Non-compete Clauses Unenforceable in India

JURIST Guest Columnists Valerie Demont and Janaki Rege Catanzarite of Pepper Hamilton LLP discuss the futility of non-compete clauses in India, contending that Indian courts remain sensitive to the possibility that employers may try to use restrictive covenants as a back-door means of restraining employees from exercising their trade and will place an extremely high burden of proof on employers seeking to enforce these provisions....

With the increase in cross-border trade and an enhanced competitive climate in India, confidentiality, non-compete, and non-solicitation agreements are becoming increasingly popular there, especially in the IT and technology sectors. An increasing number of outsourcing and IT companies are including confidentiality, non-compete, and non-solicitation covenants in agreements with their employees, with terms ranging from a few months to several years after the employment relationship is terminated. The companies claim that such restrictions are necessary to protect their proprietary rights and their confidential information.

Similarly, foreign companies doing business in India often seek to include confidentiality, non-compete, and non-solicitation covenants in their agreements with senior management and employees, as is customarily done in certain foreign jurisdictions.

However, Indian courts have consistently refused to enforce post-termination non-compete clauses in employment contracts, viewing them as "restraint of trade" impermissible under Section 27 of the Indian Contract Act, 1872 (the Act), and as void and against public policy because of their potential to deprive an individual of his or her fundamental right to earn a livelihood.

The principles of Section 27 were aptly summarized by the Supreme Court of India 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), which involved a senior marketing manager at a manufacturer of evaporative cooling components, products and systems. As part of his employment agreement with Desiccant, the manager agreed that for two years following the termination of his employment, he would be bound by a covenant with Desiccant that would require him to keep Desiccant's matters confidential, and that would prevent him from competing with Desiccant and soliciting Desiccant's customers, suppliers and employees. Expressly embodied in the employment agreement was an acknowledgment by the manager that he was dealing with confidential material of Desiccant, including: know-how, technology trade secrets, methods and processes, market sales, and lists of customers. After a few years of employment, the manager resigned and-notwithstanding the terms of his old employment agreement-within three months of his resignation joined a direct competitor of Desiccant as country manager in charge of marketing and started contacting customers and suppliers of Desiccant. In injunctive proceedings against the manager by Desiccant, the High Court reiterated the principles embodied in Section 27 of the Act and the individual's fundamental right to earn a living by practicing any trade or profession of his or her choice. Brushing aside any argument by Desiccant that the restrictive covenants were primarily designed to protect its confidential and proprietary information, the High Court ruled that in the clash between the attempt of employers to protect themselves from competition and the right of employees to seek employment wherever they choose, the right of livelihood of employees must prevail. Similarly, in a 2007 decision in V.F.S. Global Services Ltd. v. Mr. Suprit Roy (2008 (2) BomCR 446 ) the Bombay High Court held that a fully paid three-month "garden leave" agreement with a senior manager did not renew the employment contract and constituted a "restraint of trade" unenforceable by V.F.S.

Foreign investors in India need to be aware of Section 27 of the Act and the well-established line of court cases under it, as they structure their employment relationships and incentives with local management. As a general principle, confidentiality, non-competition and non-solicitation agreements will be enforceable during the term of the employment relationship. After termination of employment, however, many provisions of these agreements will be struck and deemed unenforceable by Indian courts in enforcement proceedings, even if the provisions are reasonable in scope and duration, subject to certain exceptions.

One of the few instances in which non-competition clauses will generally be enforceable is in the context of the 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.

Non-solicitation obligations post-termination of employment may be enforced in limited circumstances, based upon the facts of each individual case. For example, they were upheld in the Desiccant case, in which the High Court did allow an injunction against the manager prohibiting him from soliciting Desiccant's customers and suppliers to stand in effect. In the V.F.S. case, however, relief for breach of non-solicitation obligations was denied on the basis of vagueness of the relief claimed.

Confidentiality obligations post-termination of employment will similarly be enforced in limited circumstances so long as they remain reasonable and limited in time and scope and the employer can support that the information is confidential and proprietary to it. Indeed, while denying enforcement of the garden leave in the V.F.S. case, the Bombay High Court established the principle that a restraint on the use of trade secrets during or after cessation of employment is not tantamount to a "restraint on trade" under Section 27 of the Act and therefore can be enforceable under certain circumstances. This case and others show that Indian courts will in certain circumstances enforce confidentiality agreements intended to protect an employer's proprietary rights. But the courts remain sensitive to the possibility that employers may try to use these covenants as a back-door means of restraining employees from exercising their trade and will place an extremely high burden of proof on employers seeking to enforce these provisions. In the Desiccant case for example, the court held that a marketing manager could not be deemed to possess confidential information and that his written declaration to that effect in his employment agreement were meaningless; the court rejected Desiccant's claim to enforce the confidentiality obligations of the manager.

Therefore, 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.

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