Non-Compete Clause

NON-COMPETE CLAUSE
 What is a non-compete clause?

A non-compete clause (NCC) refers to a clause under which one party (usually an employee)
agrees not to enter into or start a similar profession or trade in competition against another
party (usually the employer). The use of such clauses is premised on the possibility that upon
their termination or resignation, an employee might begin working for a competitor or start a
business, and gain competitive advantage by exploiting confidential information about their
former employer's operations or trade secrets, or sensitive information such as
customer/client lists, business practices, upcoming products, and marketing plans.
 Validity
In Indian jurisprudence, the validity of NCCs is ascertained on the touchstone of Section 27
of the Indian Contracts Act, 1872 (“ICA”), which deems agreements made in restraint of
trade void. The provision 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.”
Traditionally, the judiciary in India has strictly adhered to the wordings of the provision by
abstaining from upholding the validity of NCCs. It is pertinent to note, however, that courts
have made a distinction between an NCC operative during the pre-completion period and the
post-employment period. Accordingly, while the aforementioned stance (regarding non-
validity) applies to post-employment scenario, these clauses remain valid during the course of
contract.
For instance, in Superintendence Company of India (P) Ltd. v. Krishan Murgai, the
Supreme Court held that while the mere existence of negative covenant in a service
agreement did not make it void, its application post the termination of the agreement served
as a restraint of trade, and was therefore illegal under Section 27 of the ICA.
Similarly, in Pepsi Foods Ltd. and Ors. v. Bharat Coca-Cola Holdings Pvt., the Delhi
High Court, in no uncertain terms, held that “It is well settled that such post termination
restraint, under Indian Law, is in violation of Section 27 of the Contract Act. Such contracts
are unenforceable, void and against the public policy.”
In D’ Mark (India) Pvt. Khan Ltd. v. Zaheer and Anr. Shed, the Supreme Court expressly
laid down the legal position of non-compete clauses under contract law by holding –
“The legal position with regard to post-contractual covenants or restrictions has been
consistent, unchanging and completely settled in our country. The legal position clearly
crystallised in our country is that while construing the provisions of Section 27 of the
Contract Act, neither the test of reasonableness nor the principle of restraint being partial is
applicable, unless it falls within express exception engrafted in Section 27.”
However, in subsequent years, a more liberal interpretation has been accorded to Section 27
of the ICA. Exceptions to the provision have been devised, with the principle of
reasonableness serving as the standard to determine whether or not NCCs shall apply post-
termination. Consequently, NCCs have been deemed to be legally binding so long as the
clause contains reasonable limitations as to the geographical area and time period in which an
employee of a company may not compete. This approach has been undertaken by keeping the
interests of the employer in mind.
For instance, in Niranjan Shankar Golikari v. Century Spinning & Mfg. Co., the
Supreme Court clarified that –
“A negative covenant that the employee would not engage himself in a trade or business or
would not get himself employed by any other master for whom he would perform similar or
substantially similar duties is not, therefore, a restraint of trade unless the contract as
aforesaid is unconscionable or excessively harsh or unreasonable or one-sided”.
Another instance of the shift in judicial approach towards a liberal interpretation of non-
compete covenant is evident in V.F.S. Global Services Pvt. Ltd. v. Mr. Suprit Roy,
wherein the Bombay High Court held that restraint on the use of trade secrets during or after
the cessation of employment does not tantamount to a "restraint on trade" under Section 27 of
ICA and therefore, is enforceable under certain circumstances.
The case of FL Smidth Pvt. Ltd. v. Secan Invescast (India) Pvt. Ltd. is highly significant
for expounding on the ambit of reasonable restrictions that can be placed by the employer
over their ex-employee through NCCs. Herein, the Madras High Court held that reasonable
restraints are permitted and can be placed in the following ways – distance, time limit, trade
secrets and goodwill.
 Reasonable Time Limit
It must be noted that there is no strait jacket formula for determining the reasonableness of
duration present in the non-compete clause. For instance, a court will likely refuse to enforce
an agreement that prohibits an employee from competing for the rest of his or her life. In
contrast, in many industries, a NCC with a duration of 6-months will be considered
reasonable, and therefore enforceable. Accordingly, determination of reasonableness is
subjective and varies from case to case. This stance is affirmed by the court in the FL Smidth
case (Supra), wherein it held that the test of reasonableness has to be carried out in light of
multiple other factors. The general rule is that the duration of the agreement should not
exceed the time reasonably necessary to protect the employer’s legitimate business interests.
What is considered “reasonable” varies from business to business, and requires a specific
consideration of the facts and circumstances surrounding the agreement.
 Interpretation of “Competitor” under NCCs
It is important to keep in mind that the test of reasonableness serves as an exception in

matters concerning the enforceability of NCCs. What flows from this is that the interests of
the employee must only be restricted to the extent necessary to protect the employer. In this
light, the interests of the employee will be highly impeded in case the term “competitor” is
accorded a very broad interpretation, since the employee would be restricted from engaging
in all activities even where the employer is not engaged. This stance has been affirmed by the
Virginia Supreme Court in Omniplex World Servs. Corp. v. US Investigations Servs. Inc.,
wherein it held –
“Covenants not to compete have only been upheld when employees are prohibited from
competing directly with the former employer or through employment with a direct
competitor.”
In addition, the notions of confidentiality, trade secrets, and solicitation of clients only gains
true significance if a breach can directly benefit the employer’s competition, while having
adverse effects on the employer’s trade.

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NON-COMPETE CLAUSE

 What is a non-compete clause?

 Reasonable Time Limit

 Interpretation of “Competitor” under NCCs

It is important to keep in mind that the test of reasonableness serves as an exception in

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