Indian Law On The Validity Of Trade And Employment Restraints

Indian Law on the validity of Trade and Employment Restraints The Indian contract law stipulates that an agreement, which restrains anyone from carrying on a lawful profession, trade or business, is void. As per Section 27 of the Indian Contract Act, 1872 (“the Act“), agreements that places restraint of trade or business are unfair, as they impose an undue restriction on the personal freedom of the contracting party. Thus, the Act invalidates all restraints of trade, whether general or partial restraint unless it falls within the exception of this section.

However, there are two exceptions to this provision (i) provided by the statute, and (ii) arising from judicial interpretation of Section 27 of the Act.

I. Statutory Exceptions:

As per the statutory exceptions, an agreement for one who sells the goodwill of the Company has to specify the local limits of the restraints. The seller can be restrained within certain territorial or geographical limits and the limits must be reasonable.

In Affle Holdings Pte Limited v. Saurabh Singh, OMP1257/2014, the petitioner had bought the entire controlling interest in the company from the promoters after paying substantial consideration with a view to acquire the promoter’s business along with its goodwill. The Delhi Court held that the case would fall within the preview of Exception 1 to Section 27 of the Act and that non-compete restrictions on the promoter not to engage in a competing business for a period of 36 months is not void as substantial consideration had been paid by the petitioner to the promoter under the Share Purchase Agreement.

II. Judicial Interpretation:

In the case of Gujarat Bottling Co Ltd v. Coco Cola Co, OMP1257/2014, there was an agreement for grant of franchise by Coca Cola Co. to Gujarat bottling Co not to manufacture bottle, sell and deal or otherwise be concerned with the product, beverages of any other brands or trademarks/tradenames during subsistence of the agreement. It was held that the negative stipulation was intended to promote the trade and the stipulation was confined only to subsistence of the agreement and not after termination thereof. Hence, the stipulation could not be regarded as in restraint of trade. Then doctrine of restraint of restraint of trade would not be attracted unless the contract is wholly one-sided.

In a recent judgement, the Karnataka High Court in the case of MU Sigma Business Solutions Pvt.Ltd v. Sagar Balan and others, the Karnataka High Court dealt with the question whether to grant an injunction against former employees of the plaintiff. The Plaintiff claimed that the cause of action is based on the non-compete and confidentiality clause whereby the plaintiffs asserted that the defendants have utilised the plaintiffs’ confidential information, specific strategies, trade secrets which is against the employment agreement. It was held that the plaintiffs claim does not sufficiently elucidate a justification for an order of injunction. In concluding the above, the Karnataka High Court relied on the following cases:

  1. Wipro Limited v. Beckman Coulter International S.A, 2006 SCC OnLine Del 743, the Supreme Court opined that negative covenants tied up with positive covenants during the subsistence of a contract be such as employment, partnership, commerce, agency, would not normally be regarded as being in restraint of trade, business of profession. In this case, the question that arose was whether the non-solicitation clause in question amounts to a restraint of trade, business or profession. It was held that the clause by itself does not put any restriction on the employees. The restrictions put on the petitioner and the respondent have to be viewed more liberally than a restriction in an employer-employee contract. Therefore, the non-solicitation clause does not amount to a restraint of trade, business or profession and would not be hit by Section 27 of the Act as being void.
  2. Beckmen Desicant Rotors International Pvt. Ltd. v. Bappaditya Sarkar and Another – Reported 2009 (112) DRJ 14: it was held that ‘trade secret is some protected and confidential information which the employee has acquired in the course of his employment and which should not reach others in the interest of the employer. However, routine day-to-day affairs of the employer which are in the knowledge of many and are commonly known to others cannot be called trade secrets. The Delhi High Court, confirmed an injunctive order that restrained the employee from approaching his employer’s suppliers and customers or soliciting business in direct competition with the business of the employer because such limited order did not impinge on the employee’s freedom to choose his own workplace, but was necessary to protect employees’ Confidential Information.
  3. Superintendence Company of India v. Krishna Murgai, 1980 SCR (3)1278, the Supreme Court while discussing the objective behind Section 27 of the Act analysed the difference of negative covenant between an employer-employee and a seller-purchaser and stated that a negative covenant between the employer – employee, pertains to performance of personal service which is altogether different in substance from purchase and will have vastly different social and economic implications. The essential line of distinction is that the purchaser is entitled to protect himself against competition on the part of his vendor, while the employer is not entitled to protection against mere competition on the part of his servant. A restrictive covenant ancillary to a contract of employment is likely to affect the employee’s means or procuring a livelihood for himself and his family to a greater degree than that of a seller, who usually receive ample consideration for the sale of the goodwill of his business.
  4. Similarly, in the case of Polaris Software Lab. Limited Case AIR 1980 SC 1717, the Supreme Court while disfavouring a restrictive covenant of the employer held that in order to validate a restrictive covenant, an employer must establish that the covenant (i) operates for a restricted period and areas, (ii) pertains to information that is exclusive and shared with the confidence that the employee shall use such information only for the benefit of the employer and maintain fidelity, and (iii) the restraint will not tantamount to restraining the employee from using his own acumen or skill sets.

Subsequently, there are several judgements wherein reasonable restraints have been upheld. In the case of Ozone Spa Pvt. Ltd. v. Pure Fitness & Ors, 222 (2015) DLT 372, the Delhi High Court upheld that negative covenant restraining the defendants from establishing, running or setting up any competing business in any area that falls within a range of 4 kilometres from the premises of the plaintiff is valid as invalidating the covenant would cause irreparable loss to the company, trade or business. Similarly, Apurva v. Valuefirst Digital Media Pvt. Ltd ARB.A.2/2015, the Delhi High Court upheld the decision of the Sole Arbitator, restraining the appellant from carrying any activity which is competitive to that of the company and also from soliciting, interfering with, disturbing or attempting to disturb the relationship between the company or subsidiary and third party, including any customer or supplier of the company or subsidiary.

CONCLUSION

Though Section 27 of the Act clearly stipulates that any non-compete agreement is void and not binding on the contracting parties, there are several decisions which say that a negative clause in an agreement which is intended for advancement of trade would not be regarded as being in restraint of trade.

The judiciary while determining whether a negative covenant is in restraint of trade, business or employment or not, the courts have taken a stricter view with regard to employer-employee contracts than in other contracts, such as partnership contracts, collaboration contracts, franchise contracts, agency/distributorship contracts, commercial contracts. Negative stipulation during the period of employment has been held to be is valid and is not in restraint of trade. However, the judiciary has refused to enforce post termination non-compete clauses in employment contracts as “restraint of trade” and it is impermissible under section 27 of the Act. Such agreements of restraint are held void because of being unfair and depriving an individual of his or her fundamental right to earn a living.

Therefore, in order to validate negative covenants in employment agreements or contracts the following reasonable restrictions may be imposed:

  1. Restricted territorial limit: If the restriction is within certain territorial or geographical limits;
  2. Restricted time limit: If the time frame is within a specified limit;
  3. Trade Secrets: If the information shared is exclusive and shared with confidence that the employee shall use such information only for the benefit of the employer; or
  4. The restriction falls within Exception 1 to Article 27 of the Act: restraint of trade on the sale of goodwill.

Hence, the law manages to protect the rights of both the parties without jeopardising fundamental rights.


Article by Angelina Talukdar was 1st published on Mondaq

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