Non-compete covenants: Time for change in the Indian perspective.
n today's commercial world, sensitive information holds a position so influential that unregulated generation, dissemination and modification thereof can result in shocking financial ramifications for an interested business entity. As such businesses in all sectors have taken to relying upon numerous tools to regulate the creation, use and dissemination of such information to consolidate and leverage their financial position.
Non-compete covenants are one such contractual tool employed by businesses to protect their financial position by restricting participation in a certain market by a business or individual under specific circumstances
There are two basic genres of non-compete agreements one which fall in the sphere of employment and service contracts and the other in the sphere of acquisition and dissolution of businesses. The agreements falling in the first genre are employed to restrict certain entities and persons privy to sensitive information-centric transactions from entering into the market to prevent possible dissemination of such information to possible competitors of businesses whereas the ones in the second genre more or less guarantees that the acquirer receives the full value of the assets transferred
Non-Compete Contracts falling in both these spheres are entered mainly because of the non-linear information associated with such proprietary rights. Non-compete agreements mainly seek to protect all proprietary rights and information which are operative in ensuring the competitive edge enjoyed by an enterprise. The nature of such right basically being information-centric can easily shift from one enterprise to another with an employee relocating or a seller opening a new business.
As such an infringement of such proprietary rights would not only be difficult to pin down due to lack of appropriate knowledge as to when precisely the same occurred but also due to the activities of such an individual being hard to establish. This ambiguity regarding the source of infringement results in an insecurity in decision-making in an enterprise which is counter-productive for businesses in general. Further, the cost associated with monitoring any infringement is very high. So prevention is considered better than cure and these covenants are generally executed to ensure employees leaving the enterprise and joining a rival enterprise do not compromise on the business security of the enterprise. They are increasingly being resorted to in cases of distribution agreements, licensing, joint ventures and partnership dissolution agreements and also in case of sale of businesses. When signed at a horizontal level especially in a sale of business scenario, they bring a direct or indirect obligation upon a party to the acquisition agreement not to manufacture, purchase, sell or resell independently like goods or services which compete with the buyers, generally in respect to a certain geographical market.
In India by virtue of sec. 27 of the Indian Contract Act, 1872 there is no legal ramification of an agreement which restrains trade and business and as such in the eyes of law such an agreement does not exist thereby making non enforceable. The reason being that such agreements are unfair, as they impose an undue restriction on the personal freedom of a contracting party. However, as an exception, if a party sells his goodwill to another he can agree with the buyer that he will not carry on a similar business within the specified local limits.
If one thinks about it all commercial agreements have tradeoffs and in different degrees restrain the parties and their right to trade, profession and business. However the same does not mean that all agreements of such nature executed in India would not have any legal ramifications and be thereby void. In fact the courts have interpreted that negative covenants in existing agreements are governed by the doctrine of reasonableness and have repeatedly upheld them, on facts and circumstances unless they seem prima facie oppressive and one sided. Farran C.J in India Charlesworth v. MacDonald while answering whether a negative stipulation during the tenure of a contract would be an agreement in restraint of trade eloquently stated.
Is it an agreement which restrains the defendant from exercising his lawful pro fession? Is it an agreement in restraint of trade? I think not. I do not think that an agreement of this class falls within the section. If it did all agreements for personal service for a fixed period would be void. An agreement to serve exclusively for a week, a day, or even for an hour, necessarily prevents the person so agreeing to serve from exercising his calling during that period for any one else than the person with whom he so agrees. It can hardly be contended that such an agreement is void. In truth. a man who agrees to exercise his calling for a particular wage and for a certain period agrees to exercise his calling, and such an agreement does not restrain him from doing so. To hold otherwise would, I think, be a contradiction in terms..... As such restrictive covenants during the service period are not really considered to fall foul of sec. 27 and are out side their operative scope.
However Indian courts have repeatedly refused to enforce restrictive covenants extending beyond the term of the contract holding the same as void and not enforceable (1). The courts have been unfazed by arguments that these covenants were primarily designed to protect its confidential and proprietary information, on the reasoning 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(2). Innovative tactics by companies such as executing garden leave agreements which come into force after termination of employment, though against consideration, have been held to not renew the employment contract and have upheld the law that post termination of service, agreements in restrain are void and cannot be enforced(3) (4).
As such for near about 100 years the law in India has been well set that that non compete clauses that extend after the termination of employment are not enforceable in India. In the garb of confidentiality, an employer cannot be allowed to perpetuate forced employment, as it is hit by Section 27
Though the law stands thus, it should be noted that the Law Commission in its 13th report has recommended that the provision (section 27 of the Contract Act) should be suitably amended to allow such restrictions and all contracts in restraint of trade, general or partial as were reasonable in the interest of the parties as well as public. In the backdrop of foreign entities emerging and entering India's commercial domain, especially from countries wherein such negative covenants are not statutorily restricted and are interpreted in a far more realistic manner, the current scenario is ripe for legislative and judicial change. If India needs to become more investor friendly, tools employed by entities to retain their competitive edge by regulating sensitive information must be sharpened. Entities in India should lobby for a change in the law along with incorporating such clauses in their contracts.
Meanwhile as the common law in India perceives negative covenants in drastically different ways, depending upon the termination or existence of employment contracts, entities should ensure that, firstly they have policies for control of sensitive information across all hierarchies of their structure. Secondly ensure that at the time of termination of the employment contract, an agreement bearing details of all sensitive information privy to an employee, which is in his knowledge only due to his employment with the business entity, is executed by him with an obligation to not disseminate this information. This contract should be against a suitable consideration, past or present, with quantifiable damages to be paid in breach thereof. Thirdly allocate a certain budget to such monitoring practices and diligent pursue such dissemination of information to deter further dissemination.
- Percept D' Mark (India) Pvt. Ltd v Zaheer Khan AIR 2006 SC 3426
- 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
- V.F.S. Global Services Ltd. v. Mr. Suprit Roy 2008(2)Bom CR 446, 2007(2) CTLJ 423 Bom
- Superintendence Company of India vs Krishan Murgai 1980 AIR 1717, 1980 SCR(3)1278