What is a Non-Compete Clause?
A non-compete clause restrains a party to a contract from providing assistance or services to direct competitors of the other party, while the agreement is in subsistence. Moreover, this restraint is often extended post-termination for a stipulated period of time. It aims at protecting the intellectual property, trade secrets and strategies of a business.
Why is its Enforceability Contested?
Section 27 of the Indian Contract Act, 1872 ("ICA") states that any agreement (except for the exceptions mentioned in the section) restraining a person from practising a lawful profession, trade or business is void, i.e. not legally binding, to the extent of the clause imposing the restraint. In light of this section and the nature of non-compete clauses, controversies have been stirred amongst parties to contracts with a non-compete clause, leading to intense deliberations regarding its enforceability in commercial and employment agreements.
How Do Indian Courts Interpret Non-Compete Clauses?
The restriction of a non-compete clause is applied during the term of employment, and is sometimes extended for a stipulated period of time and/or geographic location post the termination of employment.
The Hon'ble Supreme Court in Niranjan Shankar Golikari v. Century Spinning & Manufacturing Co. Ltd.[1] held that preventing an employee from providing services to the employer's competitor during the course of employment is not void. It is essential for fulfilment of the terms of the agreement and to protect the interests of the employer, and thereby does not violate Section 27 of the ICA.
As far as post-termination restrictions are concerned, the Hon'ble Court held that unless the restriction is unconscionable, excessively harsh or one-sided, such a restriction would not amount to restraint of trade. However, in Percept D'Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr.,[2] the Supreme Court refused to enforce a non-compete clause post the termination of the contract, on the grounds that it was void and unenforceable in light of Section 27 of the ICA. The Hon'ble Court assertively laid down that, while analysing Section 27, the test of reasonability of the non-compete clause, or the reasoning that partial restraint is applicable, does not come into the picture unless it falls within the ambit of the exceptions under Section 27.
It is therefore clear from the above cases that restraints imposed on parties during the course of an agreement are legally valid and fair. However, post-contractual restraints attract Section 27 of the ICA and are largely considered void and unenforceable.
Conclusion
It is vital for businesses to protect their intellectual property and trade secrets, since these are a means of generating revenue. However, an employee's right to practise their profession cannot be curtailed. Courts have to maintain a fine balance between protection of intellectual property and the right to profession, trade or business, giving them wide discretionary powers in deciding the enforceability of a non-compete clause on a case-to-case basis.
[1] (1967) 2 SCR 378. [2] AIR 2006 SC 3426.
Disclaimer: The content of this article is intended to provide general guidance on the subject matter. Specialist advice should be sought about your specific circumstances.