RESTRICTIVE COVENANTS IN INDIA

The pandemic has brought fundamental changes in the job market such as higher attrition rates, impetus for the gig economy and a larger incidence of moonlighting. These developments underscore the increasing relevance of restrictive covenants and the need to strike a balance between the right to an employee's livelihood and an employer's proprietary interests

In April 2022, the Indian Ministry of Labour and Employment issued a notice to an information technology company after receiving a complaint from an NGO regarding certain clauses that are considered by most employers and employees to be commonplace in an employment agreement, viz., a prohibition on employees joining technology firms considered direct competitors for a predetermined period post-employment and a prohibition on servicing clients at rival firms. While this appeared to be one of the first news reports of the government examining the practice of including restrictive covenants in employment agreements, Indian courts have been examining restrictive covenants in employment agreements and have developed significant jurisprudence on the subject. Nonetheless, this incident caused many potential employees and their employers to re-examine their employment agreements.

In this article, we seek to simplify the law on post-employment restrictive covenants in India to provide clarity to both employers and employees to help them better understand the restrictions that are enforceable and those that are meant to act as deterrents.

What are restrictive covenants?

Restrictive covenants in employment agreements are contractual obligations placed on employees prohibiting them from engaging in certain actions/activities. The most common kinds of restrictive covenants in the employment context are:

• Exclusivity Clauses: These obligations are coterminous with employment and prohibit employees from taking up any other employment or engagements without the express permission of the employer.

• Non-Compete Clauses: Employers use these clauses to bar employees during and post-termination from taking up employment or engagements with competitors or from conducting business that would compete with the employer.

• Non-Solicit Clauses: These clauses typically restrict an employee from soliciting the employer's clients post cessation of the employee's employment with the organization.

• Confidentiality Clauses: These clauses protect trade secrets or other proprietary information from unauthorized disclosure by an employee during and after employment. A confidentiality clause usually defines what information should be considered confidential, the temporal and geographical scope of the obligation, and related rights and consequences for breach of the obligation.

Besides the above, organizations may also include non-hire clauses in their agreements with each other, to prevent the hiring of each other's employees. However, while these clauses impact employees, they are typically not included within an employment contract.

Enforceability of Restrictive Covenants in India

The enforceability of restrictive covenants is governed by Section 27 of the Indian Contract Act, 1872 ("Indian Contract Act"), which renders any agreement in restraint of the exercise of a lawful profession, trade or business, void. The sole statutory exception extends to agreements where the seller of the goodwill of a business agrees not to carry out a business of a similar nature within specified and reasonable local limits. When interpreting such clauses, courts have attempted to strike a fair balance between the constitutional right to livelihood and competitive interests inherent to the conduct of business.

Non-compete clauses

As stated above, the Indian Contract Act invalidates any agreement which constitutes a restraint on trade, irrespective of the reasonableness or nature of the restraint. On analysis of court decisions examining this restraint, it is clear that the Indian Contract Act only prohibits an agreement in restraint on trade when it amounts to enforcing a contract of a personal nature. Courts have also held that restrictive covenants during the term of employment are enforceable, but those applicable post-employment are generally void.

For instance, in the landmark case of Niranjan Shankar Golikari v. The Century Spinning and Mfg. Co. Ltd., the former employer was able to successfully establish that an employee who had joined its competitor had received special training and knowledge of certain techniques, processes, and machinery from the former employer. Importantly, the case of the former employer was that the employment contract was for a fixed period and the employee resigned from the employment in breach of the terms of the fixed term employment contract, a fact which weighed heavily in favour of the employer. Therefore, a clause imposing a non-compete restriction on an employee during the term of employment or during the term of a fixed-term employment agreement may be enforceable. However, a non-compete restriction post-employment will not be held enforceable.

Non-solicit clauses

In an employer-employee relationship, non-solicitation agreements are generally understood to refer to contracts whereby an employee is restricted from soliciting the employer's clients, customers, vendors, or employees for a pre-determined duration after termination of the employment. While courts have approached non-solicit clauses in a manner consistent with their approach to non-compete clauses, such restrictions have been upheld in limited circumstances. Courts have held that employees and customers cannot be restricted from moving to a soliciting party, however the soliciting party may be injuncted from carrying out future solicitation and may be penalised with damages. In Wipro Limited v. Beckman Coulter International SA, the Delhi High Court explained that when restraints on employment cannot be placed directly, indirect restraints would also not be permissible.

Confidentiality clauses

Confidentiality clauses have generally been enforced in India even in a post-employment context. In a pioneering case, Zee Telefilms Limited v. Sundial Communications Private Limited, the Bombay High Court recognized that the maintenance of confidence is in public interest. The court noted that no one should be allowed to profit from the wrongful use of information received in confidence. Therefore, a breach of confidence whether arising from contract or an equitable right, may be judicially restrained.

Subsequent cases have added nuance to the evidentiary thresholds for establishing a breach. In 2010, in the case of Anindya Mukherjee v. Clean Coats Private Limited, the Bombay High Court noted the importance of negative covenants in a 'global competitive and commercial world' where it is necessary to view data from the perspective of the employer's business interests. The court also stated that confidentiality clauses are 'regular features of commercial arrangements as it is based upon the trust, honesty and confidential relationship between the parties.' On the 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 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.

Courts have also restricted the kind of information which can be considered confidential. In a case before the Delhi High Court (Stellar Information Tech Private Limited v. Rakesh Kumar), the plaintiff company alleged that the defendants (its former employees) breached confidentiality by copying the plaintiff's database and approaching its clients. However, the court found that merely approaching customers does not establish a breach of confidentiality. The details of such customers were already in the public domain. Courts have held that while an employer cannot bar a former employee post-termination from using the skill and knowledge acquired during his employment, the employer can bring an action to protect their trade secrets or customers from the influence of the former employee.

Conclusion

The pandemic has brought about fundamental changes in the job market – higher attrition rates, an impetus for the gig economy, and a larger incidence of moonlighting. These developments underscore the increasing relevance of restrictive covenants, and the need to strike a balance between the right to livelihood and an employer's proprietary interests. However, it is important that organisations take an equitable approach when including such clauses in employment agreements to ensure that it is not a blanket prohibition, and such restrictions are enforceable.

Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature.