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Restrictive Covenants under an Employment Contract

The advent of globalization, technological advancements, trans border transactions, frequent employment shifts and increased competition between businesses have necessitated increased complexity in the relationship between an employer and an employee calling for a detailed employment contract to be executed between both these parties.

In order to safeguard the business, employers have started including certain restrictive covenants within the scope of employment contracts. As the term suggests, a restrictive covenant refers to a clause that restricts or limits an employee from performing certain acts, both during and after the conclusion of the employment contract. Restrictive covenants would include clauses such as non-compete,non-solicitation and protection and non-disclosure of confidential information. Employment contracts also contain an innocuous though essential clause regarding return of the company’s property.

Non-Compete Clause 

A non-compete clause prevents an employee from entering into or starting a trade that is same/similar to that of the employer. Most non-compete clauses contain this restriction, not only during the term of the employment contract but also after the contract has concluded. It is imperative to understand whether such a restriction is enforceable under India law.

Section 27 of the Indian Contract Act, 1872 (“Act“) deals with the enforce ability of such restrictive covenants. Section 27 of the Act 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.

To determine whether such restrictive covenant would be valid or not, Indian courts have taken into regard the reasonableness of the restrictions set out as well as the time, place and manner of such restrictions.

The Apex Court in Percept D’Mark (India) Private Limited vs. Zaheer Khan & Another[1] has been of the view that, “… a restrictive covenant extending beyond the term of the contract is void and not enforceable. 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.”

Non-Solicitation Clause

A non-solicitation clause is a clause which prohibits an employee(former or current) from soliciting either the employees or the customers against the interest of the business. The tenure of this clause is generally not restricted to the period of the contract but is usually valid even after the expiration/termination of such contract.

As per Indian courts, a non-solicitation clause has been upheld in some cases whereas in some circumstances the same hasn’t been enforced.

In FL Smidth Private Limited vs. M/s. Secan Invescast (India) Private Limited[2], the Madras High Court laid down a standard to establish non-solicitation as follows:

“……solicitation is essentially a question of fact. The appellants should prove that the respondents approached their erstwhile customers and only on account of such solicitation, customers placed orders with the respondents. Mere production of quotation would not serve the purpose. It is not that the appellant is left without any remedy. In case the Court ultimately holds that the appellant has got a case on merits, they can be compensated by awarding damages. The supplies made by the respondent to the erstwhile customers of the appellant would be borne out by records. There would be no difficulty to the appellant to prove that in spite of entering into a non-disclosure agreement, respondent has solicited customers and pursuant to such solicitation they have actually supplied castings. When there is such an alternative remedy, question of issuing a prohibitory injunction does not arise.”

Thus, after the termination of the employment, non-solicitation clause is applicable only in certain circumstances.In order for the same to be applicable, reasonable restrictions are required to be placed such as time frame of the non-solicitation clause, protection and non-usage of trade secrets and goodwill.

Non-Disclosure of Confidential Information vis-a-vis Intellectual Property

The non-disclosure covenant restricts an employee from disclosing any confidential information related to the business to any third party. This clause is usually widely worded and included information that an employee may have had access to during the course of employment. Such restriction is valid post the termination of the employment agreement and non-adherence of the same on the part of the former employee attracts legal consequences.

Confidential information and intellectual property are two different aspects. Intellectual property refers to all the patent, copyright, trademarks, trade secrets, service marks, logos and various other facets of the intellectual property. The employment contracts should specify regarding the ownership of such intellectual property.

Though there are legislations in India that protect the owner of the intellectual property rights, companies in India still strongly rely on having watertight employment contracts so as to safeguard their intellectual property and confidential information.

Return of Property

Though this is not a restrictive clause, it is important that an employment contract contains a clause which ensures that all the property, in any form whatsoever and its respective copies stored in any form are returned to the employer on the termination/expiration of such employment contract. This clause ensures that all property belonging to the employer is possessed with the employer. This clause warrants that all the information including but not limited to any intellectual property and confidential information is retained with the employer.

Conclusion

Restrictive covenants are a part and parcel of employment contracts. These clauses tend to set certain obligations and responsibilities on behalf of an employee towards the employer and the company. However, merely by virtue of being present in the contracts, such covenants cannot be held enforceable by law. These restrictions can be enforced by the court of law only if they are held to be reasonable and it strikes a balance between the rights and obligations of the employer as well as that of the employee.

[1] AIR 2006 SC 3426
[2] (2013) 1 CTC 886

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