provision included in a contract between an employer and an employee that restricts the employee from engaging in certain activities after the termination of their employment. The purpose of a non-compete clause is to protect the employer’s legitimate business interests, such as confidential information, customer relationships, and trade secrets.

Key elements of a non-compete clause typically include:

  1. Scope of restrictions: The clause outlines the specific activities that the employee is prohibited from engaging in, such as working for a competitor, starting a competing business, or soliciting customers or employees of the former employer.
  2. Timeframe: The duration of the non-compete clause specifies the period during which the restrictions apply. It can range from a few months to several years.
  3. Geographic scope: The clause defines the geographic area where the restrictions are applicable. It can be limited to a specific city, region, or country.
  4. Reasonableness: Non-compete clauses must be reasonable in scope and duration to be legally enforceable. Courts will consider factors such as the employee’s position, the industry, and the potential harm to the employer to determine the reasonableness of the clause.

Pros and cons of a non-compete clause

Pros

The pros of the non-compete clause are:

  1. Protection of confidential information: Non-compete clauses help protect an employer’s confidential information, such as trade secrets, customer lists, and proprietary processes. By preventing former employees from working for competitors, businesses can reduce the risk of their confidential information being shared or misused, maintaining their competitive edge.
  2. Preservation of goodwill: Non-compete clauses help preserve a company’s goodwill by preventing former employees from soliciting or diverting clients or customers to competitors. This ensures that the employer’s investment in building customer relationships is protected, preserving the value of the business.
  3. Stability of workforce: Non-compete clauses contribute to the stability of the workforce by discouraging employees from leaving for competing companies. This helps maintain a productive and cohesive work environment, reducing the costs and disruptions associated with frequent turnover.
  4. Fair competition: Non-compete clauses promote fair competition in the marketplace by preventing former employees from immediately joining competitors and leveraging their knowledge to gain an unfair advantage. This ensures that businesses compete on their merits and not solely on the ability to hire away employees with valuable knowledge.
  5. Protection of investments in training and development: Non-compete clauses help protect a company’s investment in training and development by ensuring that former employees do not immediately benefit competitors with the skills and knowledge they acquired at the company’s expense. This encourages businesses to invest in employee development, enhancing the overall quality of the workforce.

Cons

The cons of the non-compete clause are:

  • It can limit your career opportunities: A non-compete clause can prevent you from working in your field of expertise for a certain period after leaving your current job. This can make it difficult to find new employment opportunities, especially if you are specialised in a particular industry or profession.
  • It can be unfair and restrictive: Non-compete clauses are often seen as unfair and restrictive by employees. They can prevent employees from pursuing new opportunities and stifle their career growth. This can be particularly problematic for employees who are laid off or terminated without cause.
  • It can be difficult to enforce: Non-compete clauses are often difficult to enforce, especially if the employee moves to a different state or country. This can make it costly and time-consuming for employers to pursue legal action against former employees who violate the clause.
  • It can damage relationships: Non-compete clauses can damage relationships between employers and employees. Employees may feel resentful towards their former employers for imposing such restrictions on their careers. This can lead to a loss of trust and cooperation in the workplace.
  • It can stifle innovation: Non-compete clauses can stifle innovation by preventing employees from sharing ideas and knowledge with other companies. This can lead to a lack of competition and a slower pace of innovation in the marketplace.

Overall, non-compete clauses can have a number of negative consequences for employees, employers, and the economy as a whole. They should be used sparingly and only when absolutely necessary.

Non-compete agreement  vs. non-disclosure agreement

A non-compete clause is part of an employment contract that is signed between employee and employer. A non-compete clause is a covenant clause, which means it puts some restriction on employees from engaging in similar types of employment or starting the same kind of business during the course of employment or after the termination of employment. Non-compete agreements are used to deter the employee from starting a similar business and becoming a direct competitor of the parent company , but they are not always enforceable in court.

A non-disclosure agreement is also known as a confidentiality agreement; it is a wider concept than the non-compete clause. Non-disclosure agreements can be made between employers, – employee, individual entities , business firms. It protects the confidential information of the parties to the agreement by creating an obligation on the parties  to protect the breach of confidential information, and it is enforceable in court.

Purpose of non-compete clauses

The purposes of non-compete clauses are:

Protection of secrets

Employers use non-compete clauses to protect valuable information and trade secrets of their businesses. During the course of  employment, employees often gain access to confidential data, client lists, business strategies, and proprietary knowledge. The clause prevents them from exploiting this sensitive information for competitive purposes.

Protects the interest of the employer

A non-compete clause helps the employer protect their interests by preventing a former employee from starting the same kind of business or accepting employment from the direct competitor of the employee.

Prevention of unfair competition

By restricting an employee’s ability to work for a competitor within a specified timeframe and geographic area, non-compete clauses aim to prevent unfair competition. This protects the company’s investment in training and development of its workforce, as well as its competitive advantage.

Constitutional safeguard

Article 19(1)(g) of the Constitution of India provides the right to practise any profession or to carry on any occupation, trade or business to all citizens, subject to Article 19(6), which enumerates the nature of restrictions that can be imposed by the state upon the above rights of the citizens. However, the non- compete clause is mutually agreed upon between the parties and it does not violate Article 19(1)(g).

Article 19 is available against the state – Many times, the apex court has mentioned that Article 19 is available against any state or body.

Non-compete clause under Indian Contract Act 1872

Section 27 of the Indian Contract Act, 1872 deals with agreements in restraint of trade. It states that every agreement by which any one is restrained from exercising his lawful profession, trade or business of any kind, is to that extent void. This provision is based on the principle that everyone has a right to earn a livelihood and any agreement that restricts this right is against public policy.

What constitutes a restraint of trade? A restraint of trade is any agreement that prevents or restricts a person from engaging in a lawful trade or business. It can be expressed or implied, and it can be either partial or complete.

Examples of express restraints of trade include:

  • Non-compete clauses: These clauses prevent employees from working for a competitor for a certain period of time after they leave their job.
  • Non-solicitation clauses: These clauses prevent employees from soliciting customers or employees from their former employer.
  • Exclusive dealing agreements: These agreements require a buyer to purchase all of its goods or services from a single supplier.

Examples of implied restraints of trade include:

  • Covenants not to compete: These covenants are implied in some contracts, such as partnership agreements, and they prevent partners from competing with each other after the partnership is dissolved.
  • Duty of loyalty: This duty requires employees to act in the best interests of their employer, and it can prevent them from engaging in activities that are harmful to the employer’s business.

When is a restraint of trade valid?

A restraint of trade is only valid if it is reasonable and necessary to protect the legitimate interests of the party who is seeking to enforce it. The following factors are considered when determining whether a restraint of trade is reasonable:

  • The nature of the trade or business: Some businesses are more likely to be harmed by a restraint of trade than others. For example, a restraint of trade that prevents a doctor from practising medicine is more likely to be considered unreasonable than a restraint of trade that prevents a salesperson from selling products for a competitor.
  • The duration of the restraint: A restraint of trade that lasts for a longer period of time is more likely to be considered unreasonable than a restraint of trade that lasts for a shorter period of time.
  • The geographic scope of the restraint: A restraint of trade that covers a large geographic area is more likely to be considered unreasonable than a restraint of trade that covers a small geographic area.
  • The impact of the restraint on the employee: A restraint of trade that prevents an employee from earning a livelihood is more likely to be considered unreasonable than a restraint of trade that does not have a significant impact on the employee’s ability to earn a living.

Consequences of an invalid restraint of trade

If a restraint of trade is found to be invalid, it is void and unenforceable. This means that the parties to the contract are not bound by the restraint and they can engage in the trade or business that was restricted by the restraint.

In addition, the party who was injured by the restraint of trade may be entitled to damages. The damages can include lost profits, loss of goodwill, and other expenses that were caused by the restraint of trade.

Legality of non-compete clause in employment contracts

According to Section 27 of the Indian Contract Act 1872, an agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind is, to an extent, void. This means that non-compete clauses are not legally enforceable in India, as they are considered to be in restraint of  trade and against Section 27 of the Indian Contract Act. However, there are some exceptions and circumstances where a non-compete clause may be valid and enforceable, such as:

  • During the term of employment, you may restrict the employee  from engaging in any activity that is directly or indirectly in competition with the employer’s legitimate interests.
  • After the termination of  employment, an employee may be restrained from using or disclosing any trade secrets, confidential information, or proprietary data of the employer, as long as the duration, scope, and geographical area of the restraint are reasonable and do not impose a question of livelihood on the  employee. The doctrine of “the rule of reasonableness” is applied by court to decide whether the restrictions are valid or not.
  • A non-compete clause may also be valid and enforceable if it is part of a sale of goodwill or a partnership agreement where the seller or the outgoing partner agrees not to carry on a similar business within a specified area and time in order to protect the buyer or the remaining partners from unfair competition.
  • The courts have the discretion to examine each case on its own merits and decide whether a non-compete clause is reasonable and necessary to protect the legitimate interests of the parties involved.

Case laws

Superintendence Company of India (P) Ltd. vs. Krishan Murgai (1980)

The case of Superintendence Company of India (P) Ltd. v. Krishan Murgai (1980) is a landmark case in the realm of non-compete clauses in India. In this pivotal judgement, the Supreme Court of India underscored the significance of upholding the delicate balance between an employer’s legitimate business interests and an employee’s fundamental right to pursue their chosen profession.

Central to the Court’s decision was the interpretation of Section 27 of the Indian Contract Act, 1872. This provision declares void any agreement that unreasonably restrains a person from exercising their lawful profession or trade. The Supreme Court examined the ambit and implications of the non-compete clause, highlighting its potential to stifle competition and hinder the employee’s freedom to engage in their chosen field. The Court held that such a clause was overly broad and went beyond what was reasonably necessary to protect the employer’s legitimate business interests.

This landmark judgement set a significant precedent, establishing the principle that non-compete clauses must be tailored to strike a fair balance between the employer’s need for protection and the employee’s right to pursue their livelihood.

Percept D’Mark (India) Pvt. Ltd. vs. Zaheer Khan & Anr (2006)

This is one of the recent cases involving the non-compete clause in India. The central issue in this case was whether the non-compete clause for the period of 3 years was valid under Section 27 of the Indian Contract Act of 1872. The Bombay High Court held that a non-compete clause that prevented a cricketer from endorsing any competing brands of the company for three years after the expiry of the contract was valid and enforceable, as it was reasonable and necessary to protect the company’s interest in the exclusivity of the endorsement.

Orchid Pharma Ltd.  vs. Hospira Healthcare Pvt. Ltd. (2019) 

This  is one of the first cases where the Competition Commission of India (CCI) expressed its views on the non-compete clause. The CCI observed that a non-compete clause should be reasonable in terms of the duration, the scope, and the geographical area of the restraint, so as to ensure that it does not result in an appreciable adverse effect on competition.

In Niranjan Shankar Golikari vs. The Century Spinning and Manufacturing Co. (1967)

In this case, the Supreme Court held that a negative covenant during the period of employment  when the employee is bound to serve his employer exclusively are not to be regarded as restaurant of trade and do not fall under Section 27 of Indian Contract Act

Conclusion

The governing body for non-compete clauses is Section 27 of the Indian Contract Act of 1872, which says that every agreement is void if it’s restraining someone from exercising a lawful profession, trade or business. However, non-compete clauses are mutually agreed upon and allowed in some exception cases. Therefore, it can be concluded that non-compete clauses require a balanced approach to save the interests of both the employer and employee.

References

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