This article is written by Mishika Bedi and Vishakha Somani, 3rd Year Students, Symbiosis Law School, Pune.
Business practices in today’s globalized era heavily rely on various sensitive processes, trade secrets, and confidential information. This has made it important for the companies to protect their intellectual proprietary to ensure the success and growth of their business ventures. However, the exponential spread of Covid-19 has made it even more difficult to ensure such protection, owing to the lack of monitoring, use of personal devices or unsecured networks, and frequent changes in the jobs due to voluntary as well as involuntary terminations.
One of the ways that companies may use to protect their sensitive information is the inclusion of a non-compete clause in the employment agreement. Such a clause is meant to restrain an employee or a former employee from pursuing a similar business or trade with the competitor of his previous employer.
However, under Indian jurisprudence, such clauses that are in the form of post-service restrictive covenants are considered to be void, falling under the mischief of Section 27 of the Indian Contracts Act, 1872, and being considered against the right to exercise lawful profession, trade or business. The present blog, therefore, seeks to discuss the impact of the strict operation of Section 27 of the Contracts Act and the need to have a re-look into its interpretation.
IMPACT OF THE STRICT OPERATION OF SECTION 27 OF THE CONTRACTS ACT
Section 27 of the Contracts Act states that every agreement by which any person is restrained from exercising lawful possession, trade, or business of any kind, shall be void to such extent. This Section was enacted at a time when trade and business were at their developing stage. However, even today, when business practices all over the world have massively evolved, and there is an increasing need to protect business confidentiality, the Section has remained unamended.
Such strict operation of the Section heavily favours the employees over the employers and disinclines them to invest in training and development of the workers due to the possibility of them taking their skills and secrets to the competitors. Further, it also discourages innovations and inventions owing to the fear of substantial loss that may be caused due to the revelation of the same to a competing business by an ex-employee, especially in the present mode of remote working where controlling and monitoring the storage, and transmission of sensitive data has become nearly impossible, owing to the usage of private operating systems.
Even though at times, the courts have exercised their discretion and deviated from the strict interpretation of Section 27, there is nothing per se in the Indian law that mandates the courts to adopt that fair and reasonable approach.
APPROACH IN FOREIGN JURISDICTIONS
The above-mentioned problems have been dealt with in certain foreign jurisdictions such as the US and UK by adopting the Doctrine of Reasonableness. According to this doctrine, post-service restrictive covenants are enforceable if they pass the test of reasonability. The courts in India, on the other hand, have refrained from incorporating the doctrine due to the rigidity of Section 27.
The object of such a test is simply to protect a legitimate business interest. Therefore, if the non-compete clause does not seem to fulfil such objective but only seems to impose an unreasonable restraint on the employee, then the same must be unenforceable. Accordingly, the England and Wales High Court (Chancery Division) in Invista Textiles UK Ltd v. Botes and others held that if the employer gets no real benefit from a non-compete clause, then it must be considered as an unreasonable restraint of trade and must be made unenforceable. This doctrine has also been expanded to incorporate the ‘blue pencil test’ in the UK whereby the unreasonable part of the non-compete clause is severed by the courts and the reasonable part stays intact.
The courts in the US and UK have recognised that for a non-compete clause to be enforceable, three major factors have to pass the reasonability test:
1. The Length of time of the Restrictive Covenant – Whether the length of time of the restrictive covenant is reasonable, usually depends on factors like the amount of time the employee had worked for the employer, the amount of confidential information he/she may have possessed, and the potential harm that can be caused to the employer in the case of leak of that information.
For example, in Ideal Standard International SA v. Herbert, the employee had been working closely with the company for many years. He had access to a lot of important confidential information, which had a long shelf life. It was held by the court that the non-compete clause which imposed an 18-month restriction on such an employee was reasonable as it legitimately protected the business interests.
2. Geographical Area – Whether the geographical area that the restrictive covenant extends to is reasonable, usually depends on factors like the location of the employer’s business or clients or areas which the employee has significantly worked under and established his contacts. It was held in Natsource LLC v. Paribello that the same would depend upon the nature of the business.
For example, in Freshasia Foods Ltd v. Lu, the geographical scope of the non-compete clause extended to the whole of Europe. The court held that in such cases, where the employee might suffer an unquantifiable loss that outweighs any possible loss that could be suffered by the employer, the non-compete clause should be made unenforceable.
3. Scope of definitions – Whether the definitions in the restrictive covenants are reasonable, would depend on their scope. For example, the use of open-ended words that unreasonably restrict the employee from working in any industry of the same kind cannot be held enforceable.
Accordingly, the Court in Invista Textiles UK Ltd v. Botes and others held that the scope of the words “competing business” and “competing products” in the contract was too broad and hence, the non-compete clause should be made unenforceable.
INCORPORATING THE DOCTRINE OF REASONABILITY IN INDIAN LAW
In India, Article 19 (1) (g) provides for the right to practice any profession, occupation, trade, or business. However, this is subject to Article 19 (6) that allows reasonable restrictions to be placed on such a right in the public interest. In light of this, even the interests of the employer can be held to be a reasonable restriction on this right enshrined under Article 19 (1) (g).
It was stated in the case of Bholanath Shankar Das v. LachmiNarain, that it is indeed unfortunate that Section 27 in its current form trenches upon the individual liberty in contractual matters concerning trade.
Accordingly, in the case of Niranjan Shankar Golikari v. The Century Spinning and Mfg. Co. Ltd., a liberal interpretation was given to Section 27. It was stated that an agreement that restrains an employee from engaging in a similar trade or business with a competitor is not void unless it can be shown that the same is unreasonable and harsh on such employee. However, even today, the Section has remained unchanged and the question has been left to judicial interpretations that may not be uniform.
Therefore, for the sake of uniform law and protecting the interests of employers, especially when there are high chances of exploitation in a pandemic-hit economy, Section 27 of the Indian Contract Act must be amended to allow for reasonable restrictions on the right of the employees.
Two factors that can be broadly looked into while applying the doctrineare:
- Possibility of Unconscionable harm: In deciding whether the non-compete clause is to be considered valid on the ground of reasonability, it may be looked into whether the terms of the clause are necessary for protecting the legitimate business interest to avoid irreparable losses or they merely impose an undue hardship on the employee. For example, in Ticor Title Ins. Co. v. Cohen, it was held that where an employee continues to receive his basic salary during the period in which he is restrained from joining a competing firm, and the time period of such restriction is also limited to protect the business and customer base of the company, such restrictive covenant must be considered to be reasonable.
- Unique abilities of Employee: If the employee has certain specialised skills that are likely to draw the customers towards his service, then the restrictive covenants may be considered to be reasonable. For example, in BDO Seidman v. Hirshberg, it was held that where a broker whose primary skills involve maintaining robust customer relationships leaves the company and joins a competing business, it may lead to the departure of customers to such competing business, which may only be prevented through non-compete clauses.
Therefore, the law with regards to the enforceability of non-compete clauses in employment agreements should be a balancing act between the interests of the employee to use his skills and earn his livelihood and the interest of the employer to protect his legitimate business interests. There is a need to introduce the reasonability test so that we can achieve the balance between the rights of the employee and employer.
The overall aim of the law should be to fairly protect both the employers as well as the employees. It must not give undue advantage to the employees, simply because they prima facie seem to be the more vulnerable party.
This change is especially important in the present scenario as businesses all over the nation are looking to explore alternate areas to sustain themselves. This change in the law will encourage the businesses to invent and innovate without fearing the possibility of their former employees either establishing a new business of a similar kind or spilling their secrets out to the competitors.