Articles

Non-Compete Clause in Contracts- An Insight

By April 10, 2020 May 1st, 2020 No Comments
NON-COMPETE CLAUSE IN CONTRACTS_ AN INSIGHT

NON-COMPETE CLAUSE IN CONTRACTS_ AN INSIGHT

A. INTRODUCTION:

A non-compete clause under the contractual laws can be included in various agreements between two parties whereby one party undertakes and gives his acceptance to the other party or may be in some cases both parties undertake and gives acceptance to certain conditions which is very vital and needs protection from a business point of view. Article 19(1)(g) of the Constitution of India, 1949 confers upon all the citizen right “to practise any profession, or to carry on any occupation, trade or business”. Further, reasonable restriction can be imposed on this right ensuring the principles of natural justice and ethics are followed properly on case to case basis. Non-compete clause can simply be incorporated in any agreement or else it can also be drafted as a stand-alone agreement.

The parties of the contract endeavor to shield themselves from the activities of the other party by explicit inclusion of covenants in the contracts. Non-compete clause is one of those important clauses, which puts a restriction on one of the parties from competing or engaging in similar line of business with the other. The advantage of mentioning this clause in a contract is to provide either one of the parties or both the parties with a degree of protection from any damage or loss. The usage of non-compete clause is most commonly seen in employment agreements because the employer bestows upon its employees certain sensitive and confidential information which is acquired by the employee in due course of his employment with the company. Therefore, it is very important for the company to protect such information for safeguarding the business and the interest of the company. Apart from employment agreements there are also other agreements in which non-compete clause has a role to pay. In share purchase agreement where a promotor of a company is outrightly selling all his shares, in such a scenario non-compete clause can be incorporated for protecting the business of the company. Further, in a service agreement if one company is into software development and other company is into hardware manufacture, in such a situation non-compete clause can be incorporated restricting both the parties from entering into the similar line of business of the other party. Apart from the aforementioned agreements non-compete clause can also be incorporated in distribution agreements, consultancy agreements, supply agreements, sale and purchase agreements, investment agreement, founder’s agreement etc. but on case to case basis.

B. ENFORCEABILITY:

The non-compete clause in our country is regulated by Section 27 of the Indian Contract Act, 1872 (“Contract Act”), clearly states that:

“Every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void”

The only exception to aforesaid section is “Sale of Goodwill”

The law is well settled that a contract which restrains trade of anyone in our country cannot be enforced unless:

  1. it is considered reasonable and fair to both the parties of the contract;
  2. protects the rights of both the parties;
  3. is consistent with the public interest;
  4. mentions a reasonable time period;
  5. ensures goodwill.

C. TIME LIMIT:

In agreements where non-compete clause is included, one of the important factor that has to kept in mind while drafting the non-compete clause is to mention the time limit for validity of the clause or time limit for which the restriction imposed by the non-compete clause will last. Generally, the time limit lasts for the entire term of the agreement and also for a certain period after the agreement has expired, which differs from case to case.

D. OUR VIEW BACKED BY JUDICIAL PRONOUNCEMENTS:

We can say that non-compete clause can be used as a weapon which prevents either one party or both the parties to the agreement from competing with the other party and such restriction imposed is valid and cannot be treated as a restrictive covenant because the only motive behind incorporating this clause in the agreements is to protect the interest of the parties. The usage of this clause is not only limited to employment agreements, but its ambit also extends to various other agreements, however, the same would depend and differ on a case to case basis. This view of ours is backed by few judicial pronouncements i.e. the Supreme Court of India in Niranjan Shankar Golikari v. The Century Spinning and Mfg. Co.[1], held that non-compete clause is operative during the period of employment whereby the employee is expected to solely work for his employer. In such situation non-compete clause is not to be treated as a restrictive covenant and therefore the clause does not fall under the purview of Section 27 of the Contract Act and in the case of Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr.[2], the Supreme Court of India has confirmed that as held in M/s. Gujarat Pottling Co. Ltd. & Ors. vs The Coca Cola Co. & Ors.[3], the non-compete clause is not only applicable to employment contracts, but it is also relevant in other contracts.

E. CONCLUSION:

In India, the judiciary has always been weary of validating such restrictions and has always interpreted the clauses in a flexible manner to ensure that principles of natural justice, morality and fairness are always kept in mind, depending upon the scenario of each case. With respect to determining whether the inclusion of a restrictive clause in a contract would be valid or not, the judiciary has paid due regard to the negotiating power of each party entering into a contract for setting out rational restrictions in the clause and ensure that such clauses are in no manner whatsoever, irrational and unreasonable in nature.

Authors: Prashant Jain, Co-Founder & Partner; Jaisis Srikrishna Das, Associate.

Disclaimer: The content of this article is intended to provide a general guide to the subject matter. For any queries, the authors can be reached at (i) prashant@samistilegal.in (ii) jaisisdas@samistilegal.in.

Updated as on April 10, 2020

[1] 1967 AIR 1098, 1967 SCR (2) 378

[2] (Appeal civil) 5573-5574 of 2004)

[3] 1995 AIR 2372, 1995 SCC (5) 545

Image generation credits: https://www.canva.com/templates/

Leave a Reply