Restrictive covenants under the Employment Contract mean clauses that are incorporated in an Employment Contract in order to impose certain restrictions on the employees. These clauses are incorporated to safeguard and protect the business interests of the Company. This is the first part of a two-part series wherein we discuss about the legality of the restrictive covenants under the Employment Contracts. This article aims to ascertain the legal validity of such restrictive clauses.
Introduction
Restrictive covenants as the name suggests are the clauses within the Employment Contract that limits an employee from performing certain acts for a certain time period, both during and after the conclusion of the Employment Contract. The purpose of such Covenants is to safeguard and protect the business interests of the Company.
The Indian Contract Act, 1872 does not expressly provide for restrictive clauses, instead, it negates it. Section 27 of the Act 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’. This also includes the Indian Constitution which under Article 19(1)(g) provides the ‘right to practice any profession, or to carry on any occupation, trade or business‘ as subject to certain restrictions.
This makes enforcement of restrictive clauses a controversial matter. Despite the existence of these provisions, enforcement of such clauses can still be carried out. This article series (Part – 1 & Part – 2) aims to ascertain the essentials of a valid restrictive clause along with examining some popular clauses such as Non-Compete, Non-Solicitation and Non-Disclosure clauses.
Deciding the Legal Validity of Restrictive covenants
While enforcing a restrictive covenant seems antithetical to the Indian Contract Act, 1872 and the Constitution, the same should not be declared as an absolute rule since both the statutes agree upon providing certain reasonable exceptions.
A distinction was laid down between covenants that restricted employees during the period of employment and after an employee is no longer associated with the Company. The Supreme Court in Niranjan Shankar Golikari v. Century Spinning and Manufacturing Co,[1] held that negative covenants during the period of employment do not attract section 27 while those after termination shall be considered a restraint. More importantly, the Court here held that any such restriction may be upheld if found reasonable to protect the legitimate interests of both the parties. However, such restraints must be limited by time, space and to the nature of employment.
This does not imply that all post-employment covenants shall be rendered unenforceable by the Court of Law. In Hi-Tech Systems & Services Ltd. v. Suprabhat Ray and Ors.[2] the defendants were supposed to maintain confidentiality with respect to all information and documents provided to them during their employment. The defendants however left the company and started their own, where it was found that they were soliciting plaintiff’s clients by using confidential data handed to them when they were employees. During the course of employment of defendants in the plaintiff’s company, they were obliged to keep confidential all information and materials provided to them during their employment and thereafter for a period of three years from the date of termination vide a code of conduct policy circulated to them. The Court here held that even post-employment, a restrictive covenant can be enforced for a certain period of time from the date of resignation/termination from the Company. This was because firstly the purpose of the covenant was to prevent misuse of the confidential information of the plaintiff’s company and secondly, the covenant was time-bound and hence fulfils the reasonability test laid down in Niranian Golkari’s case.
Another important case law concerning restrictive covenants vis-à-vis Section 27 of the Indian Contract Act is Zee Telefilms Ltd. v. Sundial Communications Pvt. Ltd.[3] Here, the Court propounded three elements for the party claiming breach to prove in order to establish that the restrictive covenants does not clash with Section 27. The elements are as follows:
i. That the information was of a confidential nature;
ii. That the information was communicated in circumstances importing an obligation of confidence; and
iii. That there has been unauthorized use of the information to the detriment of the person communicating it.
Hence it can be said that covenants which fulfil these elements, along with clearing the standard laid down in the case of Neelanjan Shankar Golikari, it can be contended that a restrictive covenant under Employment Contract cannot be deemed to be violative of Section 27 of the Indian Contract Act, 1872.
Corrida Legal is the preferred corporate and employment law firm in Gurgaon (Delhi NCR) and Mumbai. Reach out to us on Linkedln or contact us at contact@corridalegal.com /+91-9211410147in case you require any advice or legal assistance.
[1] AIR 1967 SC 1098.
[2] AIR 2015 Cal 261.
[3] 2003 (27) PTC 457 (Bom).
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