To be able to appreciate the advent of non-compete and non-solicitation clauses in the contractual realm, one has to dig deep into history. In 1414, Hull J, speaking for the bench in Dyer’s Case[1], struck down with a heavy hand an agreement in restraint of trade stating, “On my action, you could claim a demurrer, on the plea that the obligation is void, or that the contract is contrary to common law; and on Oath, if the plaintiff were present, he would be put in close confinement and pay a fine to the King.”[2] The scathing remarks are reminiscent of the rigid attitude that prevailed in the judicial fraternity with regard to agreements in restraint of trade. It was only after the 1711-landmark case of Mitchel v. Reynolds[3] that principles of these clauses came to be etched in common law systems, and later spilled over to other jurisdictions as well. This case rejected the contrarian opinion that agreements in restraint of trade were always illegal by delineating the fine line between reasonable and unreasonable restrictions.

But what is the practical implication of such clauses?

Fathom this: you have on board a Co-Founder in furtherance of pursuing your idea of founding your dream company. You start off well, share confidential data (say patents), place him on equal pedestal as you making him a part of the team that directly manages the company and in turn he becomes one of the prominent faces of it. Gradually, differences arise and the co-founder decides to walk away from your company. In the process, he also takes away crucial information privy to your company and forms his own, thereby resulting in losses to you (read Mark Zuckerberg – Winklevoss brothers saga, rechristened into a full-blown feature film, The Social Network, 2010). This is exactly where non-compete and non-solicitation clauses come into play – in essence to protect you from potential loss on account of a fall-out. The pertinent question however remains- do such clauses really work in India in protecting the interests of employers?

Position Under the Indian Legal System

For better clarity- what is a non-compete clause and what is a non-solicitation clause?

A non-compete clause or agreement is a contract wherein an employee promises not to enter into competition of any kind with an employer after the employment period is over. These agreements also prohibit the employee from revealing proprietary information or secrets or confidential information to any other parties during or after the employment. This can also apply to agreements between business transactions between independent parties such as a dealer and distributor and similarly placed relationships.

A non-solicitation clause typically refers to an agreement between an employer and employee that prohibits an employee from utilizing the company’s clients, customers, contact lists, etc. after such employee leaves/exits the Company. These, like non-compete clauses/agreements, can also exist to even between independent parties such as above.

Insofar as the Indian position is concerned such agreements have been held to be valid on very restrictive grounds. Indian Contract Act, 1872 (“Act”) is the primary legislation in India that deals with agreements in restraint of trade and legality thereof. Section 27 of the Act bars such agreements in clear and express terms. It states, “Every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.” It provides for one exception for those agreements that entail a bar on carrying on a business of which good will is sold.

The Indian law does not carve out an exception for partial and absolute restraint of trade. Both are void ab initio (i.e. illegal from the very inception) as per the law and cannot be placed in watertight compartments as is visible from a string of judicial pronouncements. This subtlety is further evident from a bare perusal of Section 28, which deals with ‘Agreements in restraint of legal proceedings,’ and provides for ‘absolute’ restriction for the section to be applicable.

Courts in India, have lately adopted a slightly more flexible view, though it is far from an ideal situation from an employer’s perspective. While it is largely settled now that such restrictive covenants in agreements are binding on the signee during the course of the partnership / employment, the applicability of these clauses post termination, where a lot of judicial deliberation has happened leading to divergent views.

Judicial Trend in India

In Niranjan Shankar Golikari v. The Century Spinning And Mfg. Co.[4], the Supreme Court categorically held that approach against restrictive covenants such as non-compete clause and non-solicitation clauses 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 that are deemed to be operative during the period of the contract of employment when the employee is supposed to serve his employer are usually not considered as restraint of trade and therefore do not fall foul of Section 27 of the Act.

The Supreme Court followed a similar approach in Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr.[5], but went on to add an exception inasmuch as operation of restrictive covenants post termination of contract is concerned. It stated, “Under Section 27 of the Contract Act (a) a restrictive covenant extending beyond the term of the contract is void and not enforceable. (b) The doctrine of restraint of trade does not apply during the continuance of the contract for employment and it applied only when the contract comes to an end.”

Moreover, courts have been careful to treat non-solicitation contracts between say business partners / distributors on a different footing from those of non-compete / non-solicitation between employer-employee per se. For instance, consider the Delhi High Court case of Wipro Ltd. v. Beckman Coulter International SA[6] where the Petitioner was appointed as the sole canvassing representative / distributor for the Respondent and continued in the position for 17 years, after which the Respondent decided to start an independent business in India calling for prospective candidates to work for it etc. The Court pointed out that bar under Section 27 of the Act will not be attracted in cases where non-solicitation clauses operate between business partner and distributor contracts or similar partnership contracts between two independent entities as opposed to that between an employer and an employee. Therefore, non-solicitation clauses have more sanctity when part of agreements such as those of partnership where there is a strong implicit presumption that each party had an equal opportunity at the negotiation table and there was an absence of dominance of will of one party over another. This however would be dependent on the facts of each case and the language of each contract.

Conclusion

Therefore, what is evident from the foregoing is that courts in India have taken a rather restrictive approach. A non-compete / non-solicitation contract or a clause therefor is valid in India on very narrow grounds viz. on satisfying three-pronged test of being reasonable, in furtherance of promoting trade and commerce rather than creating an impediment for it, and not operate so as to curtail employees’ fundamental right to trade and commerce and livelihood. They, however, can be enforced to prevent proprietary information or secrets or confidential information of an employer being infringed or transferred or exposed, especially to competitors. It can also be enforced in a more effective manner in respect of relationships between business partners / distributors/etc.

Moreover, the restrictions operate majorly at partnership and senior management levels while employees, such as marketing executives or call centre employees, have been left out of its purview as on date. The reason for such approach is the dominance of employers over employees in India. The courts tend to strike a fine balance between promotion of trade of the employer while ensuring rights of employees are protected. This arrangement forms backbone of conducting business smoothly, and seems to be in consonance with long-term goals of helping India achieve higher rankings on indices such as ease of doing business.

-Namitha Mathews (Partner) and Ketul Hansraj (Junior Associate)

[1] (1414) 2 Hen. V, fol. 5, pl. 26.

[2] Translated from French by Thomas Tayler in The Law Glossary 27 (1877).

[3] 1 PWms 181, 24 ER 347, 45 Digest (Repl) 395, [1558-1774] All ER Rep 26.

[4] 1967 AIR 1098, 1967 SCR (2) 378

[5] AIR 2006 SC 3426.

[6] 2006 (3) ARBLR 118 (Delhi).

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