This article is written by Shraddha Maheshwari who is pursuing a Diploma in Business Laws For In-House Counsels from Lawsikho.
In the era of stifling competition and technological advancement, employees form a critical resource of every business and play an important role in growth of a business. In the course of their employment with an organization, they may be privy to confidential information, trade secrets and other critical information about the business and organization. Thus, it becomes essential for any business to protect its interest and to ensure that the aforesaid information is not disseminated and revealed to competing businesses. Restrictive covenants play an important role in prohibiting dissemination of such information and intellectual property. Such restrictive covenants may be included in an employment agreement with the intention to bind the employee.
A restrictive covenant is a restraint on a party to undertake certain tasks during or beyond the term of the contract. Restrictive covenants can be in the forms as enlisted below-
- Non-Disclosure or Confidentiality
- Non- Poaching
- Garden Leave
Indian Law on Restrictive Covenants
It is a fundamental right of all Indian citizens to practice any profession or to carry on any occupation, trade or business as prescribed under Article 19 (1) (g) of the Indian Constitution. However, the State has the power to impose restriction on this fundamental right.
Further, Section 27 of the Indian Contract Act, 1872 (“ICA”) governs the agreements in restraint of trade and declares such agreements to be void. It provides that every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.
The principles laid down by Section 27 of the ICA are as set out below:
- A restrictive covenant extending beyond the term of the contract is void and unenforceable;
- The doctrine of restrictive covenant applies after termination of the agreement and not during its continuance;
- This doctrine is not confined only to employment contracts but to all kinds of contracts.
An agreement in restraint of trade or profession is not enforceable and void unless it meets the test of justification. The test of justification lays down the following two parameters-
- Reasonableness of the restriction as between the parties to the agreement; and
- Consistency with the interest of the public.
To determine whether a restrictive covenant is reasonable and just or not, due regard is given to the bargaining capacity of the parties to the agreement.
Reasonable restrictions which may be imposed include:
- Time limit;
- Trade secrets; and
The exception S.27 of ICA is where the goodwill of a business is sold and the restriction is upon the buyer to not carry on a similar business within specified local limits as may be provided in the agreement.
Thus, the parameters and tests as laid down above play an important role while determining the extent of the restriction imposed and its legality.
Non-Competition Clause and its enforceability
Non-competition clauses in an employment agreement restrict an employee to take employment in a competing organization or business. This is to ensure that the employee does not use the resources developed with the former employee to grow a competing business. Such restrictions stipulated may be absolute or partial. It is generally observed that employment agreements contain a non-competition clause which extends beyond the duration of the employment.
Absolute restraint of trade is not enforceable and Section 27 of the ICA strictly prohibits such a restriction. The test of justification must be complied with, in drafting and enforcement of such restrictive covenants. Further, a restrictive covenant is construed strictly in employment contracts as the employer and employee are not considered to be on the same footing.
In case, the restrictive covenant is unreasonable, unconscionable, excessively harsh or one sided, it falls within the purview of Section 27 of ICA and is liable to be set aside.
Non-Solicitation Clause and its enforceability
Non-solicitation protects the interests of the employer by prohibiting the employee or former employee from indulging in business with or soliciting other employees or customers of the employer. Thus, the company or the employer can prevent loss of employees or customers. Such clauses generally lay down a time period for which the clause continues to operate.
Non-solicitation covenants are considered to be partial restrictions and are enforceable on case to case basis as it does not violate the principle laid down under Section 27 of the ICA. Further, any form of active solicitation which induces an employee to terminate the contract with the employer and take employment under the former employee does not violate Section 27 and cannot be considered to be an agreement in restraint of trade.
Non-Disclosure/ Confidentiality Clause and its enforceability
In the era of technological advancement where intangible assets such as intellectual property are the soul of the business, confidentiality clause or non-disclosure agreements are critical to every business. Such clauses are valid under Indian law. Any knowledge developed or materials such as agreements, due diligence reports or client lists made available to a person during the relationship which is per se confidential, cannot be utilized by such a person. Such a person may be restrained from disseminating such confidential information.
The provisions of Indian Penal Code, 1860 and Information Technology Act, 2000 are also attracted in case of breach of confidentiality or data theft. Temporary removal of data with dishonest intent may also be considered as theft.
Thus, an employer can proceed to file a criminal complaint against the employee in breach of confidentiality or non-disclosure clause. Further, any theft of data may also be construed as hacking under the provisions of Information Technology Act, 2000.
Non-Poaching Agreements and their enforceability
A non-competition clause prohibits a person to join a competing business whereas a non-poaching clause prohibits a competing business to hire the employees. Thus, non- non-poaching agreement is entered into by competing employers to protect their talent pool. Section 3 of the Competition Act, 2002 prohibits anti-competitive activities. However, Section 3 of the Competition Act, 2002 does not prohibit lateral hiring (within the same band) of employees by a competing business but an absolute ban may attract this Section.
Garden Leave Clause and their enforceability
Due to ambiguity around validity and enforceability of non-competition clauses, there has been a shift towards insertion and inclusion of garden leave clauses in employment agreements in India. Garden leave clause provides that the employee remains away for a period of time and such an employee is paid for such period of time. This ensures that the employee is distant from the workplace and at the same time does not go ahead to join another employer or business. Garden leave operates post cessation of employment by either way of resignation by the employee or termination of services by the employer.
Such clauses can usually be observed in executive employment contracts of persons from senior management.
However, the Bombay High Court has taken a view that garden leave is a prima facie restraint of trade and such a clause is void as under Section 27 of the ICA.
Negative covenants between the employer and the employee agreements pertaining to the period post termination of services and restricting the employee’s right to seek employment,
and/ or to do business in the same field as the employer, shall be in restraint of trade. Therefore, a stipulation to this effect in the contract shall be void. In other words, no employee can be confronted with the situation where he has to either work for the present employer or be forced to idleness.
Thus, the employers need to be mindful while inserting garden leave clauses in employment agreements as they may be held as unenforceable if challenged in a court of law.
For any restrictive covenant in an employment agreement or arrangement to be enforceable and valid under the Indian law, it is absolutely necessary that it is reasonable, fair and conscionable. An absolute restriction on an employee may not hold good in the eyes of law and may be struck down by the courts, if challenged. A partial restriction which meets the parameters as set out hereinabove may be enforceable and valid under Indian law. However, these restrictive covenants shall be analyzed on a case to case basis. Thus, the employers should take due care while drafting employment agreements to ensure that the restrictive covenants are not unconscionable and harsh to prevent any litigation which may challenge such agreements to prevent them from being challenged and struck down by the courts.
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