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Negative Covenants In Contracts Of Employment In India: An Indian Perspective

A contract of employment resonates with a contract of virtually any given nature. So to say, it has respective elements of offer, acceptance, consideration, competent parties, free consent and legal object. A contract can essentially be defined as an agreement enforceable by law, for a said duration of time for the exchange of services and remuneration.

More specifically, restrictive features of such contracts find their statutory basis in section 27 of the Indian Contract Act, 1872, which lays down that:
Every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.¯[1]

This legal basis extends to state laws, as well as central laws.

Typically, restraint of trade is applied to two situations, namely the sale of the goodwill of a business or professional practice and contracts of employment.[2] Nevertheless, for the sake of the following article, we would focus upon contracts of employment solely.

Context Of Section 27's Inception

In order to establish certain arguments over the course of this article and fully grasp where the implications of section 27 come from, It would be vital to discuss the historical context of the inception of the said section.

In Oakes & Co. v. Jackson[3], it was stated that:
trade in India is in its infancy; and the legislature may have wished to make the smallest number of exceptions to the rule against contracts whereby trade may be restrained¯

The main historical background of the said legal provision would be India at a time when trade was in its nascent stage and the primary prerogative of section 27 would have been to protect trade from any restraint whatsoever.[4]

Restrictive Covenants For Protection Of Trade

In order to explore the corresponding overview fruitfully, it is vital to establish that any given employer has two interests that are worthy of protection- namely trade secrets and business connections.

Since the term 'business connections' is fairly self-explanatory, the term trade secrets can be defined as a secret related to any part of the functioning of a business, which is of a distinctively confidential nature and would prove to be of detriment to the business in case it is to reach its competitors.

The following considerations would be purposeful in examining a so claimed 'trade secret' too[5]:
  1. The status and nature of the employee and his work
  2. The nature of the information in regard
  3. Whether the employer had communicated the confidential nature of the said piece of information to his employees
  4. Whether the confidential information in regard could be distinguished from other information that the employees had no restrictions to use

In terms of its place amongst covenants in contracts of employment, an employee may not give out a trade secret even in the case that there exists no express contract to prevent the employee from divulging the same trade secret. At the same time, an employer may not be able to protect him/herself where an ex-employee uses confidential information acquired during his/her tenure of employment, unless the given confidential information amounts to a trade secret.[6]

However, where an employer is entitled to anticipate divulgence of a trade secret by an employee which the employee acquired on account of special training given out by the employer, an injunction to enforce the said negative covenant, restricted in terms of time, nature of employment and area, may be issued so as to protect the employer's interest. The respective precedent is Niranjan Shankar Golikari v. Century Spg and Mfg Co Ltd.[7]

It has also been acknowledged that information related to technology, financials, commerce, etc is critical to the success and development of businesses and therefore a covenant imposing reasonable restrictions cannot be said to be unreasonable or unfair.[8] As an additional requirement, the Delhi high court in the case of American Express Bank Limited v. Priya Puri[9] maintained that the plaintiff, to claim a copyright, must have utilised the trade secret, intellectual property or confidential information in a manner which exhibits that they have done something with the material available in public domain¯ so that they can claim an exclusive right over it.

Finally, specifically in terms of business connections, an employee may be prevented from reaching out to the former employer's customers and/or clients by the way of a restrictive covenant.[10]

On similar lines, In Mr Diljeet Titus, Advocate v. Alfred A Adebare and Ors,[11], the Delhi high court prohibited the respondent from acquiring information from the database of the firm, which included the firm's client lists amongst other information.

A general trend can be extrapolated from the preceding information. It is that the judiciary is sympathetic to the requirements of a corporate entity to run with full sanctity and financial security when it comes to measures in place for such sensitive information. Nevertheless, resonating with the usual legal model for restrictive covenants during and after a period of employment, there can be a subjective exception of unreasonable scenarios.

To corroborate the same, the case of Gopal Paper Mills v. Malhotra should be considered[12]. This was a case of breach of a negative covenant during the course of employment, where the period of the contract was as much as 20 years. Moreover, the contract also gave the employer the arbitrary power to terminate the employee's service without notice in the three years of apprenticeship or thereafter in the case that the employer felt that the employee's service did not meet the employer's expectations. Finally, the employer's decision was supposed to be conclusive between both parties. In such a case, the single judge rightly held the same terms unconscionable and unreasonable.

Restraint During Employment

In case a contract of employment has a negative covenant restricting an employee from taking up any other form of employment, and the employee in regard leaves the original service, the said negative covenant can be enforced to the extent that the remaining part of the service, would be necessary for the sake of the fulfilment of the contract.[13]

Moreover, an agreement of service by way of which an employee binds himself while the term of the agreement of employment is going on, cannot be labelled as a restraint of trade till the time it is not conscionable or one-sided.[14]

Additionally, negative covenants in a contract of employment operative over the course of the employment when the employee is obligated to serve his employer exclusively, are conventionally not regarded as restraints of trade and do not fall under the purview of section 27 of the Indian Contract Act.[15]

During the period of employment, therefore, the employer does have the exclusive right to avail the employee's services.[16] Nevertheless, the presence of reasonability must be noted in such scenarios.

Non-Compete Restraints

A non compete clause essentially restricts an employee from competing with an ex-employer under a designated area of business.

The courts take special consideration of the leverage each party between an employer and an employee possesses. For instance, it is well recognised by courts that in a number of cases, the employee is presented with a standard form contract and is in circumstances where he/she might sign a given contract on account of an imbalance of bargaining powers.

the courts therefore view with disfavour a restrictive covenant by an employee not to engage in a business similar to or competitive with the of the employer after the termination of his contract of employment.¯[17]

The passage is supplemented by the judgement in Superintendence Company of India Pvt. Ltd. V. Krishan Murgai, where the court stated that upon any ambiguity in the construction of a contract of employment, it should be construed narrower than wider.

Under the given category, Niranjan Shankar Golikari v. Century Spg and Mfg Co Ltd[18] might add clarity by giving an insight into non-compete restrictions through the lens of time limits. It was held that a negative covenant amounting to restraint in trade during the course of employment is valid and enforceable so far as it is not unreasonable or conscionable.

The same was affirmed in Superintendence Company of India Pvt. Ltd. V. Krishan Murgai[19]and Percept D'Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr.[20]. In the case of Percept D'Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr., the supreme court additionally noted that the doctrine of restraint of trade does not apply during the continuance of the contract of employment and it applies only when the contract comes to end¯[21]

Restraint After Employment

Naturally, the restrictions imposed on employees during the course of employment via a potential contract of employment are different from restrictions imposed on the said employees after employment.

It was held in Niranjan Shankar Golikari v. Century Spg and Mfg Co Ltd[22], that a restraint of employment where the employee cannot engage him/herself in another business of similar nature or get employed by any other employer with substantially the same duties, cannot be included as a restraint of trade- unless the restrictive covenant in regard is one-sided or not conscionable.

Premature Termination Of Employment

To illustrate this concept best, it would be appropriate to explore generalised brief facts of Superintendence Company of India Pvt. Ltd. V. Krishan Murgai[23].

The company in regard developed a unique technique of quality testing and control. Moreover, it housed a reputation and trade secrets. Having employed an individual, the company entered into an agreement with him, where the agreement restrained the individual from taking up service with a competing firm. Additionally, the employee would also be restrained from starting his own business wherever he was last posted under his employment with the employing firm. The terms would become active upon the employee leaving the service of the company hiring him.

The employee's service was terminated and he consequently commenced his own similar business. The original employing company sued the terminated employee upon this commencement of his own business for damages and injunction.

It was finally held that the terms of the contract would have only applied to the employee upon his willful giving up of service or decision to leave. The suit failed.

Reasonability And Tests Of Reasonability

As affirmed by the respective legal scenarios during and after employment in terms of a negative covenant in a contract of employment, along with the judicial trend in cases of such covenants set against the backdrop of trade secrets, the caveat of reasonability still lacks a concrete solidification and understanding when compared to other areas of law with competent testing systems in place.

The test¯ referred to in multiple cases such as Superintendence Company Of India (P) Ltd. V. Krishan Murgai (Superintendence case). really is just the test of reasonability to gauge whether a covenant is void or not. I could personally not come across any methodical or component-based tests to determine the reasonability of the covenant in regard, in both India and the UK.

This test of reasonability can be traced back to Lord Macnaghten in Nordenfelt v. Maxim Nordenfelt Guns & Ammunition Co. Ltd.[24] from the superintendence case. The judges go on to cite Tindal C.J. on multiple counts when sourcing the test of reasonability.

It can be deduced from the preceding information that the decision of gauging the reasonability of certain covenants is subjective and lies with the respective judge(s) in a given case, per the given circumstances.

Nascent Trends In The Field

Garden Leave Agreements

A Garden leave agreement can be defined as an arrangement between an employer and employee wherein the terminated employee is entitled to company benefits, including salary, but may not work for the company in any capacity, nor possess any access to the company's data in any way.

It can be beneficial to an employer in a multitude of ways. The basis of these benefits is engulfed in the emotional backdrop of an employee being agitated on account of a termination, which could potentially amount to erratic behaviour averse to a company's interests.

Such erratic behaviour can range anywhere from convincing clients to leave with the employee and exhibiting unprofessional demeanour to attempting to access sensitive information in the company for ulterior intentions. Protection from such risks is offered to the company through the terminated employee's satisfaction of securing benefits which he/she possessed in any case and through distancing the place of work from the terminated employee.

On a more legal note, garden leave agreements prevent a breach of the right to livelihood of the employee in regard, while maintaining semblance with negative covenants post-termination in such contracts. This, when coupled with its implications on the freedom of such contracts, is the reason why courts in India have been sceptical about such garden leave agreements being enforced.[25]

Non- Poaching Agreements

This digresses from the general form of contracts discusses in the preceding text. Instead of being an agreement between an employer and employee, it is an agreement between employers or companies who might scout for niche talent upon the termination of employees in other companies or through other means. This agreement would provide security to competitors in the sense that their niche talented employees would not be lured by competitive parties to this contract.

Non-Solicitation

Non-solicitation clauses are bound into agreements of employment for present and former employees in order for these employees to not engage in business with the employees or customers of the company against the interest of the company. It can often translate to the former employee essentially not being allowed to utilise the client lists of the company they have exited or have been terminated from.

Non- solicitation clauses, under negative covenants in such contracts otherwise, will naturally be considered differently when applied during employment and after employment, as has been held in the Niranjan Shankar case and Wipro Ltd. v. Beckman Coulter International[26].

Moreover, in the Wipro case, a distinction was also made between non-solicitation agreements which take place between an employer and employee and those that take place between business partners or any relationship which might imply that the parties are on an equal pedestal when it comes to negotiating powers.

Conclusion
In order to provide a general guideline for restrictive clauses (negative covenants in contracts of employment) in the Indian legal scenario, I would put forward the following postulates:
  1. The Indian courts are generally sympathetic towards the interests of employers when it comes to the protection of their trade and its integrity, so far as they are reasonable.
  2. When it comes to reasonability, the covenant in regard should not be too harsh, unconscionable or one-sided. Moreover, neither should the respective clause compel the employee to idleness in case it is to be enforced, nor should it be against the public policy of India.
  3. Conventionally, the negative covenants enforced during the period of the agreement of employment are not held void.
  4. Notwithstanding the preceding text of the article, the factual matrix of a case may compel the court to take action against the judicial sentiment which has been followed in terms of negative covenants in contracts of employment, both during and after the period of employment.
Given the predominantly encompassing language used in section 27 of the Indian Contract Act, the interpretation of the courts in India provide a sigh of relief and much needed corporate liberty to companies for them to protect the integrity of their respective business through the institution of negative covenants in contracts of employment.

End-Notes:
  1. Indian Contract Act, 1872, s 27, Act no.9 of 1872
  2. Pollock F and Mulla DF, The Indian Contracts Act (1st edn )
  3. Oakes & Co. v. Jackson, (1876) (ILR) 1 Mad 134
  4. Pollock F and Mulla DF, Agreement in restraint of trade, void,¯ The Indian Contracts Act (16th edn Lexis Nexis 2019)
  5. Pollock F and Mulla DF, Agreement in restraint of trade, void,¯ The Indian Contracts Act (16th edn Lexis Nexis 2019) 639
  6. Embee Software Pvt Ltd V. Samir Kumar Shaw, AIR 2012 Cal 141
  7. Niranjan Shankar Golikari v. Century Spg and Mfg Co Ltd, AIR 1967 SC 1098
  8. Anindya Mukherjee v. Clean Coats Pvt. Ltd., 2011 1 Mah LJ 573
  9. American Express Bank Limited v. Priya Puri 2006 (110) FLR 2061
  10. Pollock F and Mulla DF, Agreement in restraint of trade, void,¯ The Indian Contracts Act (16th edn Lexis Nexis 2019) 639
  11. Mr. Diljeet Titus, Advocate v. Alfred A Adebare and Ors, 2006 (32) PTC 609 (Del)
  12. Gopal Paper Mills v. Malhotra AIR 1962 Cal 61
  13. Niranjan Shankar Golikari v. Century Spg and Mfg Co Ltd, AIR 1967 SC 1098
  14. Tapprge Gesellschaft MBH v. IAEC India Ltd, AIR 1988 Bom 157
  15. Pollock F and Mulla DF, Agreement in restraint of trade, void,¯ The Indian Contracts Act (16th edn Lexis Nexis 2019) 638
  16. Pollock F and Mulla DF, Agreement in restraint of trade, void,¯ The Indian Contracts Act (16th edn Lexis Nexis 2019) 639
  17. Pollock F and Mulla DF, Agreement in restraint of trade, void,¯ The Indian Contracts Act (16th edn Lexis Nexis 2019) 638
  18. Niranjan Shankar Golikari v. Century Spg and Mfg Co Ltd , AIR 1967 SC 1098
  19. Superintendence Company of India Pvt. Ltd. V. Krishan Murgai, AIR 1980 SC 1717
  20. Percept D'Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr. AIR 2006 SC 3426
  21. Percept D'Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr. AIR 2006 SC 3426
  22. Niranjan Shankar Golikari v. Century Spg and Mfg Co Ltd , AIR 1967 SC 1098
  23. Superintendence Company of India Pvt. Ltd. V. Krishan Murgai, AIR 1980 SC 1717
  24. Nordenfelt v. Maxim Nordenfelt Guns & Ammunition Co. Ltd. LR 1894 AC 535
  25. Amegals, Restrictive Covenants Of Employment & Contract Act, < https://www.mondaq.com/india/contract-of-employment/768944/restrictive-covenants-of-employment-contract-act?login=true>
  26. Wipro Ltd. v. Beckman Coulter International, 2006 (3) ARBLR 118 (Delhi)

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