This article is written by Mitali Yadav, Managing Partner, Alba Law Offices, a Delhi based full service law firm.
When a person is employed by another and there is a mutual agreement between them to this purpose, and the employee has agreed to the terms of the employment, then both the parties have said to be entered in a ‘Contract of Service’. An agreement thus made is a legally enforceable contract before the court of law.
The ‘Contract of Service’ also known as the ‘Employment Contract’ or the ‘Apprenticeship Contract’, details the terms and conditions of employment and thus typically, an ‘Employment Contract’ contains negative provisions which restrict the employee in certain aspects of their employment.
Incorporation and subsequent enforcement of ‘negative or restrictive covenants’ are often debatable issues in India because such provisions are inconsistent with Section 27 of the Indian Contract Act, 1872 (the “Contract Act”).
According to Section 27 of the Contract Act:
“Agreement in restraint of trade, void—Every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void. —Every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.” Exception 1.—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 on a similar business, within specified local limits, so long as the buyer, or any person deriving title to the goodwill from him, carries on a like business therein, provided that such limits appear to the Court reasonable, regard being had to the nature of the business.”
TYPES OF RESTRICTIVE COVENANTS
Any covenant which is restricting the employee in any way during or post his employment can be termed as a restrictive covenant. However, following are some of the restrictive covenants which are prevalent in most of the employment contracts:
- Non- Compete Covenant:
Any agreement “one in which a party agrees with any other party to restrict his liberty in the future to carry on trade with other persons who are not parties to the contract in such a manner as he chooses”. Under a non-compete clause an employee agrees not to enter into or start a similar profession or trade in competition against the employer. A non-compete clause will be subject to the conventional requirements of a contract and the employment of such clauses is premised on the possibility that upon their termination, an employee may start working for a competitor or starting a business, and gain some form of a competitive advantage by utilizing confidential information about their earlier employer’s trade secrets or any sensitive information such as business practices, customer/client lists, upcoming products, marketing plans, etc.
In FL Smidth Pvt. Ltd. vs. Secan Invescast (India) Pvt. Ltd. the Madras High Court laid that a non-compete clause used in agreements can be categorised into two categories, based on the period of operation:
- During the term of contract
- Post termination of the contract
The court further laid that, “The consistent view taken by the Hon’ble Supreme Court and the High Court is that the negative covenants operative during the term of the contract are not hit by Section 27 of the Contract Act because they are designed to fulfil the contract and not to restrict them. On the other hand, the restraints operative after the termination of the contract no longer works within the contract and therefore hit by Section 27 of the Contract Act.”
2. Non- Solicitation Covenant:
The main object of non-solicitation clauses is to protect the former employer from any unauthorized use of information or any utilization of knowledge gained during the employment by the former employee. Non-Solicitation is usually sub-divided into two separate categories. The first category details how the employee will not attempt to solicit or ‘poach’ other employees of the employer to move away from their current jobs with that employee. The other category covers the protection over the current clients and customers of the employer that the employee has had dealings with during the course of the employment. Non-solicitation clauses are usually defined for a set period being a number of months. The theory behind these clauses is to stop the employee from taking all of the former employer’s customers and clients when the employee moves/shifts jobs.
In FLSmidth Pvt.Ltd. v M/s.Secan Invescast (India) Pvt.Ltd. the Madras High Court 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:“…solicitation is essentially a question of fact. The appellant should prove that the respondent approached their erstwhile customers and only on account of such solicitation, customers placed orders with the respondent. Mere production of quotation would not serve the purpose. It is not as if the appellant is without any remedy. In case the Court ultimately holds that the appellant has got a case on merits, they can be compensated by awarding damages. The supplies made by the respondent to the erstwhile customers of the appellant would be borne out by records. There would be no difficulty to the appellant to prove that inspite of entering into a non-disclosure agreement, respondent have solicited customers and pursuant to such solicitation they have actually supplied castings. When there is such an alternative remedy, question of issuing a prohibitory injunction does not arise.”
3. Non- Poaching Covenant:
Whilst non-compete, non-solicitation and non-disclosure agreements deal with the employer-employee relationship, a fourth class of restrictive agreement which is often signed by the parties is the non-poaching agreement which is executed between two employers. In an age of constantly evolving specialized industries and niche talent pools, employers often tend to invest a very large amount of human capital into their employees. If these employees subsequently join direct competitors, it can result in substantial economic loss for the ex-employer. A non-poaching agreement therefore enforces guidelines to be followed in cases of lateral hiring.
NPA (non-poaching agreements) are not viable in India, because it is hit by the exceptions under Section 27 of the Contract Act. NPA would restrict an employee from being hired a competitor. Courts have ruled that restraints post termination of employment are void and not enforceable, as they are in restraint of trade under Section 27. In Gujarat Bottling vs. Coca Cola Company the Supreme Court laid that a negative covenant beyond the term of employment contract is void and not enforceable.
3. Confidentiality Covenant:
The confidentiality clause or the non-disclosure clause restricts the employee from disclosing any information which the employer shares during the course of employment with any third party until expressly told by the employer. At times, this clause is found as a completely different agreement altogether, known as the Non-Disclosure Agreement.
4. Notice Period Covenant:
The notice period covenant is a standard clause in employment contracts that comes into play once the employee serves for a resignation or an early retirement, or when the employer terminates the employment of the employee. This clause is not purely a restrictive covenant, in the sense that it not only restricts the employee but the same covenant is also capable of creating a restriction on the employer. The notice period covenant works in the manner that, either the employee or the employer, may terminate the employment of the employee by providing the other party a time duration notice in writing, where the termination date would be at the end of that time duration.
A NARROWER LOOK AT NOTICE PERIOD COVENANT
The covenant of notice period serves interests of both the employer and the employee. It gives the employee time to seek alternate employment and the employer time to substitute the employee with a new hire. “Obviously, the period of notice is generally prescribed, so that within that period the employee may be able to secure alternative employment. In some cases, even for resignation by an employee, such period is prescribed, the idea obviously being to enable the employer to secure a substitute employee within that period.” Held in A.P. Flying Club v. S.C. Saxena 
Notice period helps the employer to avoid a loss of business and helps the employee to avoid a loss of continued employment. This is the interest, which is kept in mind while the notice period clause is added to the employment contract.
Whilst, there is not a set formula to calculate the duration of notice, even if it were to be position specific. To calculate the duration of the notice period in any case, the facts and circumstances of that case, would be relevant and helpful in calculating a reasonable period of notice.
It is decided in Chairman and Managing Director, India Airlines vs. Binod Kumar Sinha and ors. that “…An employee when joins service is subject to certain terms and conditions of service and he cannot quit the employment without giving requisite notice to the employer. But what should be the duration of a reasonable notice in such circumstances is a matter to be decided in each case depending upon the exigencies, needs or necessities and the essentiality of the service concerned.”
The Delhi High Court further held in this regard, “There is no universal formula for fixing the notice period. The duration of the notice period may vary depending upon the exigencies, needs or necessities and the essentiality of the service concerned. What is required is a reasonable notice period.”
Andhra Pradesh High Court in A.P. Flying Club v. S.C. Saxena gives a test to determine the duration of notice period. “The proper test would be to look at the nature of the employment, the employment market in that behalf, and to determine what is the reasonable period within which the employee can secure an alternative employment. It would thus be a question of fact in each case, and the period may vary having regard to the nature of the post, or even from time to time. If the post is an ordinary post requiring no special skill and having a large market, the period of obtaining re-employment would be shorter; in such a case, the notice period may probably furnish the basis. But, if the employment is of a specialized nature, the openings for which are few and far in between, the period would naturally be longer. Sticking to the period of notice prescribed by the rule or the contract would not, in all cases, do justice to the parties. After all, a person is entitled to be compensated for wrongful termination of his service, and the just period would be the reasonable period within which the employee, by making reasonable efforts, is likely to obtain an alternate and substantially similar or equal employment. The principle would be the same even where the Rules or the contract do not provide the notice, or the notice period.”
ENFORCEABILITY OF NOTICE PERIOD
Courts do not ordinarily enforce performance of contracts of a personal character, such as a contract of employment. Thus, if an employee does not serve the notice period by working for the duration of the notice period, the employer may not have a decree from the court asking specific performance of the covenant to the effect that the employee would have to work for the notice period duration. But instead as a remedy to the employer, the court may grant damages for breach of contract.
Hon’ble Supreme Court of India in S.S. Shetty V. Bharat Nidhi Ltd. held that in case of breach of contract, at best reasonable damages can be granted and once there is a clause for termination of services by one month’s notice, it can only be one month’s notice which can be treated as reasonable damages in as much as parties understood the period for obtaining of an alternative employment as a one month’s notice period.
Since enforceability of the notice period is not an option available with the employers, and they may only claim damages in case of illegal termination of employment contract by the employee, it is pertinent to understand the extent of damages that can be claimed.
“Whether the contract of service is for a fixed period or not, if it contains a provision for its termination by notice, it can be so terminated. If there is no provision for giving a notice and the contract is not for a fixed period, the law implies an obligation to give a reasonable notice. Where no notice in the first case or no reasonable notice in the second case is given, the contract is wrongfully terminated and such wrongful termination will give rise to a claim for damages.” Held in Union of India and Anr. vs. Tulsiram Patel and Ors.
If there is illegal termination of employment contract by the employee, then all the damages that are liable to be paid is the salary for the notice period and nothing more. Hon’ble Supreme Court of India in S.S. Shetty V. Bharat Nidhi Ltd. held that in case of breach of contract, at best reasonable damages can be granted and once there is a clause for termination of services by one month’s notice, it can only be one month’s notice which can be treated as reasonable damages in as much as parties understood the period for obtaining of an alternative employment as a one month’s notice period.
Delhi High Court in a 2012 judgement in the matter of GE Capital Transportation Financial Services Ltd. V. Shri Tarun Bhargava, has applied the above Supreme Court judgement.
Having said so, if the employment has been wrongfully terminated by the employer, then the employee has a right to sue the employer for damages, wherein the extent of damages may not be limited to the salary for the notice period.
http://indiankanoon.org/doc/1431516/, last visited on 8th February, 2016.
Petrofina (Great Britain) Ltd. v. Martin, (1966) Ch. 146.
M/s.FLSmidth Pvt.Ltd. v M/s.Secan Invescast (India) Pvt.Ltd., (2013) 1 CTC 886.
 AIR 1995 SC 2372
 1980(1) APLJ (HC) 347
 AIR 2001 SC 3988
 Indian Commercial Pilots Association v. UOI (2006)4MLJ289
 Refer note 1
 Nandganj Sihori Sugar Co. Ltd. v. Badri Nath Dixit, (1991) 3 SCC 54
 AIR 1958 SC 12
 AIR 1985 SC 1416
 Supra Note 23
 RFA No. 294/2004