This article has been written by Sanket Nakave pursuing a Diploma in International Contract Negotiation, Drafting and Enforcement from LawSikho.

This article has been edited and published by Shashwat Kaushik.

Introduction

A non-compete clause has been one of the hottest topics of discussion among employees, especially employees of MNCs. Considering the exponential growth of start-up culture in India, the non-compete clause has never been more important than now. Therefore, it is important to know the constitutional validity and legal enforceability of such a clause in India. Along with that, it is important to understand what stance the judiciary has taken, which can help employers draft the said clause in a legally enforceable manner.

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What is a non-compete clause

Non-compete clauses are standard in employment agreements, especially with top executives, senior managers, and co-founders. Along with such employment agreements, these clauses form part of merger and acquisition transactions. Under such a clause, a person agrees to not start a new business in competition with the current employer or take up new employment with a competing entity. Periodic and geographical restrictions are imposed under this clause, which implies that the person bound by such clause shall be restrained from working in the same or similar businesses, which are either in direct or indirect competition with the business of the employer, for a reasonable, specific period within the specified geography.

Rationale for a non-compete clause

High-ranking executives have access to confidential and proprietary information, including business-related intellectual property. If departing officials carry this knowledge to their subsequent employment, it could provide an unfair advantage to the new employer and, in certain instances, pose a serious threat to the original company. In mergers and acquisitions, the commercial value of acquired entities may significantly diminish if the founders leave and join a competing business, resulting in a loss of competitive edge for the acquiring entity. Consequently, any contractual provision aimed at safeguarding the interests of business advancement should not be considered a restraint of trade. Instances like these have the potential to discourage investors from supporting new and emerging enterprises, leading to a funding shortage and ultimately impeding economic development.

Rationale against a non-compete clause

Freedom to choose any occupation, trade or profession is a fundamental right guaranteed by the Constitution of India under Article 19. Such a right is secured because it is important for the overall growth of the economy that the people of the country are encouraged to be self-reliant. The right to livelihood, as interpreted by the Hon’ble Supreme Court under Article 21 of the Constitution, provides citizens of India with the right to choose his/her livelihood and to live life with dignity. As per Section 27 of the Indian Contract Act, 1872, an agreement in restraint of any lawful profession, trade or business is void to that extent. An exception has been carved out for cases involving the sale of the goodwill of a business. Accordingly, an agreement restraining a person from choosing his livelihood must be considered a violation of fundamental rights under the Constitution and a void contract under the Indian Contract Act of 1872.

Important excerpt from landmark judgements on the topic

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

In this case, it is firmly established that employee covenants warrant meticulous examination due to the inherent inequality of bargaining power between the involved parties. In fact, bargaining power might be entirely absent, as employees are often presented with standardised contracts to either accept or reject. During the agreement phase, employees may not have given much consideration to the restrictions imposed due to their eagerness to secure employment. Such contracts “tempt individuals lacking foresight, driven by immediate gains, to relinquish their ability to pursue future opportunities, leaving them vulnerable to exploitation and abuse.”

Pepsi Foods Ltd. and Others vs. Bharat Coca-cola Holdings Pvt. Ltd. & others (1999)

In this case, it was held that the granting of an injunction aimed at creating a scenario akin to “Once a Pepsi employee, always a Pepsi employee” cannot be justified. Such a situation could be likened to ‘economic terrorism’ or the establishment of conditions resembling ‘bonded labour’. However, unlike the situation in India, Pepsi managed to secure an injunction from the Seventh Circuit U.S. court against Mr. William Redmond Jr., who had departed PepsiCo to join Snapple Beverage Corp, which was acquired by Quaker. The Seventh Circuit U.S. Court thoroughly examined the case and ruled in favour of PepsiCo, issuing an injunction preventing Redmond from joining Snapple. This decision was based on the principle of “inevitable disclosure” and imposed a permanent injunction against the use or disclosure of any trade secrets or confidential information belonging to PepsiCo. The doctrine of inevitable disclosure necessitates that an employer demonstrate in a court of law that an employee cannot fulfil their duties in a new job with another employer without relying on the trade secrets acquired from their previous employment.

Niranjan Shankar Golikari vs. Century Spinning and Manufacturing Company Ltd (1967)

In this case, it was held that restrictions imposed on employees while they are obligated to work exclusively for their employer are not classified as restraints of trade and, therefore, do not fall within the purview of Section 27 of the Indian Contract Act, 1872. A negative provision preventing the employee from engaging in trade or employment with another employer for whom they would undertake comparable or substantially similar duties is not treated as a restraint of trade, unless the contractual terms are judged to be unconscionable, unduly severe, unreasonable, or unilaterally biassed.

V.F.S. global services Pvt. Ltd vs. Mr. Suprit Roy (2007)

In this case, it was held that the provision in consideration, known as the “garden leave clause,” which grants the company the authority to compel a senior manager to stay away from work or employment for three months following the termination or resignation of their services, is considered a restraint of trade and is subject to Section 27 of the Indian Contract Act.

The Hon’ble Supreme Court of India and various high courts have consistently taken the view that: 

  • The negative covenants can only be enforceable to the extent that they are reasonable and
  • The purpose of the covenant is to protect the legitimate business interests of the buyer. Even in the aforementioned circumstances, the restraint cannot be greater than necessary to protect the interest concerned.

Global view

United Kingdom

Some restrictions imposed after the termination of employment are legally enforceable, but they must meet the criterion of reasonableness. This means that the restriction should aim to safeguard the legitimate interests of the employer or buyer. Key considerations in assessing the validity of a non-compete provision involve evaluating the potential for improper use of confidential information and ensuring that the scope of the covenant is not broader than reasonably necessary to protect those interests.

The United States of America

In certain states, an intriguing legal principle known as the ‘blue pencil’ principle is recognised, granting courts the authority to modify an excessively broad non-compete clause to make it reasonable. When courts engage in reforming a non-compete clause, they consider factors such as the bargaining power of the parties and the extent of the restriction. Proponents of this principle argue that, since the parties intended to be bound by a restrictive covenant, it is justifiable for courts to adjust the clause to make it enforceable. However, critics of the ‘blue pencil’ principle contend that it empowers courts to interfere with commercial agreements between parties, a domain they believe should be left to the parties’ commercial acumen. Additionally, they argue that such court authority may encourage employers to draft broad restrictive covenants, leaving it to the courts to narrow down the scope on a case-by-case basis, potentially leading to increased disputes and litigation surrounding such clauses.

Australia

The legal stance is evident: clauses designed solely to suppress competition are unacceptable. A clause lacking a legitimate and reasonable safeguard for a business interest cannot be upheld. In New South Wales, these clauses are presumed unenforceable under the Restraints of Trade Act. This legislation empowers courts to modify clauses to align with the public interest, ensuring they go beyond mere anti-competitive purposes.

Practical example in India

In 2022, Infosys’s ‘non-compete clause’ hit the news. The clause restrained parting employees from joining competitors if they had worked for the same customer for a period of six months. Additionally, the new contract had a clause that prohibits employees from accepting employment from customers they had dealt with in the 12 months prior to parting ways with Infosys for a period of six months. TCS, IBM, Accenture, Wipro, and Cognizant are recognised as competitors to Infosys. A Pune-based non-governmental organisation, NITES, filed a complaint with the Central Labour Ministry against Infosys, urging the removal of the clause.

Infosys described it as a standard business practice in many parts of the world aimed at safeguarding confidential information. The company asserted that such controls are necessary to protect the confidentiality of information, maintain customer connections, and safeguard other legitimate business interests. Infosys clarified that these conditions are fully disclosed to all job aspirants before they decide to join the company and emphasised that they do not impede employees from pursuing career growth and aspirations in other organisations.

Conclusion

There is no “one size fits all” concept in the case of a non-compete clause. Even the employees working under such clauses have divided opinions. The laws of the country and the specific circumstances of the case would eventually decide whether the non-compete clause is reasonable or not. If the restrictions in a non-compete clause in an employment agreement are necessary and reasonable, such clauses will be held legal in India.

References

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