Important clauses to consider before entering into a non-compete

Author’s Note

Do you wonder if the Non-Compete agreements are even enforceable in India or not?

Or is it something which we only see and hear on television or web series?

In this post we are going to elaborate the benefits of the parties along with the important factors to look out for before you jump into one, and much more.

Table of Contents

1. Important clauses to consider before entering into a non-compete
2. What is Non-compete?
3. How do employers benefit from a non-compete agreement?
4. Limited instances in which employees can benefit from a non-compete agreement
5. Legal enforceability of a non-compete agreement
6. Non-compete between partners
7. Factors to be considered before signing a non-compete agreement
8. Time period
9. Location
10. Contradictory clauses in such agreement
11. Competition law infringements
12. Can existing employees be made to sign non-compete agreements?
13. Non-compete in cases where a business is sold
14. Conclusion

What is Non-compete?

Under contract law, when a party agrees not to start or take part in a similar business against the other party while also agreeing not to join any rival businesses, working in the same profession – is what we call Non-Compete agreement (also known as a covenant not to compete).

A Non-compete also prevents the parties from poaching, soliciting, or stealing each other’s clients. It is a crucial clause in most businesses.

These contracts are bound by all the requirements of a contract under the Indian Contract Act, 1872 (hereinafter referred to as “Contract Act”) such as acceptance, consideration, competency, etc.

Section 27 of the Contract Act does not explicitly define a non-compete clause, however, the Non-compete clauses are invalid due to the general bar on any restraining agreement in any business or trade under this section.

By using the term void ab initio, Section 27 has kept such non-compete agreements and clauses non-enforceable.

The Supreme Court has clarified that the objective is to prevent sensitive, confidential information or trade secrets from being exposed and misused, harming the former employer. A court will not allow any blind ban on unreasonable competition and rather deal with the restraint of trade on a case-to-case basis. Resulting in this clause to be suitable for trade and commerce, not prevented by Section 27 of the Act.

A non-compete clause that restricts the employee too much will eventually prevent him from working elsewhere at all. Common law holds that this goes against public policy and good conscience. Therefore, they must have only reasonable limitations and restrictions such as the geographical area and time period in which an employee of a company may not compete.^[1] The restrictions differ from profession to profession and trade to trade.

How do employers benefit from a non-compete agreement?

Employers get into non-compete agreements with employees to make sure the employees do not enter into the same business and compete with them.

For example, if A is an employer who makes B sign a non-compete agreement for not entering into the same business for one year in the same state after leaving A’s company, then B cannot start the same business with his relatives, friends, and competitors for one year.

Employers get benefits because it prevents confidential information from being shared by the employees with the competitors. Other important information like industry experience, company secrets, knowledge of the company, list of data users, revenue-generating clients, objectives, and strategies developed for the growth of the company is not used against them.

This also helps employers to have a sense of assurance that the production process and trading activities will not be leaked out.

Limited instances in which employees can benefit from a non-compete agreement

Employees can benefit from a non-compete agreement when in return for their signature, they ask for something of value. Usually, the employees ask for appraisal in return that includes promotion or increment in the perks. This has further been discussed below.

For example, in the office of Toyota, if the specialist engineer is asked to sign a non-compete agreement to gain benefits, he may ask for an appraisal from being a specialist engineer to section manager.

Other benefits that the employees asked to sign a non-compete agreement are:

1. Paid leaves
2. Health and life insurance
3. Perquisites like residential accommodation, vehicle, interest-free loans, etc
4. Performance Bonus
5. Professional training and skill development

Legal enforceability of a non-compete agreement

Non-compete agreements usually are considered legally binding as long as they have reasonable limitations where employees and partners may or may not work, or an exact amount of time that must pass before an employee may commence work in the field again.

For example, a company has its factory in Gurugram and most of its clients are from Gujarat, then the agreement will clearly define that the same business idea should not be set in Gujarat and other nearby regions for a time period defined in the agreement most likely to be six months to two years.^[2]

In India, a non-compete agreement can be challenged before if it violates the fundamental right granted under Article 19(1)(g) of the Constitution of India, which lays down the right to practice any profession or to carry on any occupation, trade or business. It is written in the constitution of India under Article 19 that this right is not absolute and some reasonable restrictions can be imposed. One of the restrictions includes a non-compete agreement.

Non-compete agreements are unenforceable if the reasonable restrictions are in violation of Article 19(1)(g) of the Constitution of India. In the case of Percept D’ Mark (India) Pvt. Ltd v. Zaheer Khan^[3], the Supreme Court of India took Section 27 of the Indian Contract Act, 1872 into consideration and delivered the judgment that if a non-compete agreement is made in such a way that the restriction does not come to an end even after the expiry of the term of the contract, then the agreement is not enforceable and the same will be applicable to all contracts including employment contracts wherein the restriction continues after the expiry of the contract because such contracts are in violation to the Article 19(1)(g).

However, if the reasonable restrictions are made for a certain defined period of time and not violating the freedom to profess any trade or business constituted in Article 19(1)(g) then such agreements are legally enforceable by the court of law.

This can be seen in the judgment given by the Supreme Court of India, in the case of Niranjan Shankar Golikari v. The Century Spinning And Mfg. Co.^[4], which states that if a non-compete agreement restricts an employee during his term of employment or for a reasonable period to set up the same business idea or merge with competitors in order to avoid increased competition then such a restriction has legal validity.

Non-compete between partners

The Indian Partnership Act, 1932 (hereinafter referred to as the “Partnership Act”) also contains provisions that validate non-compete agreements. Section 11(2) of the Partnership enables partners to restrict themselves mutually by agreeing that none of them shall carry on any business other than that of the firm.

Similarly, Section 36(2) of the Partnership Act ensures that any outgoing partner may be restricted from starting a similar business within a specific territory or within a specified period or both. These are all reasonable restrictions under the Act.

In the case of BLB Institute of Financial Markets v. Ramakar Jha^[5] it was held that –

1. A restrictive covenant extending beyond the term of the contract is void and unenforceable;
2. The doctrine of restraint of trade will only apply when the employment comes to an end;
3. This doctrine is also applicable to all contracts and not only those in relation to employment.

It is pertinent to note that in reality, most employees are not happy with the existence of this non-compete clause in their employment contracts and only sign them out of necessity as they may really need the job offered. People might do it out of dire need.

For example, “A” is a single mother and breadwinner of her family who is currently working for an underpaying job finds a new job that pays well but her employer asks her to sign the non-compete agreement beforehand. she out of necessity will go-ahead to sign it however, this does not qualify as coercion, hence the agreement is legally valid and binding.

Factors to be considered before signing a non-compete agreement

Time period

The time period mentioned in the clause must be reasonable and not for a long duration. This is a subjective concept and differs from job to job. Anyone asked to sign the same must review it and check if the time period mentioned is reasonable.

For example, if it is a financial consultancy firm and the agreement specifies that one cannot compete against one’s former employer for 1-5 years, courts will deem it as a reasonable period of time. Similarly in the case of V.N. Deshpande v. Arvind Mills Co. Ltd.,^[6] where the defendant who was a weaving master at a mill was told not to take up the same job for three years in any part of India, the court held that this was a reasonable restriction and granted an injunction restraining him from doing the same.

Location

The location of the former organization matters as the success of the organization may depend on factors such as geographical location as the people in that particular location may be interested in those products specifically. Therefore, a non-compete that mentions the same is reasonably enforceable due to this reason. It also matters to businesses such as those that carry out trades that have a particular style. This has also been incorporated under the exception to Section 27.

For example, a tailor would not want his apprentice to set up shop in the same area as him as he will have the same style after working for him and may offer lower prices and take away his customers. The same phenomenon applies to large businesses as well. If one’s company is based in Bangalore but gets most of its clients from Mumbai, it would be reasonable for the non-compete clause to bar the employees from practicing that profession in Mumbai or its neighboring cities. Therefore a non-compete can be unenforceable if it restricts competition for an unreasonably large territory.

Contradictory clauses in such agreement

In some contracts, there may be conflicting clauses against the non-compete clause. Such as if the non-compete clause may have an expiry date such as 5 years and another clause may state that you cannot compete with the company ever.

There have been many examples of the same such as in the case of CN Rail CEO, Hunter Harison where his employment agreement stated that he must not work with a competitor for the next 2 years. However, another clause in the contracts stated that if he ever did, he would lose his pension and retirement benefits.^[7] Thus, one should always read the employment agreement carefully as these clauses are not always very straightforward.

Competition law infringements

If any non-compete clause goes against the Indian Competition Act, 2002, it will not be upheld in court and will be invalid. This Act provides for the rights and duties of companies while carrying out their businesses with healthy competition. Section 3 of the Act lists those types of agreements that are said to be Anti-competition agreements. Therefore, if a non-compete goes against this clause, it will not be unenforceable as anti-competition laws seek to prevent any malpractices such as price-fixing, customer sharing agreements as they limit markets and are against the law.

Can existing employees be made to sign non-compete agreements?

The answer to this question is in the affirmative. Existing Employees may be asked to sign the same but only in exchange for a consideration.^[8] For a non-compete to be enforceable, there must be a consideration (which is the legal term for the exchange of anything that has a value such as money) as it is an essential requirement for a contract. For non-competes obtained by newly hired employees, usually, the ‘consideration’ is the employer’s willingness to hire the employee in exchange for the employee’s agreement not to compete.

However, for existing employees, this is not the case as there is nothing of value given by the employer. Therefore, existing employees need not sign non-compete agreements if they are not receiving anything in return or additional consideration. This could be money, new job responsibilities, promotion, or a change from ‘at-will’ to ‘employee contract’ posts, etc. These need not be of huge value but must provide some kind of benefit to the employee.

Non-compete in cases where a business is sold

Many times, when one company buys another, the former fails to draw up a non-compete agreement with the owners or key management personnel stating that the latter should not go ahead and start another company carrying out the same kind of business or profession.^[9] This is a mistake that businesses should avoid as if the sellers of the business have good public relations or good skills in the field, they can start a new company on their own again. This will mean that the acquirers will be essentially competing with the same people they bought.

Another practical aspect that must be considered is whether the acquirers will also have to continue the existing non-compete agreements that the sellers have signed with their employees. Some jurisdictions do not allow the seller to transfer its non-compete to the buyer unless the employee consents to the same. This could prove to be a disadvantage to the buyer of the company if the employee does not consent to the same. In order to avoid this, the non-compete must include such a provision where the employer itself can assign the agreement to the buyer of the business.

Conclusion

Often companies feel that by virtue of them having a non-compete agreement with their employees, they are safe from breach of confidentiality and trust. While these agreements are without a doubt, extremely essential and valuable, they do not mean that problems will not arise. There may be some employees who will defy them and take on all risks of legal consequences. There are other ways to leak important information to rival firms. In reality, retaining key personnel and customers is a multi-faceted task and the existence of a non-compete does not mean that issues will not arise. We must think of it as a tool in a toolbox as it is only one way in which a business can be secured.

Keywords:

1. Paul W. Barada, What to Know Before Signing a non compete or Non Disclosure Agreement, Monster, https://www.monster.com/career-advice/article/noncompete-agreements. ↑
2. Will Kenton, Non-Compete Agreement, June 3, 2019., https://www.investopedia.com/terms/n/noncompete-agreement.asp. ↑
3. Percept D”Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr. (2006) 4 SCC 227. ↑
4. Niranjan Shankar Golikari vs. Century Spinning and Manufacturing Co. Ltd. (1967) 2 SCR 378. ↑
5. BLB Institute of Financial Markets Ltd. v/s Ramakar Jha, OMP 241/2008. ↑
6. V.N. Deshpande v. Arvind Mills Co. Ltd, (1946) 48 BOMLR 90. ↑
7. Stephens Bill, Hunter Harrison named CEO at CSX Transportation, Trains, (March 7, 2017), Trains.com. ↑
8. Harry J DiDonito, The Top 10 Mistakes with Non-Competition Agreements, MacElree Harve, https://macelree.com/the-top-10-mistakes-with-non-competition-agreements/. ↑
9. Ibid. ↑