This article has been written by Shlok Sharma, 4th year law student at NALSAR University of Law, Hyderabad
Introduction
Non-compete agreements (NCAs) are a contentious issue in the contemporary workforce. These agreements are meant to prevent employees from joining or starting competing firms upon leaving their current jobs. They have crucial implications for businesses and workers. Although companies argue that NCAs protect valuable trade secrets and client lists, critics contend that they restrict workers’ employment options, reducing their mobility and the competition for their services, which weakens their bargaining position with their current employers. This dynamic limits innovation and entrepreneurship, as it encumbers the flow of skilled workers to new ventures and limits their ability to start competing firms.
As policymakers increasingly focus on fostering entrepreneurship and economic growth, the debate over the legitimacy and utility of NCAs has intensified, leading to a noteworthy shift in regulatory approaches, particularly in the United States.
Shifting Regulatory Landscape: The Decline of NCAs
The shift in approach is evident in the recent regulatory and judicial decisions, especially in the US. In April 2024, the US Federal Trade Commission (FTC) approved the “Final Rule,” which essentially prohibits new employment-context NCAs and renders most existing ones unenforceable, except for senior executives. The regulation is set to take effect in September 2024. The critical requirements of the Final Rule include prohibiting employers from entering into new NCAs after the effective date and rendering most existing NCAs unenforceable, except for those involving senior executives. Employers must also notify employees about the unenforceability of these agreements.
The FTC’s decision reflects the broader trend towards prioritizing public policy concerns over traditional business protection. States like Oregon, Massachusetts, and Washington have passed laws in recent years rendering non-competes unenforceable against low-wage workers.
Even judicial decisions, such as International Business Machines Corp. v. Johnson, reflect this shift, emphasising public policy concerns over business interests.
Moreover, employers’ concern regarding the spillover of business information stifling innovation might be unfounded. Prof. Gilson’s seminal article and recent studies supporting his work show that California’s refusal to enforce non-competes has resulted in higher economic development, labour mobility, and innovation than Massachusetts, where non-competes are enforceable.
Exploring Alternatives: Lessons from the US and UK
The aforementioned decisions embody a significant development in safeguarding employees’ rights to free trade and profession. However, they raise concern for the firms reliant on these agreements to safeguard their interests. This raises the question: What alternatives can businesses adopt to safeguard their trade secrets and proprietary information?
Given the apparent limitations of NCAs as a legal instrument for protecting employer interests, alternative legal doctrines have emerged around the globe that aim to protect employers’ trade secrets and proprietary business information without imposing excessive burdens on employees or clogging innovation.
One such alternative is Garden Leave Clauses (GLCs), which mandate that the employees serve a notice period during which they are paid but are not permitted to work elsewhere. This period allows employers to protect sensitive information in the knowledge of the leaving employee. Although such an arrangement comes with additional costs for the employer, these costs are justified if the secrets being protected are valuable enough. Employers must evaluate what is more critical: retaining their trade secrets or minimizing costs. This approach is beneficial as it discourages firms from putting restraints on leaving employees over information that is not particularly important or commercially viable. GLCs are preferred in the UK, as they strike a balance between protecting legitimate business interests and respecting employee rights.
Another viable alternative is Forfeiture-for-Competition Clauses (FFCs). Unlike NCAs, FFCs do not restrict employee mobility but offer benefits, such as stock options or bonuses, which the employee forfeits if they join a competitor. This approach rewards loyalty and allows employees to compete (and relinquish benefits) or not compete (and retain benefits). In the US, pro-employee legislatures have accepted FFCs, and courts do not apply a reasonableness test to them, giving employers a broader playing field. However, a limitation of FFCs is that the remedy for breach does not include injunctive relief, only monetary damages, which can be a drawback for employers seeking immediate action to prevent competitive harm.
A significant issue with both alternatives arises in cases of bad faith by the departing employee, such as the intentional misappropriation of trade secrets. In the US, this gap is covered by Trade secrets protection laws, particularly the Uniform Trade Secrets Act (UTSA), which provides a robust remedy. Employers can seek injunctive relief if they demonstrate that the employee acted with malicious intent to misuse the protected information.
While the US has made significant strides in balancing the interests of employers and employees, India faces unique challenges in this area.
The Indian Context: Current Legal Landscape
Section 27 of the Indian Contract Act 1872 voids such agreements, which restrict any individual from exercising a lawful profession, trade, or business of any kind, unless they fall within the narrow exceptions. The underlying principle is that the law must not allow any interference with an individual’s right to exercise lawful trade or profession, even if it means interfering with the freedom of contract. The Indian courts have consistently taken the view that negative covenants during the period of employment are valid and enforceable if they are reasonable and protect legitimate business interests.
However, the survival of such restrictions beyond the period of employment is controversial. In Affle Holdings Pte Limited v Saurabh Singh, the Delhi High Court held that restrictions that prohibit the employee from carrying on a competing business beyond the term of employment, are void.
Yet, in the Niranjan Shankar Golikari case, the Supreme Court held that the enforceability of specific post-termination non-compete clauses cannot be entirely circumscribed. It can be enforced if the intended benefit is not simply unilateral or the clause is not intentionally deceptive. Hence, there seems to be no agreement among the courts regarding the enforceability of post-termination non-compete clauses.
Challenges and Issues with NCAs in India
There are two major underlying causes of the extensive use of NCAs by the companies.
- The ineffectiveness of non-disclosure agreements and the absence of any specific law for the protection of trade secrets in India leave the employers with no choice but to use NCAs in order to protect their legitimate business interests and trade secrets. Although NDAs are employed widely, it can be difficult, if not impossible, to know whether an ex-employee is abiding by the agreement.
- NCAs serve as a tool to threaten and retain employees even when the employers do not have any legitimate business interest to protect.
Taking advantage of the ambiguity surrounding the scope of non-compete clause operating beyond the term of employment, companies often include it in contracts as a soft deterrent. Employees are more likely to comply rather than bear litigation costs and carry the burden of being sued by their previous employer.
There are numerous instances of companies using NCA as a mere tool to intimidate their employees. A partner at a professional services firm admitted that legal notices are frequently issued as a warning to others “despite knowing that nothing will come of it”.
These issues prompt the question of whether India should follow in US’s footsteps and prohibit NCAs. It is essential to explore whether the alternatives can effectively protect legitimate business interest and trade secrets, especially when India lacks a specific trade secrets protection law.
Way Forward: Balancing Employee Rights and Business Interests
The twofold objectives that have to be considered are:-
- Protection of the employees’ right to free trade and profession, reasonableness of any restrictions placed on such right, and adequate compensation for such restriction.
- Protection of the employers’ legitimate business interests in the form of sensitive information, marketing strategies, and trade secrets.
The first objective can be achieved by prohibiting NCAs and adopting more employee-friendly alternatives like GLCs and FFCs. However, the second objective presents particular challenges. While these alternatives do provide some protection to the employers, they do not provide an adequate remedy in cases of wilful breach by the departing employee acting in bad faith. The damage caused by a leak of trade secrets can be catastrophic for certain businesses. Therefore, a robust trade secret protection framework is necessary for these alternatives to function efficiently.
Due to its robust Trade Secrets Protection (TSP) laws, the United States can effectively ban non-compete agreements and adopt alternative measures. In contrast, India lacks a comparable framework. The most effective course of action for India would be introducing comprehensive TSP legislation before eliminating Non-Compete Agreements. In the absence of such a framework, banning NCAs, though necessary, would lead to further complications by placing departing employees in a position of control and rendering employers vulnerable to the misuse of trade secrets by former employees.
Conclusion
In the Indian context, the limitations of non-disclosure agreements and the absence of a robust trade secrets protection law highlight the urgent need for reform. NCAs appear to serve little purpose beyond acting as a “blunt instrument” for protecting trade secrets or as a temporary substitute for a comprehensive trade secrets protection law. Therefore, it would be more advantageous to eliminate NCAs in favour of alternatives such as FFCs and GLCs, which are more equitable, employee-friendly, and better suited for the current global economic conditions and policy choices. However, this transition must be preceded by establishing a robust Trade Secrets Protection framework akin to that in the United States.