What Are Restrictive Covenants and What Do They Mean in The Context of Your Contracts?

Introduction

Advancements in technology and the expansion of global markets have introduced more intricate challenges, necessitating the businesses take steps to safeguard their rightful interests. To maintain and secure assets like confidential data, unique concepts, and trade secrets, parties entering into contracts frequently find it necessary to incorporate restrictive clauses, which limit the freedom of the other party to utilize confidential information or engage in a particular profession, trade, or business with other parties.

However, it is pertinent to note that these are often a subject of debate since these covenants contradict Section 27 of the Indian Contract Act, 1872 (ICA), which sets out that any agreement restraining someone from engaging in a legal profession, trade, or business is void to that extent. Since the legal framework addressing these conflicts is still in its early stages in India, judicial rulings and established legal principles have been crucial in shaping a jurisprudence that balances the competing interests and rights inherent in restrictive covenants and the provisions of Section 27 of the Indian Contract Act, 1872.

Nevertheless, conflicting interpretations continue to arise, making it necessary to thoroughly review the developments and validity of restrictive covenants in light of Section 27 of the Act.

 

What are restrictive covenants?

Restrictive covenants typically form a part of most agreements and aims to prevent employees from sharing confidential or valuable information which they gain access to during the term of their employment, a restrictive covenant is a provision that restricts an employee from seeking new employment for a specified period after leaving a company or organization. Notable examples of such restrictive clauses include contracts related to maintaining confidentiality, refraining from disclosing sensitive information, and avoiding solicitation of former colleagues or clients.

Restrictive covenants in employment agreements are contractual obligations placed on employees prohibiting them from engaging in certain actions/activities. The most common kinds of restrictive covenants in the employment context are:

• Exclusivity Clauses: These obligations are coterminous with employment and prohibit employees from taking up any other employment or engagements without the express permission of the employer.
• Non-Compete Clauses: Employers use these clauses to bar employees during and post-termination from taking up employment or engagements with competitors or from conducting business that would compete with the employer.
• Non-Solicit Clauses: These clauses typically restrict an employee from soliciting the employer’s and clients post cessation of the employee’s employment with the organization.
• Confidentiality Clauses: These clauses protect trade secrets or other proprietary information from unauthorized disclosure by an employee during and after employment. A confidentiality clause usually defines what information should be considered confidential, the temporal and geographical scope of the obligation, and related rights and consequences for breach of the obligation.

Types of Restrictive Covenants

Points to Remember

1. Is it lawful for the employers to use restrictive covenants beyond the termination of the employment of the employee?
   No. Any agreement which restrains a person from exercising a lawful profession, trade or business of any kind is, to that extent, void under the Indian Contract Act, 1872. The only statutory exception to this rule applies to agreements involving the sale of goodwill, wherein the seller and the buyer may agree to certain reasonable restrictions on carrying out a similar trade or business within a certain geographic area.
   In interpreting this provision, Indian courts have consistently held that while restrictive covenants operating during the term of the employment contract are valid, any clauses restricting an employee’s activities post-employment would be in restraint of trade
2. How to ensure that the Restrictive Covenants are not in contradiction to Section 27 of the Act?
   It is advisable that restrictive covenants are drafted narrowly to ensure their enforceability. However, even if restrictions are drafted broadly, the courts ordinarily use the principle of severability to invalidate the restrictions only to the extent that they are excessively broad. The courts can do this whether or not the contract contains a severability clause, although it is advisable to include such a clause in the interests of clarity. An excessively broad restriction may not render the covenant unenforceable in its entirety. For example, it is common for contracts to include restrictive covenants protecting the business of group companies, but the courts will enforce such a clause only to the extent that the employer can demonstrate a reasonable nexus between its business and that of the company concerned.
3. If an employee is dismissed or the employee resigns in response to a repudiatory breach, will the employee be still bound by any restrictive covenants?
   The restrictive covenants of non-solicitation, confidentiality and misrepresentation would survive a repudiatory breach or wrongful dismissal and would continue to be enforceable.