Negative Covenants And Agreement In Restraint Of Trade-an Insight Into Indian Laws

by Durai on April 14, 2009

The article analyses whether negative covenant restraining the employee from taking up employment with the third party after he ceases to be an employee are “agreement in restraint of trade” which is against the Indian Contract Act.

Introduction

An attempt has been made in this article to visualize how far negative covenants can be stretched and skillfully drafted vis-à-vis “agreement in restraint of trade” enshrined under the Indian Contract Act. The focus of this article would be more towards delving upon “non-disclosure agreement”, “non-compete agreement”, “non-solicitation agreements” and “garden leave clause”. The negative clauses always had an unpleasant time with freedom of contract and were prone to be easily charged as agreement in restraint of trade which is generally considered to be valid during the time of employment and the Courts have been less willing to enforce agreements relating to post-employment restraints on the employee.

Non-compete Clause and its Fortification

If there is a negative covenant restricting the employee from taking any other employment, and the employee leaves the service, the negative covenant can be enforced to the extent that the unexpired part of the term of service would be essential for the fulfillment of the contract.1 In Gujarat Bottling2 case the Supreme Court said any non-disclosure clause shall be applicable only during the period of service and any restraint beyond the service is violative of Section 27 of the Indian Contract Act.

A negative covenant that the employee would not engage himself in a trade or business or would not get himself employed by any other manner or whom he would perform similar or substantially similar duties, it is not therefore, a restraint of trade unless the contract as aforesaid is unconscionable or excessively harsh or unreasonable or one sided.3

contract which is in restraint of trade cannot be enforced unless (a) it is reasonable as between parties and (b) it is consistent with the interest of the public.4

In BLB Institute case5, the Court reiterated that under Section 27 of the Contract Act-(a) a restrictive covenant extending beyond the term of the contract is void and not enforceable, (b) the doctrine of restraint of trade does not apply during the continuance of the contract for employment and it applies only when the contract comes to an end, (c) as held by this Court in Gujarat Bottling v. Coca-Cola this doctrine is not confined only to contracts of employment, but is also applicable to all other contracts.

Therefore, it may be said that a negative covenant which restricts a person post-employment period may be struck down as violative of agreement in restraint of trade as it is pronounced by the Supreme Court in Percept D’Mark case6 a covenant is a restrictive covenant when it restricts the other person from his future liberty to deal with the persons he chooses for his endorsements, promotions, advertising or other affiliation and such a type of restriction extending beyond the tenure of the contract is clearly hit by Section 27 of the Contract Act and is void.

Non-solicitation Agreement

Non-solicitation agreements are those agreements which the employee promises not to solicit the employer’s clients or employees for a given period after terminating the employment. Generally, negative covenant during the period of the agreement is considered not to be hit by law but there are certain non-solicitation agreement which is prima facie negative in nature but still stand as an exception and are enforceable even after the conclusion of the employment are held by the Courts to be valid in law. The Delhi High Court in Wipro case7 held “the non-solicitation clause does not amount to a restraint of trade, business or profession and would not be hit by Section 27 of the Indian Contract Act, 1872 as being void”.

But in Pepsi Co8 case, which was an earlier case, the Court, prohibiting non solicitation agreement, held that where an attempt by one company to induce the employees of Competitor Company to join the employment of inducing company in contrast to the contract of employment, is not permissible and that the non-solicitation clause is hit by the provisions of Section 27 of the Indian Contract Act, 1872.

Non-disclosure agreement

Even though India has an obligation to comply with TRIPs Agreement, unlike the US and other developed countries, India has no legislation dealing with trade secrets. In India, protection of trade secrets is a common law based.9 Generally, an agreement which restraints a person after the period of employment are considered to be unreasonable restraint of trade and are struck down but “non-disclosure” agreement also stand as an exception to this general rule and the Courts have upheld the validity of such clauses post-employment period. In Gujarat Bottling case10 the Supreme Court asked a relevant question that how Pepsi may ask Coca Cola to part with its trade secrets to its business rival by supplying the syrup, etc. for which Coca Cola holds the trade marks to GBC which is under effective control of Pepsi. The recent Delhi High Court decision in Diljeeth Titus11 case also further vouches for the fact that confidential information of the employer can be protected post employment period.

In Escorts case12, the Delhi High Court restrained from manufacturing, selling or offering for sale of the Pick-N-Carry Mobile Cranes that are substantial imitation or reproduction of the industrial drawings of the Plaintiffs or from using in any other manner whatsoever, the technical know-how. In Burlington13 case the Delhi High Court again restrained carrying on any business including mail Order business by utilising the list of clientele/customers included in the database of the petitioner.

Protection of Confidential Information under Indian IPR laws

The issue of Copyright protection to confidential information was discussed by the Delhi High court in Diljeeth Titus14 case and the Court held that “thus the real test was the degree of employment control to determine whether it was a contract of service. There may not be employment in the strict sense of employment of a workman or a labourer but the degree of control would determine the obligations of the parties”, by pronouncing this the Court upheld the Copyright in database which was considered as confidential information. ‘The employee shall not, during his employment nor at any time afterwards, divulge nor communicate to any person corporation or firm, any information which he may receive or obtain in relation to the company’s affairs and customers and, all instructions drawing notes and memoranda made by the employee or which may come into his possession while engaged as aforesaid shall be the exclusive property of the company.’15

In Zee Tele film case16, the Bombay High Court approved triple test that where a Plaintiff sues, relying upon breach of confidence, he must establish three elements. These are- (1) that the information was of a confidential nature; (2) that the information was communicated in circumstances importing an obligation of confidence and (3) that there has been an unauthorised use of the information to the detriment of the person communicating it.

Where, it was undertaken by the parties “not to publish or cause to be published any work on the same subject at or about the price of sale which might reasonably be regarded as conflicting or likely to conflict with the sale of copyrighted works” this kind of confidentiality clause protecting copyright was held not to be violative of Section 27 of the Indian Contract Act.17

Remedies for Protection of Confidentiality under the Indian Law

Injunction preventing the third party from using trade secrets, return of confidential information and Compensation for damages are the common remedies which are available under the Indian Jurisdiction.

Section 72 of the Information Technology Act, 2000 deals with breach of confidentiality and privacy and any breach will attract imprisonment upto 2years, fine upto Rs. 1 lac.

The Bombay High Court in Urmi Juvekar 18 held that an action for breach of confidence succeeds only if the Plaintiff could identify clearly, what was the information he was relying on and has to be shown that it was handed over in the circumstances of confidence and could be treated as confidential.

“Garden leave” Clause-Is it the Solution?

The uncertainty of the judicial decision’s over the non-competitive clauses made the Corporate guru’s to develop a concept called “garden leave,” in which employees are paid their full salary during the period in which they are restrained from competing, this had its genesis in England.19

However, when “garden leave” clause came for consideration before the Bombay High Court it was argued that “The Garden Leave Clause is therefore, prima facie in restraint of trade and is hit by Section 27 of the Contract Act. The effect of the clause is to prohibit the employee from taking up any employment during the period of three months on the cessation of the employment”. The Court accepting the argument held “to obstruct an employee who has left service from obtaining gainful employment elsewhere is not fair or proper”.20

“Garden leave” clauses have not received much appreciation as they are considered to be as unreasonable restraint of trade which goes deep into the root of freedom of contract which is a fundamental postulate of right to contract.

Conclusion-

Negative covenant which restricts the employee beyond the period of employment are considered to be unreasonable. The exception being extended to confidential information and non-solicitation agreement to a reasonable period of time are valid and clauses like “garden leave” does not seem to protect the employer when it comes to Court of law; as they are considered to be agreement in restraint of trade and does not serve the purpose for which it was intended. Therefore, it requires the mind of an artist to draft a negative clause and the foresight of a prophet to view the consequences of such a clause which has now become absolutely imperative considering the decisions made by the India Courts.

_____________________________

* The author is a IInd Year LL.M student at National law School of India University. Bangalore. He can be contacted at E-mail- durai@nls.ac.in

1. Niranjan Shankar Golikari v Century Spg and Mfg Co Ltd [1967] 2 SCR 397

2. Gujarat Bottling Company Limited (GBC) vs. Coca Cola Company MANU/SC/0472/1995: AIR1995SC2372, (1995)5SCC545

3. Niranjan Shankar v. Century Spg. Mfg. Co Ltd. MANU/SC/0364/1967: AIR 1967 SC 1098

4. Vancouver Malt and Sake Brewing Co. v. Vancouver Breweries Ltd., 1934 PC 101

5. BLB Institute of Financial Markets Ltd v. MR. Ramakar Jha MANU/DE/1359/2008: 154(2008)DLT121

6. Percept D’Mark (India) Pvt. Ltd. V. Zaheer Khan and Anr. MANU/SC/1412/2006: AIR 2006 SC 3426, (2006) 4 SCC 227

7. See Wipro Limited v. Beckman Coulter International S.A. MANU/DE/2671/2006 : 131(2006) DLT 681

8. Pepsi Foods Ltd. v. Bharat Coca-cola Holdings Pvt. Ltd MANU/DE/0740/1999: 81(1999)DLT122

9. Gaurav Wahie, Evaluating Trade Secrets under the IPR Paradigm. CLJ 03 (01), 2005; 17-23.

10. Gujarat Bottling Company Limited (GBC) V. Coca Cola Company MANU/SC/0472/1995 : AIR1995SC2372, (1995)5SCC545

11. Mr. Diljeet Titus, Advocate v. Mr. Alfred A. Adebare and Ors. MANU/DE/1875/2006:130 (2006) DLT 330, 2006 (32)PTC 609 (Del)

12. Escorts Const. Equipment Ltd v. Action Const. Equipment P. Ltd S.No. 533/98 Decided On: 16.10.1998 MANU/DE/0185/1999

13. Burlington Home Shopping Pvt. Ltd.v. Rajnish Chibber MANU/DE/0718/1995: 61(1995)DLT6

14. Mr. Diljeet Titus, Advocate v. Mr. Alfred A. Adebare and Ors. MANU/DE/1875/2006: 130 (2006) DLT 330, 2006 (32)PTC 609 (Del)

15. Herbert Morris Ltd v Saxelby 1916 1 AC 688

16. Zee Telefilms Ltd. V. Sundial Communications Pvt. Ltd MANU/MH/0243/2003: 2003(3)MhLj695, 2003(27)PTC457(Bom)

17. The Chancellor Masters and Scholars of the University of Oxford v. Orient Longman Private Limited MANU/DE/2021/2002: 103(2003)DLT139

18. Urmi Juvekar Chiang v. Global Broadcast News Limited MANU/MH/0315/2007: 2008(2)BomCR400

19. Evening Standard Co. Ltd. v. Henderson [1987] I.R.L.R. 64. (This case is credited with giving rise to the concept of garden leave. The court found that Henderson “ought not, pending trial, to be allowed to do the very thing which his contract was intended to stop him doing, namely working for somebody else during the period of his contract.”

20. VFS Global Services Private Limited v. Mr. Suprit Roy MANU/MH/1043/2007: 2008(2) Bom CR 446, 2008 (3) MhLj 266.

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