Validity & Enforceability of Restrictive Covenants in Contract

6th March, 2023 - 9:56 am Categories: Legal Issues Technology 0 Comments

Introduction

Technological advancement and globalization have imposed additional complexity on the relationship between employee and employer, and the contract governs these relationships. However, the parties need to protect their business interests such as confidentiality and proprietary information, ideas, and trade secrets. Due to all these complexity employers often add restrictive conventions in the employment contract, which restrict the other party from exercising its liberty to use any confidential information or carry out a specific profession, trade, or business with any other party without taking prior permission from the employer. This article is going to discuss the legal validity of restrictive covenants in India and what restrictions are enforceable. This article seeks to better understand employers and employees on the matter of restrictive covenants in the contract.

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What are Restrictive Covenants?

Restrictive covenants are contractual obligations put by an employer on the employee. It could be in the form of a separate agreement or a clause of an employment agreement. It prohibits employees from engaging in specific actions. The most common use restrictive covenants in India are:
1. Non-compete Clauses: Employers use these clauses to restrict employees from taking up employment, engaging with competitors, or doing business that would be in exact competition with the employer.
2. Non-solicit Clauses: This clause put restrictions on employees from soliciting employees or clients after the termination of employment with the organization
3. Confidentiality Clauses: This clause restricts employees from sharing the organization’s confidential information such as trade secrets or other proprietary information during or after employment. A confidentiality clause also defines what information is considered to be confidential for the organization.

Indian Laws on Restrictive Covenant

1. Article 19 (1) (g) of the Constitution of India talks about the freedom to practice any profession or to carry on any occupation, trade, or business to all citizens. However, the subject to Art. 19 (6) allows reasonable restriction on the freedom to practice any profession, occupation, etc.

2. Section 27 of the Indian Contract Act, 1872 (“Contract Act”) states that every agreement by which anyone is restrained from exercising a lawful profession, trade, or business of any kind, is to that extent void.

Validity & Enforceability Non-Compete Clause

In determining the enforceability of restrictive covenants in restraint of trade, business, or profession the courts have consistently taken a restrictive view. As in these contracts, it is usually assumed that the employer has an advantage over the employee. While contracting these agreements employers usually compel employees to execute standard contracts, rather than negotiate their interests. As a result, these contract restricts the ability of the employees to earn a livelihood.
Thus, the courts in their judgments consistently held that the restrictive covenants that employers impose during employment do not amount to restraint of trade under Section 27 of the Act. However, the legality and enforceability of post-employment non-compete obligations have been much debated.
The Calcutta High Court cleared the scope of Section 27 of the Indian Contract Act, in its judgment “Madhub Chunder Poramanick v. Rajcoomar Doss and Ors.” in this case the Calcutta High Court observed that the intent behind Section 27 was not only to prevent total restrain from carrying out profession trade, or business, but also to prevent the partial restrain on carrying out profession trade, or business.

However, the Supreme Court gives its judgment about the validity of negative covenants (Restrictive Covenants) in the case of “Niranjan Shankar Golikari v. The Century Spinning and Manufacturing Company Ltd,” In this case, the Hon’ble Supreme Court observed that the negative covenants can be valid as long the restriction imposed is reasonable and not against public policy. The court further held that the negative covenants operative during employment are not regarded as restraining trade and thus, do not fall in the ambit of section 27 of the Indian Contract Act.

The court, in the above judgment, does not clearly state post-employment restrictive covenants to be void. However, The Supreme court in its judgment “Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr, clear its views about a post-employment restrictive covenant by stating that restrictive covenants extending beyond the course of employment are void and not enforceable. The court further held that the doctrine of restrain of trade is not applicable during employment and it applies when the contract comes to an end. The same was upheld by the Supreme Court while deciding the case of “Superintendence Company of India (P) Ltd. v. Krishan Murgai”.

Similarly, the Delhi High Court in the case of “Pepsi Foods Ltd. and Ors. v. Bharat Coca-Cola Holding Pvt. Ltd and Ors” held that ‘it is a well-settled position that validity of restrictive covenants post termination of agreements, violate Section 27 of the Indian Contract Act and such contracts are unenforceable, void and against the public policy.

Validity & Enforceability of Non-Solicit Clause

The non-solicitation clause in an employment contract refers to contracts that restrict an employee from soliciting the employer’s clients, customers, vendors, or employees for a pre-determined duration after the termination of the employment. The courts have approached these clauses based on facts and circumstances.

The Delhi High Court while deciding the case of “Wipro Ltd. v. Beckman Coulter International SA examined the non-solicitation clause between businesses. The clause in question bars contracting parties from inducing their employees to give up their current employment and join such other party. The court held that the bar under section 27 of the Act would not be attracted in cases where the non-solicitation clause operates between two individuals, businesses, or partnerships as the restriction was put solely on the contracting parties.
However, the Calcutta High Court while deciding the enforceability of the Non-solicitation clause between employer and employee in the case of “Embee Software Private Limited v. Samir Kumar Shaw” held that if the former employee solicit or induce the employee, client, or any other person from contracting with a former employer than that cannot be permitted.

However, The Madras High Court while deciding the case of “FL Smidth Pvt. Ltd. v. M/s. Secan Invescast (India) Pvt. Ltd” held that to prove solicitation the appellants are required to prove that the respondent approached their customers and only on the account of such solicitation, customers placed the orders to the respondent. The court further held that such a clause might be valid if reasonable restraints are imposed and summarised the reasonable restriction as follows:

1. Reasonable restrictions can be imposed on employees in relation to reasonable distance to practice the same profession within that distance.
2. A reasonable period to not practice such a profession or trade can also be valid.
3. Reasonable restrictions can be imposed on letting out trade secrets.

Validity & Enforceability of Confidentiality Clause

In India, confidentiality clauses has generally been enforced in relation to the post-employment context. This clause restricts employees from sharing the organization’s confidential information such as trade secrets or other proprietary information.

The Bombay High Court in the case of, “Zee Telefilms Limited v. Sundial Communications Private Limited”, recognized that the maintenance of confidence is in the public interest. The court held that no one should be allowed to profit from the wrongful use of information received in confidence. Therefore, a breach of confidence arising from a contract or an equitable right may be judicially restrained.

In a subsequent case the Bombay High Court in the case of “Anindya Mukherjee v. Clean Coats Private Limited” held that the confidentiality clause is a regular feature of commercial arrangements as it is based on trust, honesty, and confidential relationship. In the light of the above-stated observation court on facts, the court ascertained a breach of confidentiality when the petitioner resigned from service without adhering to the contractually mandated notice period and joined the respondent’s competitors. The court further observed that while there was no direct evidence on record to demonstrate that the petitioner had used the respondent’s confidential information when working for the competitors, the possibility of such use could not be ruled out when read in conjunction with the losses suffered by the respondents after the petitioner joined their competitors.

The Delhi High Court restricted the kind of information that could be considered confidential while deciding the case of “Stellar Information Tech Private Ltd v. Rakesh Kumar” in this case the petitioner alleged that the defendants (former employees) breached confidentiality by copying the plaintiff’s client database and approaching them. However, the court held that merely approaching a client does not establish a breach of confidentiality. The details of such customers are in the public domain. Court further held that an employer cannot bar a former employee post-termination from using the skill and knowledge acquired during employment.

Conclusion

Although the court has different views on the validity and enforceability of these covenants, The court has broadly examined such clauses in the light of the facts and circumstances of each case, by considering the reasonableness of the restriction put by these covenants. However, from these cases, it is evident that the mere presence of such clauses in the contract does not make those contracts void ab initio. And the employer can add restrictive covenants in the contract that restricts employee during employment valid; However, the post-termination restriction is subject to reasonableness.

Author: Mudit Gupta, in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at  Khurana & Khurana, Advocates and IP Attorney.

References

1. Madhub Chunder Poramanick v. Rajcoomar Doss and Ors, (1874) 14 Beng LR 76
2. Niranjan Shankar Golikari v. The Century Spinning and Manufacturing Company Ltd, 1967 SCR (2) 378
3. Percept D’Mark (India) Pvt. Ltd. vs. Zaheer Khan & Anr, (2006) 4 SCC 227
4. Superintendence Company of India (P) Ltd. vs. Krishan Murgai, 1981 SCC (2) 246
5. Pepsi Foods Ltd. and Ors. vs. Bharat Coca-cola Holdings Pvt. Ltd. and Ors, (1999) ILR 2 Delhi 193
6. Wipro Ltd. v. Beckman Coulter International SA, 2006 (131) DLT 681
7. Embee Software Private Limited vs. Samir Kumar Shaw, 2012 (3) CHN 250
8. FL Smidth Pvt. Ltd. v M/s. Secan Invescast (India) Pvt.Ltd, (2013) 1 CTC 886.
9. Zee Telefilms Ltd. And Film And … vs Sundial Communications Pvt. Ltd. … on 27 March, 2003
10. Anindya Mukherjee v. Clean Coats Pvt. Ltd., Mumbai . | Bombay High Court | Judgment | Law | CaseMine
11. M/S Stellar Information … vs Mr Rakesh Kumar & Ors on 29 August, 2016