In ancient times, it was customary for the ruler of the kingdom to cut the hands off of the artisans who created something extraordinary so as to make sure he/she could not design or create similar or better work for someone else in future. It is said that after completion of the monument Taj Mahal, Shahjahan ordered that the right hands of the masons be cut, so that the masterpiece could never be recreated. There were several incidences in the past where the King offered the artisans land, protection and caretaking for them and their families as a consideration for their exclusive services. The artisans even after the completion of work were not supposed to work for any other master to ensure they couldn’t create similar or better work for others.
Every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind is to that extent void. The only exception which is provided to the doctrine that an agreement in restraint of the exercise of a lawful profession, trade or business is void is where the goodwill of a business is being sold.
Agreements between employers and employees, whereby the employees covenant not to set up business on their own account on leaving the employers’ service or to enter into employment with a rival firm.
Agreements between the buyer and seller of a business together with its goodwill, whereby the seller covenants not to carry on a business which will compete with that of the buyer.
Non-competition clauses generally provide that an employee will not join a competitor in the same business for a specific period of time and within a certain geographical area. Such clauses are restrictive covenants in the restraint of trade. In Sanmar Speciality Chemicals Ltd. v Dr. Biswajit Roy AIR 2007 Mad 237, the Honorable High Court of Madras struck down a Non-Compete clause in the Appointment Letter of an employee.
In the 1980's, the Indian courts were very “constructionist” in the way they viewed non-compete clauses and the Bakelite Hylam Ltd. v S.J. Hasan , [(1985) 1 Lab.LJ 438] is typical of the genre. An analysis of the judgment brings out the following legal principles: When a non-compete contract is challenged, the court must determine if it constitutes a restraint on trade;
A contract which restrains trade is prima facie void;
Restrictions operating during the period of contract of employment are valid unless unconscionable or excessively harsh or unreasonable;
Restrictions operating beyond the termination of service are void;
The test of reasonableness does not apply to post service restrictions.
In 1995, the Supreme Court, in the case of Gujarat Bottling Co. Ltd. v Coca Cola Co . [AIR 1995 SC 2372]held that 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.
In the case of Niranjan Shanker Golikari v Century Spinning and Manufacturing Co. (AIR 1967 SC 1098) A shift supervisor was held bound to his non-compete obligations because his employer acquired German technology for its tire cord yarn plant subject to stringent confidentiality restrictions. Similar restraints were upheld by the Delhi High Court in Modern Food Industries India Pvt. Ltd. v Shri Krishna Bottlers Pvt. Ltd., [AIR 1984 Del 119], which has held that the validity of a restraint will generally depend on (a) the proprietary interest sought to be protected; (b) the reasonableness of the restriction; and (c) the larger public interest.
In Percept D’ Mark (India) Pvt. Ltd v. Zaheer Khan (AIR 2006 SC 3426), 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 (I.A. No.5455/2008, I.A. No.5454/2008 & I.A. No.5453/2008 in CS(OS) No.337/2008).
Sale of a business, where the owners of the business will agree to a non-compete in exchange for consideration for the goodwill associated with the business (for example, in a stock sale where the promoters will sell their stock in the business to a buyer in exchange for consideration). To be enforceable, the non-compete will need to be reasonably limited in time and scope, and consideration will need to be attributed to the goodwill in the transaction, as evidenced in the documentation. Similarly, a non-compete clause in a joint venture in which shareholders mutually agree not to compete with each other on certain terms and conditions, which include time and geographic restrictions, will generally be enforceable in India.
In the event of buying a Company/business, by another, a non-compete clause shall be enforceable provided adequate compensation is given in lieu of such abstinence. For example, the SEBI Takeover Code gives a guidance to Listed Companies which stipulates that “ A n acquirer can pay a seller a non-compete fee of up to 25% of the price offered to shareholders in an open offer and anything more than 25% has to be included in the open offer price."
In 2007, in order to curb their employees from exiting the Company, Infosys had put forward Non-Compete Agreements. The Non-Compete clause states that even after the employee quits the company, he/she cannot work for any of its top competitors – TCS, Accenture, IBM, CTS and Wipro. The clause also disallows employees from taking up jobs with Infosys customers up to six months after quitting. Such clauses are by themselves void and unenforceable. According to Mr. H.L. Kumar, Supreme Advocate and chief editor of the Labour Law Reporter, states “Any employee has a vital right to change employment for self-growth, which can neither be restricted nor curtailed by anyone, even the employer.”
There is a difference between Non-Compete and Confidentiality clauses. In the pretext of protecting the confidential information of a Company, the employer shall not restrain an employee from getting employed in any other Company carrying on business of a similar nature. In case of disclosure of confidential information of the Company by an employee after termination of his employment with the Company, the Company shall file a case for disclosure of such information alone. Non-Compete cannot be used as a weapon to stop disclosure of confidential information.
The stance of Indian courts with regard to post-contractual covenants or restrictions has been consistent, unmistakably clear and completely settled in India. The legal position clearly crystallized in India, is that while construing the provisions of Section 27 of the Contract Act, neither the test of reasonableness nor the principle of restraint being partial is applicable, unless it falls within express exception engrafted in Section 27.
Therefore, to conclude, when dealing with local management and key employees in India, foreign investors need to remember that the position of Indian courts on the question of non-competes is unmistakably clear—any restriction with regard to freedom of employees to seek employment and earn a living after termination of their employment contract will generally be unenforceable as contrary to public policy as set forth under Section 27 of the Act.