Whenever Companies appoint key managerial personnel, it makes sure that the
exit route for him is made difficult by prescribing a minimum time limit of
service, prolonged notice period and negative covenant restricting the
executive to join competitors during and beyond the term of the employment
agreement.
With the increase in cross-border trade and an enhanced
competitive climate in India, non-competent, confidentiality and other negative
covenants are becoming increasingly popular.
In this regard, section 27 of the Contract Act, 1872 states 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.
Exception 1 – Saving of agreement not to carry on business of which goodwill
is sold – One who sells the goodwill of a business may agree with the buyer to
refrain from carrying or a similar business, within specified local limits, so
long as the buyer, or any person deriving title to the goodwill from him,
carries on a like business therein, provided that such limits appear to the
Court reasonable, regard being had to the nature of the business.”
Every term in the agreement that puts restriction on the employee
to leave the present employer or to join the other employer would not be termed
as “restraint of trade” and would not be termed void.
For instance, an agreement of service under which an employee
agrees to serve a particular employer for a certain duration, and that he will
not serve anybody else during that period, is not hit by section 27 of the
Contract Act, and is valid1. If, an employee
after having entered into such an agreement make a breach of the same and takes
up another job, an injunction can be issued against him restraining him from
taking up the other employment2.
In other words, the terms in the contract of employment requiring
an employee to serve for a certain period is regarded as positive covenant and
the term restricting the employee from seeking other employment is regarded as
a negative covenant. A positive covenant in a contract for personal employment
may not be enforced by Courts; however the negative covenants in such contracts
may be enforced by Courts in India subject to certain limitations. One of the
limitations being that the employee should not be put under any negative
covenant beyond the expiry or termination of the contract.
The principles of section 27 were aptly summarized by the Supreme
Court of India in Percept D’ Mark
(India) Pvt. Ltd V Zaheer Khan, in
which the Supreme Court observed that under Section 27 of the Act a restrictive
covenant extending beyond the term of the contract is void and not enforceable.
The court also noted that the doctrine of “restraint of trade” is
not confined to contracts of employment only, but is also applicable to all
other contracts with respect to obligations after the contractual relationship
is terminated.
In the earliest times all contracts in restraint of trade, whether
general or partial, were void. The severity of this principle was gradually
relaxed, and it became the rule that a partial restrain might be good if
reasonable, although a general restrain was of necessity void. The distraction
between general and partial restraint was subsequently repudiated and the rule
now is that the restraints, whether general or partial, may be good if they are
reasonable and any restraint of on the freedom of contract must be shown to be
reasonably necessary for the purpose of freedom of trade. A covenant in
restraint of trade must be reasonable with reference to the public policy and
it must also be reasonably necessary for the protection of the interest of the
covenantee and regard must be had to the interest of the covenator. Contracts
in restraint of trade are prima facie void and the onus of proof is on the
party supporting the contract to show that the restraint goes not further than
is reasonably necessary to protect the interest of the covenantee and if this
onus is discharged the onus of showing that the restraint is nevertheless
injurious to the public is on the party attacking the contract. The court has
to decide, as a matter of law. (i) whether a contract is or is not in restrain
of trade, and (ii) whether, if in restraint of trade, it is reasonable. The
court takes a far stricter and less favourable view of covenants entered into
between employer and employee than it does of similar covenants between vendor
and purchaser or in partnership agreements, and accordingly a restraint may be
unreasonable as between employer and employee which would be reasonable as
between the vendor and purchaser of a business3.
When a seller or a manufacturer agrees to supply the whole of his
product to a particular buyer only, or a buyer agrees to purchase his
requirements of certain commodity from a particular seller or manufacturer
only, such an agreement will not be hit by section 27 of the Contract Act,
provided the object is not to corner goods or to monopolies trade4.
Contract restraining an employee to engage himself in similar
duties, unless the same is unconscionable, excessively harsh or one-sided, is
not in restraint of trade. Restraint of trade, if reasonably necessary, shall
prevail unless contrary to public policy5.
The reasonableness of the restrain is not envisaged by section 27
of the Contract Act, under section 27 – restrictive covenant extending beyond
the term of the contract is void and not enforceable. 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 an end, is not
confined to a contract for employment, but is also applicable to other
contracts. In other words, the doctrine of restraint of trade is the same for
the contracts of employment as well as the other contracts and the restrictive
covenant in the agreement to operate beyond the contract period is void and hit
by section 27 of the Contract Act. Restrictive covenant is to apply during the
period of contract, but shall fall under section 27 of the Contract Act where
it is to operate after the contract was ended6.
It is important to mention here that section 42 of the Specific
Relief Act, 1963 specifically allows injunction to perform negative agreement.
Section 42 states as follows:
“Notwithstanding anything contained in clause (e) of the section
41, where a contract comprises an affirmative agreement to do a certain act,
coupled with a negative agreement, express or implied, not to do a certain act,
the circumstances that the Court is unable to compel specific performance of
the affirmative agreement shall not preclude it from granting an injunction to
perform the negative agreement:
Provided that the plaintiff has not failed to perform the contract
so far as it is binding on him.”
With regard to a contract of employment sought to be enforced by
an employer, injunction under section 42 against the employee may be granted
only when all the following conditions are satisfied:
1. The
contract of employment contains a positive covenant;
2. The positive covenant is coupled with a
negative covenant; and
3. The employer has not failed to
perform the contract so far as it is binding on him.
For instance, the defendant contracted to sing at the plaintiff’s
theater and not to sing at any other theater. While the court cannot compel the
defendant to sing at the theater of the plaintiff it can restrain the defendant
from singing at any other theater. The defendant agreed to act as a player in a
jatra performance. The defendant was guilty of breach of contract. Court has
discretion in granting injunction in the matter of negative covenant. Court by
an order of injunction restrained the defendant from acting as a player for any
stage or screen performance for a year7. Negative
covenant that the seller will not sell the ore to anyone other than that buyer,
buyer can obtain a temporary injunction restraining the seller from selling8.
Conditions to be satisfied to obtain injunction: The stipulation
must be reasonable in reference to the interests of the contracting parties and
the public9. A
negative covenant not to serve elsewhere remains effective during the period of
service contracted, a contract not to serve elsewhere beyond the contractual
period of service being in restraint of trade is void2. The
power to grant injunction to enforce negative covenant is discretionary. It
shall not be granted if the negative covenant is extremely harsh, unreasonable
or unconscionable. It shall be refused particularly if such injunction compels
a person to remain idle and restrains him from not doing any trade or profession10.
JOINING A COMPETITOR
Almost all the contract for employment contains strict covenants
restricting employees from joining competitors even beyond the expiry or
termination of their present employment contract. The cross employment of key
personnel with competitors have been subjected to fierce legal battles, the
Courts have almost on all occasions held that the employer has no legitimate
interest in preventing an employee after he leaves his service from entering
the service of a competitor merely on the ground that he Is a competitor.
The Hon’ble High Court of Delhi In Pepsi Foods Ltd &
Ors V Bharat Coca-cola holdings Pvt. Ltd., had summarized the reasons for
refusal of grant of injunction to enforce the negative covenants, on the back
ground of joining competitors, in the following words:
(a) The injunction, as prayed for by the Plaintiffs, if granted
would certainly have a direct impact of curtailing the freedom of employees for
improving their future prospects and service conditions by changing their
employment.
(b) Rights of an employee to seek and search for better employment
cannot be restricted by an injunction.
(c) Injunction cannot be granted to create a situation such as
'Once a Pepsi employee, always a Pepsi employee'. It would almost be a
situation of `economic terrorism' or a situation creating conditions of `bonded
labour'.
(d) Freedom of changing employment for improving service
conditions is a vital and important right of an employee, which cannot be
restricted or curtailed by a Court injunction.
(e) Interchangeability of service is an accepted norm of Service
Jurisprudence which cannot be curtailed by a Court injunction.
(f) 'Employees' right to terminate their contracts also cannot be
curtailed by Court injunction.
(g) An injunction can be granted only for protecting the rights of
the plaintiffs, but cannot be granted to limit the legal rights of the
defendants.
(h) An injunction cannot be granted where the Courts have a doubt
in the credibility, veracity and truthfulness of the plaintiff's version.
(i) An injunction also cannot be granted in a case where the Court
directly or indirectly gets the impression that the injunction has been sought
for extraneous considerations or oblique motives.
(j) Rough and tumble of the business including stiff competition
has to be faced in a free market economy. The problems which should be settled
in the market place cannot be brought to Law Courts or settled by a Court
injunction.
(k) In economic matters, while granting injunction, business
ealities have to be taken into consideration. The employees seek betterment and
advancement of their careers, while they are in service. It is impracticable
and unrealistic to artificially create a situation by a Court injunction when
employees would first leave the employment and then look for better service
conditions and job opportunities elsewhere.
(l) Most of the senior employees of the plaintiffs or the
defendants were working with other multinationals or business organisations.
They joined the plaintiffs or the defendants because attractive salaries and
better service conditions were offered by them. The plaintiffs themselves have
engaged a large number of employees who were working in other multinational or
business organisations. They were appointed because they had work experience
with other organisations. The same plaintiffs are not justified in seeking an
injunction so that their employees may not join the defendants. All that is to
be seen is whether the defendants had adopted unfair means in advancing their
business interests or not.
(m) In a free market economy, everyone concerned, must learn that
the only way to retain their employees is to provide them attractive salaries
and better service conditions. The employees cannot be retained in the
employment perpetually or by a Court injunction.
(n) Free, fair and uninterrupted competition is the life of the
trade and business. This freedom in free market economy has to be zealously
protected in the larger interest of free trade and business. No injunction can
be granted which is likely to restrict or curtail this freedom11.
CONFIDENTIALITY
Confidential obligations, post-termination of employment will be
enforced in limited circumstances so long as they remain reasonable and limited
in time and scope and the employer can support that the information is
confidential and proprietary to it.
A clause prohibiting an employee from disclosing commercial or
trade secrets is not in restraint of trade. The effect of such a clause is not
to restrain the employee from exercising a lawful profession, trade or business
within the meaning of section 27 of the contract Act12.
Indian Courts will in certain circumstances enforce the
confidentiality agreements intended to protect an employer’s proprietary
rights. But the Courts remain sensitive to the possibility that employers may
try to use these covenants as a back-door means of restraining employees from
exercising their trade and will place an extremely high burden of proof on
employers seeking to enforce these provisions.
Service covenant binding the employee not to divulge any
confidential secret information acquired during employment cannot extend beyond
employment13.
NON-SOLICITATION AGREEMENT
Non-solicit contract is to restrict either party from enticing
each other employee away from their respective employments. Such contracts are
not contract between an employer and employee and the covenants bar either
party from offering inducements to the other’s employees to give up employment
and join them. As such, these contracts by itself do not put any restriction on
the employees and are therefore not covered within the purview of section 27 of
the Contract Act.
Non-solicitation obligations post-termination of employment may be
enforced in limited circumstances, based upon the facts of each individual
case.
The judicial precedents discussed above and the combined effect of
section 27 of the Contract Act and section 42 of the Specific Relief Act can be
summarized in the following words:
1. A restrictive covenant extending beyond the term of the
contract is void and not enforceable;
2. 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;
3. The aggrieved employer can claim damages for the losses
suffered from the erring employee owing to the termination of the contract of
employment.
Prepared by:
S. Hemanth
Advocate
at Hemanth &
Associates
