Non Compete Clause – Validity and Enforceability

By | April 9, 2021
Non Compete Clause

I. Introduction

A non compete clause is well defined in contract law as a clause that is written into any deal between two parties, one of which is the employer and the other the employee. Due to the presence of this non-compete condition, the employee undertakes and accepts the employer’s condition that he will not be a rival of the employer in the manner and existence of the employer’s jobs during the employment or even after the employee leaves the employer’s services/job.

Any organization spends a lot of money time and resource to build its organization and tries its best to protect its sensitive data from competitors and rivals. Since employees working in any organization form an integral part of the organization and have the access to a lot of sensitive data hence it is important to protect the data during the course of employment of the employee and even after that.

A non compete clause may have the following limitations[1]

  1. Prohibition on engaging in any capacity with rivals.
  2. Prohibition on starting your own company in a related field.
  3. Prohibition on soliciting or engaging the employer’s resources and contractors, as well as approaching the employer’s customers.
  4. Limitation on sharing or disclosing the former employer’s business information with the current employer.
  5. Limitation on living in the same geographical area.

II. Legal Framework

Indian Contract Act, 1856 and Competition Act, 2002

Section 27 of the Contract Act states that any relationship that prevents an individual from carrying on a lawful occupation, trade, or service is null and void. An individual who sells the reputation of a company to another may be prohibited from carrying on a similar business for a certain period of time and in a reasonable position as long as the buyer carries on the same business. Furthermore, a non-compete deal could be in violation of Section 3 of the Competition Act, 2002 if it has a significant adverse impact on competition in India.

Validity of Non-compete Clause in India

Legal precedent as laid by Indian courts on the enforceability of certain non-compete clauses when grappling with such a contractual problem in Superintendence Company of India (P) Ltd. v. Sh. Krishan Murgai[2], the Supreme Court of India asked the question of whether a post-service restrictive covenant can come under the ambit of section 27 of the Contract Act raised the issue of whether a post-service restrictive covenant will be subject to the mischief of Section 27 of the Contract Act The court ruled that a contract with the purpose of restricting trade was prima facie void.

In Foods Ltd. and Others v. Bharat Coca-Cola Holdings Pvt. Ltd.[3] and Others, the Delhi High Court upheld that

“It is well settled that such post-termination restraint, under Indian Law, is in violation of Section 27 of the Contract Act. Such contracts are unenforceable, void, and against public policy. What is prohibited by law cannot be permitted by Court’s injunction.

Based on the above findings, it can be deduced that when dealing with conflicts relating to certain non-compete clauses in employment agreements, Indian courts have distinguished between the pre-termination period of the employment and the post-termination period of the employment.

Validity of Non-Compete Clause post-termination

It is important to ensure that the restrictions enforced by the company are fair and not harsh on the workers in order for them to be enforceable by statute. It wouldn’t hurt to mention that the prohibitions on “non-solicitation” and/or “non-disclosure” may be seen as an exception to this clause.

Test of Reasonableness

Various legal decisions lead to the view that fair restraint is permissible to some extent and does not render the contract void from the start.” Fair restraint is based on a variety of factors, and it must be necessary in the parties’ interests to ensure adequate protection of the arrangement in order to prevent the disclosure of trade secrets or contractual relationships.

An agreement is said to be against public policy when any agreement aims to harm the general interest or welfare is against public policy, for example. It may also refer to anything that refers to institutional segregation, rights restrictions, commerce, and human or civil liberties, as well as anything that appears to prevent tyranny or violations of legislation, and anything that contradicts reasonable standards.

III. Situations/cases where a non-compete clause post-termination of employment is Valid

  1. In the Context of Mergers and Acquisition Transactions

This exemption protects the acquisition firm by ensuring that the target company’s departing proponents do not launch a new business after the merger.

The Delhi High Court upheld the legal relevance of a non-compete requirement in the case of Affle Holdings Pte Limited v. Saurabh Singh & Others[4] in 2015, which allowed the outgoing promoters to not compete with the company for 36 months after the completion date in a 100 percent share acquisition scenario.

It was stated that non-compete restriction is valid when

  1. The company’s entire majority interest was purchased with the intention of acquiring it’s business and goodwill;
  2. Substantial compensation was charged for the sale of those interests, and the limitation falls under the first exception to section 27 of the Contract Act; and
  3.  The ban on engaging in the direct market or economic practice was appropriate in time and stipulation.

In the case of Lal Pathlabs[5] the high court ruled that the exceptions to the Contract Act’s section 27 apply to the selling of goodwill in any activity, regardless of whether it is labeled as a corporation, a trade, or an occupation. It went on to say that the situation came under the exception to section 27 since the papers signed by the parties for the selling and purchasing of shares were also meant to cover the sale of goodwill.

  1. Disclosure of sensitive data post-employment

In the case of Diljeet Titus v. Mr. Alfred A. Adebare and Others,[6] The plaintiff’s legal firm employed the appellant, who was an attorney. When the plaintiff’s work was terminated, the defendant took away sensitive private company documents such as customer lists and proprietary draughts. Since the parties’ relationship was not that of employer and employee, the claimant claimed that he was the owner of the copyrighted work because it was completed by him during his/her job.

As a result, the Delhi High Court barred the complainant from using the unlawfully obtained material. It should be noted that the defendants were not barred from providing a comparable facility by the Delhi High Court. The defendants were only prohibited from using the information they obtained because it was important to protect the plaintiff’s rights.

  1. Carrying Similar Business

GEA Energy System India Ltd. v. Germanischer Lloyd Aktiengesellschaft, the Madras High Court had occasion to consider that the operation of Section 27 in the context of two joint venture partners. In this case, Defendant had terminated the Joint Venture Agreement (‘Agreement’) and the plaintiff sought to restrain Defendant from setting up a similar business in India. Although there were several other issues, the High Court examined the contention of the parties regarding the act of restraining Defendant from carrying on business in India and its legality in the context of Section 27 of the Contract Act.

The Madras High Court observed that the restrictive clause only stated that Defendant may not carry on a business which is prejudicial to the plaintiff’s company and as such did not restrict Defendant in absolute terms from carrying on any business. The Madras High Court further noted that the parties entered into an agreement of their own free will and as per the terms therein had equal bargaining power. The terms were not one-sided and did not betray the weakness of any one party. It would thus be seen that the same test as is applicable in the context of employment contracts, would be substantially applicable even in the context of joint venture agreements.

 IV. Conclusion

In India, any trade restriction covenant is presumed to be invalid, and can only be imposed if it can be argued as fair in the circumstances, taking into account both the public interest and the parties’ interests. However, based on whether the covenant was issued in the form of a contractual arrangement or as part of an employment contract, the method of the courts in determining the matter of reasonableness differs significantly. However, when dealing with a non-compete clause in a contractual agreement or another work arrangement, there are no set rules or parameters that determine the degree to which those provisions should be accepted since each case is unique.


References

[1] Verma, Ayush. “Post Termination Non-Compete Clause in Employment Contracts.” Available Here, 17 Sept. 2020, Accessed 8 Apr. 2021.

[2] (1981) 2 SCC 246

[3]  AIR 1995 SC 2372

[4]  OMP 1257/2014

[5] Dr. Lal Pathlabs Pvt. Ltd. & Anr. v. Dr. Arvinder Singh & Ors. on 15 October 2014

[6] 2006 (32) PTC 609 (Del)


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