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Validity of post-termination negative covenants



1. Introduction


A post-termination negative covenant refers to any clause in a contract which applies after the termination of the contract. Such contracts either restrict any party to the contract from entering enter into competition of any kind with the Company or restrict any party from revealing proprietary information or secrets or confidential information to any other parties during or after the termination of the agreement. These covenants to agreements apply to a variety of arrangements be it employer-employee, partnerships, joint ventures or any such arrangement between independent parties on equal footing.


The contemporary economy consists of a high degree of innovation and competition amongst businesses owing to the liberalised market policies and a greater emphasis on globalisation. The need to protect innovation, proprietary information, and internal workings amongst other things becomes crucial for any business to survive and thrive as it gives them a competitive edge over their adversaries. Businesses tend to incorporate such restrictions to protect their trade secrets and confidential information. The misuse of any such information by an employee during or post-termination of employment could have dire consequences for any business.


2. Position under Indian Law


In India, as per Section 27 of the Indian Contract Act (“the Act”) any agreement which aims to restrain anyone from exercising any lawful profession, trade or business is deemed to be void.[1] Furthermore, Article 19 (1)(g) of the Constitution provides every citizen the right to practice any profession, trade or business and reasonable restrictions are only imposed on this right in the interest of the public.[2]



3. Post-termination Negative Covenants


3.1 Non-Solicitation


A non-solicitation clause typically refers to an agreement between parties whereby a party is restricted from approaching the opposite party’s clients, customers, contact lists, etc. after the termination of such agreement. These clauses may be incorporated into employer-employee agreements or any such transaction between two independent parties.


In Wipro Ltd. v. Beckman Coulter International SA[3], the Delhi High Court held that the bar under Section 27 of the Act will not be attracted in cases where non-solicitation clauses operate between business partner and distributor contracts or similar partnership contracts between two independent entities as opposed to that between an employer and an employee.


Similarly, in M/S. Fl Smidth Pvt. Ltd. v. M/S. Secan Invescast (India) Pvt. Ltd[4] , the Madras High Court stated that reasonable restrictions can be placed in the form of:-


  • Distance: suitable restrictions can be placed on employee to not practice the same profession within a stipulated distance, the stipulation being reasonable.


  • Time limit: if there is a reasonable time provided in this clause then it will fall under reasonable restrictions.


  • Trade secrets: The employer can put reasonable restrictions on the letting out of trade secrets.


  • Goodwill: There is an exception under section 27 of the Act on the distribution of goodwill.


The Calcutta High Court provided clarity with regards to the enforcement of non-solicitation between an employer and employee in Embee Software Private Limited vs. Samir Kumar Shaw[5], wherein it was held that ‘acts of soliciting committed by former employees take such active form that it induces the customers of the former employer to break their contract with the former employer and enter into a contract with the former employee, or prevent other persons from entering into contracts with the former employer cannot be permitted’.


The enforceability of non-solicitation clauses which were initially extended to parties on equal footing have now been given more flexibility in terms of implementation. This ensures greater protection especially to start-ups as such companies tend to have small teams with greater expertise and therefore, any loss of employee or client data could have an adverse impact on the business prospects of the organisation.


3.2 Non-Disclosure


In today’s day and age, every employer has to exercise caution with respect to any proprietary information, trade secret, internal workings, intellectual property amongst other things being misused by a competitor. Therefore, a Non-Disclosure Agreement (“NDA”) helps employers protect their business interests.


Courts have generally ruled in favour of such clauses stating that such protection afforded to businesses would not amount to restraint of trade as was held by the Bombay High Court in VFS Global Services Private v. Mr. Suprit Roy[6] wherein a clause prohibiting an employee from disclosing proprietary information or trade secrets would not attract Section 27 of the Act.


Similarly, the Delhi High Court in Diljeet Titus vs. Mr. Alfred A. Adebare and Others[7] , granted an injunction to the plaintiff against his former partners to restrict them from using confidential data which included “…confidential documents, legal opinions, legal action plans, computerized database containing client information, proprietary client list, proprietary potential client list and other related information”.


In the start-up sphere, where any idea has the potential to make or break a business, it becomes necessary to impose certain negative covenants which would help protect the interests of the company against any misuse of any proprietary information. Companies must be allowed to use such clauses against CXO employees, who are well-versed with the proprietary information and the internal workings of a business, as a means of safeguarding their business interests from being exploited by a former employee.


3.3 Non-Compete


A non-compete clause aims to avoid competition between two parties. The agreement puts a prohibition on a party restricting them from working for a competitor in the same market or starting up another business in the same field. Businesses tend to add such covenants in the hopes of protecting their business interests which may suffer an irreparable damage owing to a loss of “competitive advantage”.


The Courts in India have more or less adhered to a conservative approach with respect to non-compete clauses and have generally abided by the letter of the law. In India, companies tend to have a higher bargaining power and therefore, the Courts take it upon themselves to protect the rights of an employee and implement an interpretation which is favourable to them.


The Supreme Court in Niranjan Shankar Golikari v. The Century Spinning And Mfg. Co.[8], categorically stated that the legal position of the courts differ on restrictions such as non-compete and non-solicitation depending on when such restrictions are to be applied. The Court held that such covenants would be valid and reasonable if they operate during the term of employment and would not be considered as restraint of trade under Section 27 of the Act.


In Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr[9], the Supreme Court stated 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 applied only when the contract comes to an end.”


The Delhi High Court in Ozone Spa Pvt Ltd v Pure Fitness & Ors[10] restrained the defendants from establishing, running or setting up any competing business in the local area where the premises of the plaintiff was situated. Non-compete restrictions are enforceable between a buyer and a seller of a business extending beyond the period of engagement, where such restrictions accompany the sale of goodwill of a business as long as such restrictions are reasonable and apply within specified local limits.


The validity of non-compete clauses is a grey area in the legal sphere of India. The Courts have maintained a restrictive stance with respect to the enforcement of non-compete clauses post-termination of employment agreements as such restrictions are held to be in restraint of trade and a violation of one’s right to practice any trade, business or profession and earn a livelihood. When determining whether a restrictive covenant in employment contract would be valid or reasonable, the courts pay due regard to the bargaining power of each party, the reasonableness of such restrictions set out in the agreement, duration and the nature of such restriction.


4. Author’s Comments


The Law Commission of India with respect to Section 27 of the Indian Contract Act (“the Act”), in its 13th Report stated “…was enacted at a time when trade was yet undeveloped and the object underlying the section was to protect the trade from restraints…but today, trade in India does not lag far behind that in England or the United States and there is no reason why a more liberal attitude should not be adopted…we recommend that Section 27 be suitably amended to permit reasonable restrictions”.[11]


It was recognised that the change in the economy would result in changes to the existing regulations to keep pace with the developments and allow a more conducive environment for any business to thrive. The Judiciary has made considerable progress with regards to the enforcement of post-termination covenants as noticed in its various judicial pronouncements. While adequate protection has been given to non-disclosure and non-solicitation clauses, the position with regards to the validity and enforcement of non-compete clauses still requires more deliberation and consideration. It is important to balance the rights of every person to practice any trade, business or profession a regime but a safeguard to protect the interests of businesses in a fair and reasonable manner must also be considered to adapt to the contemporary economic scenario of the country.


The enforcement of these post-termination clauses in a judicious and reasonable manner would provide a safety valve to start-ups. Such covenants would help improve the confidence of investors who may deem such covenants as reasonable collateral for their investments towards the business. The start-ups on the other hand would breathe easier knowing that their intellectual property, confidential information, employees, clients and business ideas are adequately protected in a highly dynamic and competitive environment.

[1] Section 27 of the Indian Contracts Act 1872. [2] Article 19(1)(g), the Constitution of India. [3] Wipro Ltd. v. Beckman Coulter International SA , 2006 (3) ARBLR 118 (Delhi). [4] M/s.FLSmidth Pvt.Ltd. v M/s.Secan Invescast (India) Pvt.Ltd., (2013) 1 CTC 886. [5] Embee Software Private Limited vs. Samir Kumar Shaw , 2012 (3) CHN 250 [6] VFS Global Services Private Limited v. Mr. Suprit Roy, 2008 (2) Bom. CR 446. [7] Mr. Diljeet Titus vs Mr Alfred A Adebare And Ors, 2006(32) PTC 609(Del). [8] Niranjan Shankar Golikari v. The Century Spinning And Mfg. Co, 1967 AIR 1098. [9] Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr, AIR 2006 SC 3426. [10] Ozone Spa Pvt Ltd v Pure Fitness & Ors, 2015 222 DLT 372 [11] 13th Law Commission of India Report, on the Indian Contract Act, 1872, available at https://lawcommissionofindia.nic.in/1-50/Report13.pdf.

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