Management | Enforcing non-competes in India

Management | Enforcing non-competes in India

During your employment with the company and for two years thereafter, you shall not solicit employment of or accept any contract or other arrangement for providing services to any other person or organization. Such “non-compete" restrictions are familiar to many people who have signed on an agreement for employment. And the typical question that arises is whether such a restriction can actually be enforced. After all, don’t all Indians have the freedom to practise their trade and profession? In considering this question, it is worthwhile to not limit the discussion to employment agreements. Restrictive covenants and non-compete provisions are also common in acquisition transactions and joint ventures and sometimes become the most heavily negotiated point.

First, the law. Section 27 of the Indian Contract Act, 1872, provides in no uncertain terms that every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind is void to that extent. However, Section 27 of the Act also provides an exception such that a person selling a business along with the associated goodwill may agree with the buyer to refrain from carrying on similar business, within specified local limits, for a period that the buyer (or any person deriving title to the goodwill from him) carries on a similar business.

There are several types of agreements that can restrain trade. There can be agreements between an employer and his employee, where the employee agrees not to set up business on his own account or to enter into employment with a rival firm. Then there can be agreements between a buyer and seller of a business, where the seller undertakes not to carry on a business which will compete with the business being sold by the seller. Then there can be agreements between traders, where they contract to regulate their supplies or production.

The law seems well established regarding employment contracts. Indian courts are of the view that agreements containing a covenant preventing the employee from working elsewhere after expiry of the term of his employment are in restraint of trade under Section 27 and are void. Once an employee’s relationship with the employer ends, an employee is free to pursue his own business or seek employment with another. However, during the term of employment, an employee can be restrained from working elsewhere—such a non-compete provision is good in law. The reason a non-compete during subsistence of employment is enforceable is that such a non-compete restriction is intended to ensure the fulfilment of the contract and, therefore, is not in restraint of trade, business or profession.

Attempts have been made to seek positive results on enforceability of post-term non-compete provisions in employment contracts on the basis of reasonableness. Thus, it has been argued that a post-contract restraint may be justified if it has partial applicability or a short time period, etc. The courts in England have followed such an approach. However, the position of Indian courts differs. The Supreme Court of India (in Gujarat Bottling Co. Ltd vs Coca-Cola and others, 1955) and, more recently, the Delhi high court, in Wipro Ltd vs Beckman Coulter International, 2006, have held that neither the test of reasonableness nor the principle of partial restraint are applicable to a case governed by Section 27, unless it falls within the relevant exception (sale of goodwill). Thus, Indian courts have refused to inquire whether a restriction on an employee to work elsewhere post-termination of his services is reasonable.

Another category is that of agreements between a buyer and the seller of a business (including goodwill) where the seller covenants not to carry on a business competing with that of the buyer. These restrictions are enforceable, provided they are reasonable in light of the nature of business being sold (as provided in the proviso to Section 27) and are not opposed to any existing law or public policy (particularly competition laws). Whether the restriction is reasonable or not is a mixed question of law and fact, to be determined by the court on a case-to-case basis.

Indicative factors for determining reasonableness include the location of the business (for example, a restriction on starting an educational institution on the seller of an educational institution in the very locality of the institution he has sold is valid), target market of the business (restriction on a seller of a business to operate in the same target market for a specific period of time as that of the business being sold is valid), time period of restriction, etc. In such cases, the onus of justifying the reasonableness of the restriction is on the buyer, while the onus of proving that the restraint impinges on public interest by restraining trade is on the party challenging the restriction (Niranjan Shankar vs Century Spinning and Manufacturing Co. Ltd, Supreme Court, 1967).

Agreements between traders where they contract to regulate their supplies or production may also contain restrictions on dealing in goods other than those of the supplier, which have been upheld during the term of such agreements. However, the enforceability of such non-competes post-termination of these contracts is debatable. The judiciary tends to examine the restrictions under such contracts from the standpoint of whether they restrain or advance trade.

In the Gujarat Bottling case, the court maintained that restricting a franchisee’s right to deal with competing goods facilitates the distribution of such franchised goods and cannot be regarded as a restraint of trade.

However, no exhaustive list of “contracts in restraint" or “contracts in advancement" of trade exists, so the court must adjudge such disputes on a case-by-case basis. With respect to JVs, not many cases have been brought before courts for examination of non-competes. However, the ample case law on other categories of contracts safely enables an inference that even in JV agreements, the enforceability of “during term" non-competes is possible to achieve, but a post-termination non-compete will raise the same considerations and will have to be examined on a case-by-case basis. Having said that, non-compete or restraint provisions, applying during and after the term of contracts, are fairly common in Indian transactions. Contracts are often worded to expressly include an acknowledgement by the parties of the reasonableness of such restraint provisions and that such restrictions are intended in “advancement" of trade.

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This column is contributed by AZB & Partners, Advocates & Solicitors.