India - Affirmation Of Non-Enforceability Of Non-Compete Clause.

Legal News & Analysis - Asia Pacific - India - Labour & Employment

21 March, 2017

 

A non – compete clause in an employee agreement is being used frequently by most of the Employers but there are some uncertainties amongst stakeholders with respect to whether such clauses are enforceable in India or not. Section 27 of the Indian Contract Act explains that every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is, to that extent, void. 

 

The only exception provided in the said section is involving the sale of goodwill. The purpose of this exception is to protect the interest of the buyer in an agreement where the buyer has agreed to purchase the seller’s goodwill. In such circumstances, the seller may agree with the buyer from carrying on a similar business within specified local limits. What is important here is that there should be a genuine goodwill which can be sold. In absence of such real and genuine goodwill, all such agreements are likely to held void. In common parlance,   the term “goodwill” indicates an intelligible advantage of reputation and trust which have been built by years of hard work by the business or person. Therefore, the restraint section declares all agreements void except in the case specified in the exception.  

 

The question of restraint of trade amongst partners of the partnership firm needs to be analyzed under the provision of Indian Partnership Act. The partners may enter into an agreement where partners are not permitted to carry on any business other than that of the firm during the continuance of the firm.  Moreover, it can be agreed that outgoing partner will not carry on any business similar to that of the firm within a specified period or within specified local limits provided the restrictions imposed are reasonable. As can be seen, the provisions of the Partnership Act allow more flexibility to partners in order to have more restrictive covenants.

 

Recently, Delhi High court in M/s Stellar Information Technology Private Limited Versus Mr. Rakesh Kumar & Ors has dealt with the dispute where the Plaintiff (Employer) filed the suit inter-alia for enforcement of non-compete clause against its erstwhile employees. In the said suit, the Plaintiff sought the relief to retrain the defendants from carrying on the competing business for a limited period and therefore argued that the relevant clause in the agreement was reasonable and it is entitled to injunctive relief.

 

It was argued by the Defendants that they could not be restrained from carrying on their business or approaching the customers as any such restrictive covenant in the agreements would be void by virtue of Section 27 of the Indian Contract Act. The Court, after applying the rationale of Section 27 held that the restriction to carry on competing business for a limited time being reasonable and consequently, enforceable cannot be accepted. Once it is held that Plaintiff is attempting to enforce a covenant in restraint of trade, the same must be held to be void. The court observed that whether a restriction is reasonable or not is relevant only if the case falls within the exception.

 

It becomes important to highlight the observation in Wipro Limited V Beckman Coulter International S.A. where it was noted that the courts take a stricter view in employer-employee contracts than in other contracts, such as partnership contracts, collaboration contracts, franchise contracts, agency/distributorship contracts, commercial contracts. The reason being that in the latter kind of contracts, the parties are expected to have dealt with each other on more or less an equal footing, whereas in employer-employee contracts, the norm is that the employer has an advantage over the employee and it is quite often the case that employees have to sign standard form contracts or not be employed at all.  

 

In the event, the parties are faced with the issue of restraint of trade, the statutory provision under the Contract Act and judicial pronouncements by Indian courts serve the guiding and helping tool.  

 

lexorbis

 

For further information, please contact: 

 

Omesh Pur, LexOrbis

omesh@lexorbis.com