Negative Covenants of employee agreement

Employment Law
Employment contract

RESTRICTIVE CLAUSES IN EMPLOYMENT CONTRACTS AND ITS ENFORCEABILITY

Headnote: 

Employment contracts are contracts which are drafted by the employers in order to safeguard the interest of the business. As we all know that Contracts are agreements enforceable by law, where there are two parties to the contract defining their rights and liabilities towards each other. One such type of contract is employment contract. In 

these contracts, the employer’s define various terms of business to be executed between the parties. 

These contracts include both positive and negative rights of the employer towards the employees. The main crux of introducing these restrictive or negative rights is that, in this era of globalization, trans- border transactions and increase in the ratio of employment shift, employers have started to introduce certain restrictive conditions within the scope of their contract. 

This article mainly deals with following pointers: 

  1. What are restrictive covenants 
  2. Types of restrictive covenants 
  3. Remedies for breach of contract 
  4. Applicability of section 27 of Indian contract act,1872 
  5. Related case laws 
  6. Practical tips.

INTRODUCTION: 

Organizations make an attempt to protect their trade secrets and confidential information by the use of ‘restrictive’ agreements between employers and employees, which place limitations and restrictions on the latter, pertaining to the knowledge and information gained in the course of employment and how it shall be disseminated. However, where the employer has the right to protect the invented and technical secrets, the employee has a right to strive for progress and to earn his livelihood. 

Article 19(1) (g) of the Constitution of India gives every citizen the right to practice any profession, trade or business. This right is not absolute nature but reasonable restrictions are been imposed. The use of restrictive covenants such as Non- competition agreement, Non- solicitation agreement and Non- disclosure agreements by the employers for protecting interest of their business. 

Judicial precedents have, however, made benchmarks for the protection of rights of an employee seeking employment. The numerous precedents have, in light of the constitutional and statutory provisions under the Indian Contract Act, 1872, held that the right to livelihood should be given more importance than any provisions under Contract Law. 

A restrictive covenant restrains an employee to profess a certain profession after the termination of his employment. It is a clause forming a part of the contractual agreement of employment between an employee and employer.

What are employment contracts? 

An employment contract is all the rights, responsibilities, duties and employment conditions that make up the legal relationship between an employer and employee. It includes a number of terms which, whether written down or not, are legally binding – the employer’s duty to pay the employee wages, for example. 

Therefore, an employment contract is a bilateral agreement for an agreed duration for the exchange of service and remuneration. 

In general, there are three types of employment contracts: 

  • Permanent employment contracts 
  • Fixed term contracts 
  • Casual employment contracts

Why do we need employment contracts? 

The law does not mandate employers to have employment contracts, however, it is always advantageous to define the terms of employment to avoid any further complications. 

  • It avoids misunderstanding 
  • It makes working of the business easy. 
  • With defined terms, it simplifies the relationship of both the parties. 
  • It reduces the chances of disputes between employer and employees.

What are restrictive covenants? 

A restrictive covenant is typically a clause in a contract which prohibits an employee from competing with his ex-employer for a certain period after the employee has left the business, or prevents the ex-employee from soliciting or dealing with customers of the business by using knowledge of those customers gained during his prior employment. 

For example: Every business has certain kind of information which are vital for its functioning. Restricting the use or transfer of this information by employees after their employment is vital to the protection of your business or customer contacts. An ex-employee who has knowledge of your technology, strategic information or customers or clients may be an important asset to a competitor seeking to poach your market.

There are certain terms which are defined into employees’ contracts which may provide safeguard for employers whilst the employee’s employment continues. 

The effect of the provision eliminates the possibility of the employee to do unauthorised use of the business secrets, trade connections or confidential information in a competing business after he has terminated his employment. 

Apart from the regular employment agreements, such covenants are also at times included in the agreements like 

  • sale of goodwill of business or professional practice, 
  • franchise agreements, 
  • partnership agreements, 
  • employment exit agreements and 
  • other exclusive dealings and service arrangements

Types of restrictive or negative covenants in the contract: 

  1. Non – competent clause 
  2. Non soliciting clause 
  3. Non- disclosure clause vis a vis IPR (confidential information and trade secrets ) 
  4. Return of property 
  5. Non poaching clause

Non – Competent Clause: 

The clause is inserted in order to protect the trade secrets, expertise and knowledge of the employers. The clause states that the employees are not allowed to indulge in same profession as that of the employer or perform any similar duties performed by him at his current employment. 

This clause acts as a shield for the employers, safeguarding him from any unauthorised disclosure of his trade or business secrets to his competitors leading to any intellectual loss in his business. 

At the legal standpoint, this clause violates the rights of the people to practice any profession for betterment of their livelihood, but stating exception to this right, the court as well as the law of land considers this clause to be valid in order to protect the interest of the employer. 

In the case of IEC School of Art & Fashion Vs.Mr. Gursharan Goyal and Others1, the court has laid down various categories in relation to non-competent clause: 

  • Goodwill; 
  • competitive business during the term of contract, franchise/collaboration agreement in a specified area during the period of contract; 
  • the partnership agreements providing for restraint of trade after dissolution of the partnership; 
  • Restrictions put on employees joining during the course of employment in another business; restraint of using information acquired during employment, after employment etc. 

Applicability of this clause: 

This clause can be inserted in any 

  1. employment contract 
  2. franchise agreement
  3. Trade agreements 

The court in the case of Gujarat Bottling Co. Ltd. and others v. Coca Cola and ors held that any agreement containing clause restricting the parties to carry out any similar trade practices forming part of the business, will not amount to restrain to trade and such clause is valid to protect the interest of the business.

Non – soliciting clause 

According to this clause, restrictions are imposed upon the employees- whether existing or former from indulging with employees or customers of other business, which might harm the interest of the company or business, he is or was employed. 

In simple terms, the employees are restrained from indulging themselves with any other employee or customer of other companies with similar business in a way that it might have negative impact on the growth and prosperity of the current business. 

Now, the difference between non competent and non-soliciting clause is that , former clause restricts the employees in practicing the same business as that of the existing employment while the latter restricts him from indulging with employees or customers other business in order to safeguard the interest of the current employer. 

The Delhi High Court, in the Wipro case2 , held that “the non-solicitation clause does not amount to a restraint of trade, business or profession and would not be hit by Section 27 of the Indian Contract Act, 1872 as being void“.

Non- disclosure clause: 

This clause is the most popular clause in any trade agreements. As the name states, non-disclosure clause refrains the employees from disclosing any information pertaining to trade or business secrets, business connections or trade related practices whether he is or not part of the employment. 

Not only this clause restricts the employees from sharing their business related information to outsiders but also bind them to keep the information’s related to the customers confidential. This clause comes with an exception that, if demanded by any provision of law, under certain circumstances, the employees can disclose the information to the concerned authorities. 

With respect to protection of intellectual property rights of the owner of the business, it is essential to define the boundaries of the employees very clearly in the employment contract.

Return of the property: 

Every employees is entrusted with some kind of role and responsibility in the business, for which it has to use the resources- both information and documents, of the business to perform his duty. The return of property clause implies that upon termination of employment, the employee has to return the property back to the company. 

This implies that the employees have to return all the property, in any form whatsoever and its respective copies stored in any form upon 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.

Non – Poaching clause: 

Poaching refers to hiring of employees- current or former by the competitor or similar business. Employers invest lot of time and energy in training their employees in order to have optimum growth in their business. Such poaching practices might lead to immense loss to the employers. Although such clause is in violation with antitrust laws, however, they are considered essential in normal run of business. 

They specifically do not form a part of agreement under section 27 but, to protect the interest of the employers and business, such clauses are introduced in the employment contacts. 

This particular clause can be enforced between: 

  1. The competing firms, and , or 
  2. Employer and employees 

Thus, it is important that such clauses are clearly given n the employment contracts and made sure that the employees clearly understand the follow the covenants.

Remedies for breach of clauses: 

If an employer has reason to believe that an employee has breached the post- termination restriction, the most common remedy sought is an injunction.

Guidelines followed by court to grant injunction are: 

  1. It is a discretionary power of the court to grant injunction. 
  1. The negative covenants should be reasonable and not harsh
    1. It should protect the interest of parties and public4. 

non-compete restriction on him to prohibiting him from carrying out a profession or trade of a similar nature, holds no ground. 

The court exclaimed that the protection of right to livelihood must prevail over any other cause in Desiccant Rotors International Pvt. Ltd. vs. Bappaditya Sarkar and Anr. The view of the employer was also duly considered and the court observed that the employers, by executing a restrictive covenant or a negative stipulation in the contracts of employment, only seek to protect their private and confidential information and the secrets of their own trade. Where there is a clash between the two, and the negative stipulation is hampering the right of livelihood of an individual, the latter shall unquestionably prevail.

Section 27 of the INDIAN CONTRACT ACT, 1872: 

Section 27 of the Contract Act, is the governing principle of such agreements and has been evaluated to determine that which restriction would amount to be reasonable in law. 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. 

Exception: Saving of agreement not to carry on business of which goodwill is sold.-One who sells the goodwill of a business may agree with the buyer to refrain from carrying on a similar business, within specified local limits, so long as the buyer, or any person deriving title to the goodwill from him, carries on a like business therein, provided that such limits appear to the Court reasonable, regard being had to the nature of the business 

For example, if an employer makes an agreement with the employee that, during the term of his employment, he is has to be with the company for say, a period of 3 years and during the term, he is not supposed to work with anyone else in the similar business line, then the question arises whether such clause is hit by section 27 of Indian contract act, 1872? 

To answer this, let’s divide the part into two sections: 

First part: “during the term of his employment, he is has to be with the company 

for say, a period of 3 years” 

under this part, employer imposes a condition that he has to work with the company for three years – this part is a positive covenant and it cannot be enforced by law. So, if the employee breaches the term then no legal implications can be made against the employee. 

Moving on to second part: “during the term, he is not supposed to work with 

anyone else in the similar business line”

Now this is called a negative covenant where the employee is restricted to not to work with anyone during his term of employment. So, in case of any breach, legal actions can be taken subject to discretion of court and limitation under the Act. 

The contracts with respect to “Restraint to trade” are particularly null and void. As far as covenants to restraint to trade are concerned pertaining to employment contracts, certain things has to be considered: 

  1. Such contracts to restraint to trade are particularly null and void. 
  2. Onus of proof is upon the employer to prove that such clauses do not come under the ambit of section 27. 
  3. The employer has to prove that the covenants are to protect the interest of the business 
  4. The employer also has to prove that these restrictions are not injurious to public.6 

Upon proving the reasonableness of the covenants, the Court will still has the discretion to decide upon it as a matter of law based on facts and circumstances of each case. 

However, there are various judicial pronouncements which state that restrictions by employer upon employee to not to engage in any another business is not hit by section 27 and therefore cannot be classified as restraint to trade. 

A point to be noted here is that: 

“Restrictive covenants imposed during the term of employment is valid but contrary is not. 7 

This implies that any covenant imposed on employee restrictive in nature beyond the term of employment is null and void and not enforceable.

Judicial trends: 

INDIAN JUDICIARY HAS TIME AND AGAIN GIVEN JUDGEMENTS IN THE CASE OF NEGATIVE COVENANTS AND THE JUDGEMENST HAVE SET A BENCHMARK IN THE EMPLOYMENT CONTRACTS. 

The Supreme Court gave its view in the case of Niranjan Shankar Golikari v. The Century Spinning and Manufacturing Company Ltd8 that negative covenants can hold validity if the restriction imposed on them is reasonable. The court exclaimed that “if a negative covenant restricts the employee fromengaging in a particular trade or business where he is required to perform same functions is not a restraint of trade ab-initio, unless the contract as aforesaid is unconscionable or excessively harsh or unreasonable or one sided. Thus, a restrictive covenant can be enforced only when the restrictions are reasonable and the clauses are consistent with the public policy” 

  1. In the case of Wipro Limited vs. Beckman Coulter International S.A, the court held that employer is always in a dominant position therefore, in contract, parties have to be in equal footing, which is not in the case of employer- employee agreement. 
  2. It was reiterated in Ambiance India Pvt. Ltd.Vs.Shri Naveen Jain,9 that everybody has the right to strive for progress and career, thus, any restrictions imposed by the employer are void and unconscionable. A trade secret and the confidential information which the employee has acquired in the course of his employment require protection and should not reach other competitors to safeguard the interest of the employer. 
  3. In the case of M/s Vogueserv International Pvt. Ltd. vs. RaajeshGosain&Ors10, when the employee cannot prove that the information is not easily available in the public domain, the benefit of Section 27 shall not be granted. The ownership of all rights, titles and interest of the intellectual propriety rights were to vest in the employer and in breach thereof the employer was to take recourse of legal remedies. 
  4. In LE Passage to India Tours & Travels11the court held that it is evident that a contract of employment which debars an employee by restraining him to carry on an employment, after the term of employment, is not protected under Section 27 of the Contract Act. 
  5. It was held in Pepsi Foods Ltd. and Ors Vs. Bharat Coca-Cola Holdings Pvt. Ltd. & others12 it is well settled that such post termination restraint, under Indian Law, is in violation of Section27 of the Contract Act. Such contracts are unenforceable, void and against the public policy. What is prohibited by law cannot be permitted by Court’s injunction.

Practical tips while drafting such covenants: 

For a restrictive covenant to be enforced it must not be drafted too widely.

It will be for the employer, in the event of a clause being challenged, to show that the clause is justified and sufficiently narrow. 

To meet these criteria an employer must be mindful of certain factors: 

  • The breadth of the geographical area of any restriction and the length of time of the post termination restriction must be justified. It is unlikely that a wide geographical area will be justified and, as a general rule, a restriction for more than 6-12 months will be difficult to justify. 
  • The breadth of the activities that the employer is trying to restrict. 
  • The type of interest being protected, for instance, information such as trade secrets may be granted wider protection than customer information, given that its potential use across markets is wider. 
  1. The extent of clauses, therefore, must be relative to the employee’s position within the business. 
  2. Restrictive covenants may also require periodic review in order to maintain their enforceability as the reasonableness of the covenant is judged at the time it was entered into. 
  3. Employers should consider what they want to achieve and the commercial implications of taking a particular stance in relation to publicity, client relationships, management time and cost.
     

Conclusion: 

Restrictive covenant clauses can be enforced if the restrictions imposed are reasonable and not harsh. It should also strike a good balance between the rights of the employer as well as that of the employee considering the dominant position of employer over the employee. 

Therefore, the employers have to be quite vigilant while drafting these clauses and make sure that rights of the employees are considered. Also, it is well settled after discussion that positive covenants cannot be enforced under law while negative can be subject to limitations. In case of dilemma between, right to livelihood and negative covenants, right to livelihood will be give higher priority.

Legal Disclaimer: The information contained in this blog post is for general information and educational purposes only. Nothing contained in this blog post should be construed as legal advice from The Aran Law Firm or the individual author, nor is it intended to be a substitute for legal counsel on any subject matter.

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