Essential for preserving the competition of businesses, contract laws internationally recognize non-compete clauses or restrictive covenants or covenants not to compete, wherein one party undertakes and agrees not to enter into or start a similar profession or trade in competition against another party. In India, the Indian Contract Act deals with such covenants and specifically under provision contained in Section 27 of the Indian Contract Act, 1872, which is being reproduced for reference below:
“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.
Exception 1.—Saving of agreement not to carry on business of which good-will is sold.—One who sells the good-will 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 good-will 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.”
A perusal of the above provision indicates that the Indian law does not allow or recognize agreements or clauses which are in the nature of restraint of trade, profession or business of any kind. However, there is exception to this rule, which is, that when the good will of a business is sold, the seller may execute a non-compete clause to refrain from carrying on a similar business with reasonable limits as to location and time period.
Reasonableness of the limits of restraints have been regularly adjudicated upon by the Indian Courts and the Hon’ble Supreme Court of India has laid down that the doctrine of restraint of trade is not confined to contracts of employment, but is also applicable to all other contracts. Some guidelines[1] that have emerged in the context of restraint in employment agreements are as under:
Distance: Suitable restrictions can be placed on employees to not practice the same profession within a stipulated distance which has to be reasonable.
Time limit: If there is a reasonable time provided in the non-compete clause then it will fall under reasonable restrictions.
Trade secrets: The employer can put reasonable restrictions on sharing of trade secrets of the business/company/profession.
In a landmark judgment passed by the Hon’ble Supreme Court of India in the case of Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr.[2], it has been held that a restrictive covenant extending beyond the term of the contract is void and not enforceable:
“… a restrictive covenant extending beyond the term of the contract is void and not enforceable”. The Supreme Court also held that “the doctrine of restraint of trade does not apply during the continuance of the contract of employment and it applies only when the contract comes to end.” The Supreme Court further went on to observe that the doctrine of restraint of trade “is not confined to contracts of employment, but is also applicable to all other contracts”.
However, the Apex Court has also clarified in an earlier judgment that considerations against restrictive covenants are different in cases where the restriction is to apply during the period after the termination of the contract than those in cases where it is to operate during the period of the contract. Negative covenants operative during the period of the contract of employment when the employee is bound to serve his employer exclusively are generally not regarded as a restraint of trade and therefore do not fall under section 27 of the Contract Act. A negative covenant that the employee would not engage himself in a trade or business or would not get himself employed by any other master for whom he would perform similar or substantially similar duties is not therefore a restraint of trade unless the contract as aforesaid is unconscionable or excessively harsh or unreasonable or one sided.[3]
The Three Judge Bench of the Apex Court in Superintendence Company of India (P) Ltd. v. Krishan Murgai[4] held in a case concerning claim for injunction post cessation of employment the Hon’ble Court held that if the employee had left the employment voluntarily he would be bound by the restraint in trade, however since in the case the employment of the employee was terminated therefore the restrictive covenant was hit by provisions contained in Section 27 of the Contract Act.
Furthermore, the Delhi High Court in the case of Le Passage to India Tours & Travels Pvt. Ltd. v. Deepak Bhatnagar[5] observed that under Indian law there is a complete embargo to an agreement in restraint of the trade with the sole exception that one who sells goodwill of a business may agree with the buyer to refrain from carrying a similar business “within specified local limits” provided that such limits appear to the Court to be reasonable, regard being had to the nature of the business. However, in the garb of the alleged sale of goodwill of the trade, parties cannot enforce a restraint on the employment even after the employee ceases to be in the employment.
In another interesting matter, the Delhi High Court was, in injunctive proceedings against the manager by Desiccant, considering a case[6] where the employment agreement stated that for two years following the termination of the employment, the employee would be bound by a covenant with Desiccant that would require him to keep Desiccant’s matters confidential, and that would prevent him from competing with Desiccant and soliciting Desiccant’s customers, suppliers and employees. After a few years of employment, the manager resigned and-notwithstanding the terms of his old employment agreement-within three months of his resignation joined a direct competitor of Desiccant as country manager in charge of marketing and started contacting customers and suppliers of Desiccant.
In this context the High Court while brushing aside the arguments by the Company that the restrictive covenants were primarily designed to protect its confidential and proprietary information, reiterated the principles embodied in Section 27 of the Contract Act and the individual’s fundamental right to earn a living by practicing any trade or profession of his or her choice. Thus, the High Court ruled that in the clash between the attempt of employers to protect themselves from competition and the right of employees to seek employment wherever they choose, the right of livelihood of employees must prevail.
Therefore, from the above it can be concluded that in India courts do not recognize restrictive clauses operating after the termination of employment as the same are seen as restraint of trade and hit by provisions contained in Section 27 of the Indian Contract Act.
[1] FL Smidth Pvt. Ltd. v. Secan Invescast (India) Pvt. Ltd., Madras HC, 2013 SCC OnLine Mad 389
[2] (2006) 4 SCC 277 (2 judge bench)
[3] Niranjan Shankar Golikari v. Century Spg & Mfg Co. Ltd (1967) 2 SCR 378 (2 judge bench)
[4] (1981) 2 SCC 246
[5] 2014 SCC OnLine Del 259
[6] Desiccant Rotors International Pvt Ltd v Bappaditya Sarkar & Anr (I.A. No.5455/2008, I.A. No.5454/2008 & I.A. No.5453/2008 in CS(OS) No.337/2008)