Validity of the Non Compete Clause in employment contract

959 votes

A clause in an employment agreement that restrains an employee from working with a competitor or carrying out a competing business is called a Non-Compete clause. An agreement in restraint of trade has been defined as “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.”[1]

Vis-à-vis Indian Contract Act

The non-compete covenants used in agreements can be categorized into in term and post term covenants. Non-compete clauses are valid only to a very limited extent in India, because of the rider under Section 27 of the India Contract Act, which reads as follows:

“27. 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. Saving of agreement not to carry on business of which good-will is sold.”

The legal position with respect to Indian Contract Act is that restrictive clauses pertaining to post employment period are null and void, while the ones imposed on employees during employment are legally enforceable.

In the case of V.V. Sivaram and others v. FOSECO India Limited[2], an employee was restrained from using secrets and confidential information, which he gained during job, even after moving out of the job. The employee had access to confidential information pertaining to several products including the patent ‘Turbostop’. He left under voluntary retirement scheme. Injunction restraining him from manufacturing and marketing a product similar to ‘Turbostop’ was held to be not violating Section 27.

The principles of Section 27 were aptly summarized by the Supreme Court of India in Percept D’ Mark (India) Pvt. Ltd v. Zaheer Khan[3], in which the Supreme Court observed that under Section 27 of the Act a restrictive covenant extending beyond the term of the contract is void and not enforceable. The court also noted that the doctrine of “restraint of trade” is not confined to contracts of employment only, but is also applicable to all other contracts with respect to obligations after the contractual relationship is terminated.

This long-standing stance was clearly reaffirmed recently in a 2009 decision by the New Delhi High Court in Desiccant Rotors International Pvt. Ltd. v. Bappaditya Sarkar & Anr[4], wherein the Delhi High Court ruled that in a 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.

On similar lines, in V.F.S. Global Services Ltd. v. Mr. Suprit Roy[5] the Bombay High Court held that a fully paid three-month “garden leave” agreement with a senior manager did not renew the employment contract and constituted a “restraint of trade” unenforceable by V.F.S.

Indian Courts have refused to enforce post-termination non-compete clauses in employment contracts, viewing them as violative of Section 27 of the Indian Contract Act, as being in “restraint of trade”.[6]

In the case of Gujarat Bottling Company Limited (GBC) vs. Coca Cola Company[7], the Supreme Court said any non-disclosure clause shall be applicable only during the period of service and any restraint beyond the service is violative of Section 27.

However, the Court in the case of Nilanjan Golokari v. The Century Spinning and Mfg[8]. ruled that non-compete clauses cannot be considered as restraint of trade against the employee, if they are operating during the course of employment.

The reasoning given by the Court was that such a restriction imposed on the employee cannot be regarded as a restraint of trade due to the apprehension of the employer that his trade secrets and confidential information acquired by the employee throughout the time of employment can be disclosed.

In the case of Dr. S. Gobu vs. The State of Tamil Nadu[9], the High Court refused to let the employee have the benefit of Section 27, ruling that “the agreement executed by him does not suffer from any arbitrariness or it was not done due to any unequal bargaining power”, in the light of the fact that the petitioner was the beneficiary of three years leave period together with salary paid and he was treated as service candidate and not as a direct candidate. The Court ruled that, he cannot have best of both Worlds.

Advocate Siddhant Sharma LawRato