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Employment/Labour- India.

Background

 

Non-compete and non-solicit agreements are a popular way to try to prohibit employees and former employees from working for a competitor or divulging trade secrets or other proprietary data. In several jurisdictions, such as England and Wales, the law has evolved to uphold such agreements, subject to how reasonable the limits imposed are.

 

In India, such agreements are affected by Section 27 of the Indian Contract Act 1872, whereby any agreement that restrains a party from exercising a lawful profession, trade or business is void. The section sets out an exception applicable to cases where a party sells the goodwill of a business. In such cases, the seller of the goodwill of the business may agree with the buyer to refrain from carrying on a similar business within a specific geographical area provided that the buyer or any person deriving title to the goodwill from the buyer is carrying on similar business in that area. However, such limits must appear reasonable to the court given the nature of the business. Where the goodwill of a business is sold without an express non-compete agreement, the vendor may set up a rival business but is not entitled to canvass customers of the old firm. The grounds for this may be either that (i) the vendor may not derogate from its own grant, or (ii) the vendor had impliedly contracted not to solicit its former customers or it would be fraudulent to do so.

 

Decision

In Percept D'Mark (p) Ltd v Zaheer Khan the Supreme Court clarified this area of law as follows:

 

  • A restrictive covenant extending beyond the term of the contract is void and unenforceable;
  • The doctrine of restraint of trade does not apply during the continuance of the contract for employment and applies only when the contract ends; and
  • This doctrine is not confined only to contracts of employment, but is also applicable to all other contracts.
  • Based on the court's decision in this case, the provisions of Section 27 may be split to deal with two phases: the period for which a contract is in force and the period after it has expired.

 

When the contract is in force, judicial precedent has established that restraints, both general and partial, are permissible unless they are contrary to public policy. For example, during the period of employment an employer has the exclusive right to the services of the employee. Therefore, a negative covenant (eg, that the employee may not engage in a trade or business or take up employment with another employer to perform similar or substantially similar duties) is not a restraint of trade.

 

The court's decision also confirms that all covenants existing beyond the contract are void. However, an exception to this rule is where a covenant exists for non-solicitation. It has been held by both the Supreme Court and the Delhi High Court that non-solicit covenants are covenants that essentially prohibit either party from enticing each other's employees away from their respective employers. This restriction is imposed on the contracting parties and not on the employees. The restriction relates to inducements offered to the other party's employees to change employer. By itself, the clause imposes no restriction on the employees and is viewed more liberally than a similar restriction in an employer-employee contract. Therefore, a non-solicit clause does not amount to a restraint of trade, business or profession and will not be declared void under Section 27 of the act.

 

Comment

Where a contract imposes a non-compete covenant during the term of the contract, that covenant will be enforced unless a court deems it to be contrary to public policy. However, if a contract imposes a non-compete covenant that extends beyond the term of the contract, the covenant is enforceable only if it relates to non-solicitation.

 

The tussle between freedom of action and the right to contract freely needs to be revisited in light of the rapid development of a free market economy in India. In this regard, the cue may be taken from developments in England and Wales, where parties are free to agree not to compete after the contract term expires provided that the limits imposed are reasonable. The Indian courts have touched upon this issue time and again and have highlighted their inability to push forward reform in light of the explicit legislative provisions, which leaves little room for judicial activism. Therefore, it is up to the legislature to deal with this issue by amending the act to recognize that employers have a legitimate interest in protecting financial and time investments in employees. The law needs to protect an employer's reasonable business interests without unduly limiting an employee's other work opportunities.

 

International Law Office