Enforceability of Non-compete Clauses in India

Introduction

In June 2007, tech giant Infosys Ltd. introduced non-compete agreements for its employees¹. The clause, which was subsequently made part of the employment agreements, required that post termination of an employee, such employee agrees to not accept any offer of employment from: (i) any Infosys customer (from the last 12 months); and (ii) a named competitor of Infosys (including TCS, Wipro, Accenture, Cognizant and IBM) if the employment would require work with an Infosys customer (from the last 12 months), for a period of 6 months.

Following an increased attrition rate in Q4 of Financial Year 2022, the company began to implement this clause², leading to the Nascent Information Technology Employees Senate (NITES), an IT workers union based out of Pune, filing a complaint with the Union Labour Ministry in April 2022³. Deeming the application of the clause post exit of an employee from Infosys to be “illegal, unethical and arbitrary”, NITES demanded the removal of such clauses from the employment agreement. Defending the clause, Infosys issued a statement claiming that the non-compete clause was a “standard business practice in many parts of the world for employment contracts”, to include “controls of reasonable scope and duration” to protect the “confidentiality of information, customer connection and other legitimate business interests”⁴. 

While there is limited public information available on the outcome of the discussions between NITES, Infosys and the competent labor authorities, this throws light on an issue that has been the subject of legal discourse in India time and again: enforceability of non-compete contracts.

In this piece, we break down what non-compete is; the legal framework governing such contractual provisions; and practical considerations for employers and employees, to facilitate informed decision making at all levels. 

What is a Non-compete Clause?

Non-compete clauses are a contractual provision whereby a person exiting a business typically agrees to not start a new business, take up employment in or otherwise engage in any manner with a competing entity. Also termed as “negative covenants”, these clauses impose a contractual obligation on the person to not undertake certain activities. Consequently, failure to abide by these contractual restrictions would result in a breach of the contract: 

• Duration: Non-compete clauses can be for the duration of the employment relationship but also are typically contemplated for a specific period post termination, i.e., post exit of the individual from the business. 
• Limitations to Restrictions: These contractual restrictions are usually limited by geographical location or for a fixed period of time having the effect that the said person would be in breach of the non-compete agreement if they were to start a new business/engage with a competing entity within the same geographical area and within such time period.
• Who is Restricted: These clauses are typically built into employment agreements (particularly of founders and key managerial personnel) where access to confidential and proprietary information pertaining to a business (including with respect to intellectual property) is to be considered; if such information is used by the departing employee/founder/key employee, the likelihood of an unfair business advantage is increased.
• M&A perspective: Non-compete clauses are also seen in transaction documents executed in mergers and acquisitions, where the value of the investment can be impacted if exiting founders/key employees start or join a competing business, leading to loss of competitive advantage to the acquirer.

Can non-compete contracts be enforced in India?

Once a breach of contract is determined, the parties to such contract would have the appropriate remedial measures built in, which can typically include compensation for any loss suffered as a result of the breach. However, in order to be able to enforce such remedial measures, it is critical for the underlying contractual obligation itself to be enforceable. It is against this backdrop that the provisions of the Indian Contract Act, 1872 (“ICA”) become relevant. Section 27 of the ICA stipulates that any agreement in restraint of trade is void. In other words, any agreement that restricts a person from exercising a lawful profession, trade or business of any kind is to that extent void⁵. Stemming from the fundamental right to practice any profession or occupation protected by Article 19(1)(g) of the Constitution of India, the intent 

behind Section 27 of the ICA is to guard against any interference with freedom of trade even if it results in interference with freedom of contract. 

However it is important to note that even within the Constitution, the freedoms protected by the fundamental rights are not absolute and can be limited within specified circumstances. Historically, the Supreme Court of India and various high courts across the country have consistently adopted the following approach towards enforceability of such negative covenants: 

• Reasonableness: The enforceability will be limited to the extent that such a negative covenant is reasonable⁶; and
• Legitimacy: The purpose of the negative covenant is to protect the legitimate business interests of the buyer. The restraint cannot be greater than necessary to protect the interest concerned⁷. 

In light of the above, the Indian courts have adopted the approach that these restrictions during the period of employment are valid, as they can be considered legitimate for the protection of the business interests of the company. Against this reasoning, Section 27 would not be violated⁸. However, such obligations cannot be unconscionable, excessively harsh, unreasonable or one-sided, i.e., satisfying the requirement of reasonableness and legitimacy..

The controversy associated with such negative covenants arises when they are sought to be enforced beyond the period of employment. In a high profile ruling, the Supreme Court held that a media management company’s non-compete clause that prevented a prominent Indian cricketer from joining their competitor for a specific period of time after their agreement had terminated, could not be enforced⁹. The principle that enforcement of non-compete beyond the period of employment is void under Section 27 has been well-settled¹⁰. In a pattern followed by high courts across the country, post-termination non-compete clauses have generally not been enforced on the rationale that the right to livelihood of a person must prevail over the interests of an employer¹¹.

However, this is not to say that all non-compete clauses are automatically unenforceable. For instance, the Delhi High Court held that while employees who had already accepted the offer of employment with the competitor could not be injuncted against (as the same would read a negative covenant into their employment contracts which would violate Section 27), an injunction against future solicitation could be granted on the grounds it was a legitimate and reasonable restriction¹².

Given the uncertainty over enforcement of non-compete clauses, employers have adopted a novel approach of inserting a “garden leave” clause, during which the employee is fully paid their salary for the period in which they are restricted by such negative covenants. While such a concept has been held by the Bombay High Court to be a prima facie restraint of trade affected by Section 27¹³, it is a popular solution practiced widely by employers. Additionally, restrictions on non-disclosure of confidential information and non-solicitation of customers and employees have been previously enforced¹⁴. Non-compete obligations are also often found in mergers and acquisitions transactions, with the courts permitting such restrictions on the basis of specified local limits that are reasonable to the court, having regard to the nature of business/industry concerned¹⁵. 

Practical Considerations

Despite the trend of non-enforceability of non-compete contracts, such negative covenants are commonly found in employment and M&A contracts. These restrictions are still seen as soft deterrents, with employees preferring to comply rather than bear litigation costs and the burden of being sued by a former employer¹⁶. Here are some practical considerations for employers and employees when considering a non-compete contract: 

• Legitimacy: Employers should carefully consider whether the non-compete restriction is necessary to protect business interests. It would be prudent for employers to undertake a reasonable calculation of quantifiable harm and risk from such a breach and inform the employees of the same. 
• Reasonableness: The clause should consider: (i) the duration of restriction and geographical scope; (ii) nature of the employees position and exposure to trade secrets, proprietary information, etc.; (iii) availability of alternative employment; and (iv) compensation in terms of salary, etc. for the duration of restriction.  
• Review Impact: It is critical that employees are made fully aware of the extent to which such negative covenants are applicable and the legitimacy and reasonableness of the same arising from the impact of the employee’s departure from the organization.  

Conclusion

Non-compete clauses continue to face enforceability challenges, with the most recent example being Wipro’s lawsuit against its former CFO for violating the restriction in his employment contract and joining Cognizant as a competitor in December 2023¹⁷. India’s judicial approach to enforceability of post-termination non-compete clauses is clear: if it is not permissible within the scope of Section 27, it would not be enforceable. This differs from jurisdictions such as the United Kingdom, where post-termination restrictions that are designed to protect a proprietary interest of an employer or buyer are enforceable provided there is a material risk and the restriction is itself reasonable, are enforceable; and the United States, where the US Federal Trade Commission recently banned non-compete clauses for US workers¹⁸. The clear conclusion is that a uniform approach to enforcement of negative covenants cannot be adopted.  

Frequently Asked Questions (FAQ) on Non-Compete Clauses

1. What is a non-compete clause?

A non-compete clause is a contractual restriction that prevents an employee from joining a competitor or starting a competing business after leaving a company. It may include specific limitations on time, geographic location, and types of activities.

2. Are non-compete clauses legally enforceable in India?

In India, enforceability of non-compete clauses is limited. Section 27 of the Indian Contract Act deems any restraint of trade to be void. While certain in-employment restrictions may be valid, post-employment restrictions are generally not enforceable, as they can interfere with an individual’s right to livelihood.

3. Why do companies use non-compete clauses if they are often unenforceable?

Despite legal limitations, companies may still include non-compete clauses to act as deterrents. Many employees prefer to comply rather than face potential legal disputes.

4. What are some exceptions where non-compete clauses may be enforceable?

Non-compete clauses may be enforceable if they are reasonable in scope and necessary to protect legitimate business interests, such as confidential information or trade secrets. Courts may uphold them if they are limited to the duration of employment or for protecting specific business interests.

5. How does India’s approach compare with other countries?

India’s approach to non-compete clauses is more restrictive compared to countries like the UK, where reasonable post-termination restrictions are often enforceable if they protect a legitimate proprietary interest. In the US, non-compete laws vary by state, and recently, the Federal Trade Commission proposed a ban on non-competes for American workers.

6. What is a “garden leave” clause, and how does it relate to non-compete agreements?

A garden leave clause allows employees to remain on payroll after they resign or are terminated, but restricts them from joining competitors during this period. Although some Indian courts view it as a restraint of trade, it’s a popular alternative to non-compete clauses.

7. Can non-compete clauses be included in M&A agreements?

Yes, non-compete clauses are common in mergers and acquisitions (M&A) to protect the buyer’s investment and maintain competitive advantage. Courts may allow such clauses if they are reasonable and necessary for the protection of business interests.

8. What are the practical considerations for employees facing a non-compete clause?

Employees should assess the reasonableness and impact of any non-compete clause, including its duration, scope, and potential limitations on future employment opportunities.

9. What options do employees have if they disagree with a non-compete clause?

Employees may negotiate the terms before signing or, if already in effect, seek legal advice to understand the likelihood of enforceability based on Indian law and precedent cases.

1. [1] https://economictimes.indiatimes.com/news/company/corporate-trends/infy-asks-staffs-to-sign-pact-against-joining-rivals/articleshow/2101866.cms?from=mdr ↩︎
2. [2] https://www.businesstoday.in/latest/corporate/story/infosys-served-notice-by-union-labour-ministry-over-its-non-compete-clause-in-employee-contract-331508-2022-04-27 ↩︎
3. [3] https://nites.co.in/nites-submits-complaint-against-infosys-illegal-non-compete-agreement-to-labour-ministry/#:~:text=The%20employee’s%20covenants%20should%20be,clause%20from%20the%20employment%20agreements. ↩︎
4. [4]  ibid, 2 above. ↩︎
5. [5] The Indian Contract Act, 1872 exempts such restraint of trade contracts for transactions where the goodwill of a business is sold. ↩︎
6. [6] As laid down by the Supreme Court in Niranjan Shankar Golikari v Century Spinning and Mfg. Co. (1967) 2 SCR 378. ↩︎
7. [7] As laid down by the Supreme Court in Gujarat Bottling Co Ltd v The Coca Cola Co & Ors. (1995) SCC (5) 545. ↩︎
8. [8] As laid down by the Supreme Court in Niranjan Shankar Golikari v Century Spinning and Mfg. Co. (1967) 2 SCR 378. ↩︎
9. [9] As laid down by the Supreme Court in Percept D’Mark (India) Pvt. Ltd. v Zaheer Khan and Ors. Appeal (Civil) 5573-5574 of 2004. ↩︎
10. [10] As laid down by the Supreme Court in Superintendence Company of India (P) Ltd. v Krishan Murgai 1981 2 SCC 246. ↩︎
11. [11] Trend observed in rulings of: (i) Bombay High Court in VFS Global Services Pvt. Ltd. v Mr. Suprit Roy 2008 (3) MhLj 266; and (ii) Delhi High Court in Affle Holdings Pte. Ltd. v Saurabh Singh 2015 SCC OnLine Del 6765, and Wipro Limited v Beckman Coulter International S.A. 2006 (3) ARBLR 118 (Delhi). ↩︎
12. [12] As laid down by the Delhi High Court in Wipro Limited v Beckman Coulter International S.A. 2006 (3) ARBLR 118 (Delhi). ↩︎
13. [13] In VFS Global Services Private Limited v Mr. Suprit Roy 2008 (3) MhLj 266, the Bombay High Court reasoned that the payment of salary during garden leave does not renew the contract of employment and therefore amounted to a prima facie restraint of trade. ↩︎
14. [14] As held by: (i) Madras High Court in E-merge Tech Global Services Private Limited v M. R. Vindhyasagar and Ors. C.S. No. 258 of 2020; and (ii) Bombay High Court in Zee Telefilms Limited v Sundial Communications Private Limited 2003 (5) BOM CR 404. ↩︎
15. [15] As held by the Delhi High Court in Ozone Spa Pvt. Ltd. v Pure Fitness & Ors. 2015 222 DLT 372. ↩︎
16. [16] https://economictimes.indiatimes.com/jobs/c-suite/non-compete-clauses-unenforceable-under-law-but-companies-love-them/articleshow/109633571.cms?from=mdr ↩︎
17. [17] https://economictimes.indiatimes.com/jobs/c-suite/non-compete-clauses-unenforceable-under-law-but-companies-love-them/articleshow/109633571.cms?from=mdr ↩︎
18. [18] https://www.ftc.gov/system/files/ftc_gov/pdf/noncompete-rule.pdf ↩︎