India: Employers vs Employees: The Endless Saga of Non-Compete Covenants!

"Faithless is he that says farewell when the road darkens."

The quote by J. R. R. Tolkien goes very well with the fast track mobility of the key employees. The important question which strikes is how to protect the interests of an ex-employer in terms of trade secrets and confidentiality. Every departed employee poses a threat of joining a competition which could prove to be lethal to the existing business and potential strategies of the parent company. In order to protect its interests and to disarm the threat from an ex-employee, most of the companies resort to having non-compete covenants/clauses or covenant not to compete in their employee agreements vide which an employee agrees not to join a competition or start a similar profession or trade in competition against the employer.

The Law Vis-à-vis Judicial Approach

Section 27 of the Indian Contract Act, 1872 ("Contract Act") bars such agreements or clauses which restrains anyone from carrying out a lawful profession or trade or business of any kind; such agreements are kept under the category of void agreements. The statute is therefore stringent when it comes to the enforcement of such agreements. Initially, the judicial approach towards enforcement of such clauses was to declare it void as it was considered violative of the public policy because of its potential to dispossess an ex-employee of his/her fundamental right to practice any profession or to carry on any occupation, trade or business as enunciated in the Constitution of India.

The economic reforms coupled with the advent of multinational companies securing markets in India led to tremendous change in social, legal, and corporate circumstances. Consequently, the need for confidentiality and integrity of the key employees became a major concern for businesses. This resulted in significant dilution of the judicial approach towards non-compete covenant in contrast with the earlier pronouncements.

, The Judiciary has paved way for enforcement of negative covenants provided the 'restriction is reasonable' which is evident from - various judgements pronounced over the period of time that defended the cause of the employers. In the year 1967, the Hon'ble Supreme Court in the case of Niranjan Shankar Golikari vs the Century Spinning and Manufacturing Company Ltd.¹, observed and distinguished between the 'restrictive covenants during the period of the contract of employment' and 'restrictive covenants post-termination of the contract of employment'. The Court opined that the negative covenants operative during the period of the contract of employment when the employee is bound to serve his employer exclusively, are generally not regarded as restraint of trade and therefore, do not fall under section 27 of the Contract Act.

In the later years, the judicial approach shifted towards a liberal interpretation of non-compete covenant as evident in V.F.S. global services Pvt. Ltd Vs Mr. Suprit Roy², wherein the Bombay High Court held that restraint on the use of trade secrets during or after the cessation of employment does not tantamount to a "restraint on trade" under section 27 of the Contract Act and therefore, is enforceable under certain circumstances.

The major breakthrough came in FL Smidth Pvt. Ltd. v. Secan Invescast (India) Pvt. Ltd.³ wherein the High Court of Madras in para 21 of its judgement categorically observed that reasonable restrictions can be placed by distance, time limit, trade secrets, and goodwill. Suitable reasonable restrictions could be placed on an employee to not operate or practice his profession within the limits of the business of the parent company. Restricting the enforceability of such covenants to reasonable time period, putting restriction on the usage of trade secrets which being reasonable in nature and the exception to section 27 of the Contract Act, on the distribution of goodwill.

Viable Alternatives in Disguise

Over the period of time, businesses have developed several measures in disguise which could operate as restrictive covenants and can simultaneously be used to prevent competition from ex-employees apart from the non-compete covenants: -

a) Garden Leave:

The concept of Garden leave is picking up pace wherein an employee who has expressed his/her desire to resign from services is directed not to carry out the duties as an employee while he/she is on his/her notice period. All employee-benefits during this period remain intact. During this period the employee is liable to remain in the parent company but at the same time is kept away from the important projects and discussions during such leave period. The difference between notice period and garden leave is that when an employee is on his/her notice period, he/she is duty-bound to report to work during the duration of the notice period, on the contrary, when the employee is on garden leave, he/she shall be restricted to operate or resume work during the said tenure of the garden leave. Most multinationals are resorting to such measures in order to ensure that there is no disclosure of any confidential information or trade secrets by the departed employee. The duration of these leaves usually ranges from three to six months.

b) Non-disclosure agreements:

A non-disclosure agreement or popularly known as NDA is a contract between the employer and the employee through which the employee agrees not to disclose any information related to the company which is not available in public domain to any third party. An NDA creates a confidential relationship between the parties, typically to protect any type of confidential and proprietary information or trade secrets of the employer; most of the businesses nowadays emphasise on a separate agreement rather than having a clause in an employee agreement. Such agreements are detailed and are usually signed with key managerial personnel who form an integral part of working of the company.

c) Forfeiture of benefits:

This could prove to be the most effective mechanism to curb competition from an ex-employee wherein certain benefits in terms of stocks or options which could have accrued to the employee during the course of his/her employment and some of which may accrue in future are forfeited by the employer in the event he/she competes with the parent company. Such a clause can be a part of the stock option plan and can also be mentioned in the policy manual; however, the parent company, at no point of time, can forfeit the statutory benefits of an ex-employee.

Need of the Hour

There is no delusion that non-compete covenants are legally enforceable and can be the most effective mechanism to neutralize the threat from a departing employee provided there are reasonable restrictions imposed which does not bar his/her right to profession and trade. At this age of rapid globalization and industrialization, non-compete covenant proves to be a knight in the shining armour for businesses which could protect their interests and trade secrets from being passed on to the competitors provided there is an effective written agreement in place which covers the crucial aspects of protection of confidential information and trade secrets combined with non-compete covenant.

Footnotes