Restrictive covenants in Indian employment contracts

Section 27 provides that every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind is void to that extent. Exception 1 allows a person who sells the goodwill of a business to agree with the buyer to refrain from carrying on a similar business within specified local limits, while the buyer or a person deriving title from the buyer carries on a like business, provided the limits appear reasonable to the court.

The section does not contain a general reasonableness test for employment restraints. Indian courts have applied the words as they stand, rather than importing the English practice of upholding a restraint that is reasonable and limited. The sale-of-goodwill exception is the statutory exception, and it applies to a seller of goodwill, not to an employee.

Whether a clause is a restraint on trade is a question of substance. A clause that prevents an employee from working for a competitor, soliciting customers or accepting business after leaving employment is the usual target. A confidentiality clause is analysed differently because it protects information rather than preventing the employee from earning a living, but the line between the two is not always clear.

Niranjan Shankar Golikari v. Century Spinning and Mfg. Co. Ltd. concerned a negative covenant that operated during the period of employment. The Supreme Court held that a negative covenant operative during the period when the employee is bound to serve the employer exclusively is not to be regarded as a restraint of trade and does not fall within Section 27.

The Court added that even during employment, a negative covenant is not enforced if it is unconscionable, excessively harsh, unreasonable or one-sided. In that case the injunction was upheld because the restriction was limited as to time, the nature of the employment and the area.

Gujarat Bottling Co. Ltd. v. Coca Cola Co. applied the same distinction. A negative stipulation confined to the subsistence of the agreement, including a one-year notice period, was held not to be in restraint of trade so as to attract Section 27. The Court left open the treatment of a wholly one-sided contract, which is the qualification an employer should keep in mind when drafting a long notice period with no reciprocal protection.

Superintendence Company of India (P) Ltd. v. Krishan Murgai drew a clear distinction between a restriction during employment and one after termination. A clause that restrained the employee after the service ended was held to be in restraint of trade and illegal under Section 27. The Court declined to apply the English doctrine of reasonableness because the Indian statute governs the question.

Percept D'Mark (India) Pvt. Ltd. v. Zaheer Khan reaffirmed that a restrictive covenant extending beyond the term of the contract is void and not enforceable. The Court held that neither the test of reasonableness nor the principle that a partial restraint may be valid applies under Section 27. A right of first refusal in that case was held to be hit by Section 27 and void.

The practical result is that a post-employment non-compete is treated as void in India, however narrow the geography or the duration. A clause that applies for six months to one city is not saved by its moderation. An employer who wants protection after the employment ends has to look to obligations that are not restraints of trade, or to the sale-of-goodwill exception where it genuinely applies.

A non-solicitation clause can take several forms. It may stop a former employee from soliciting customers, from dealing with customers, from recruiting former colleagues, or from accepting business from clients. The wider the clause, the closer it comes to a restraint on the employee's trade, and the more likely it is to be tested under Section 27.

A clause that prevents a former employee from dealing with any customer, or from working in the same industry, is difficult to distinguish from a non-compete. A clause limited to clients the employee actually served, for a short period, is narrower, but the Act does not create a safe harbour. The authorities above read Section 27 strictly, and a court will look at what the clause does in practice.

Confidentiality is a separate obligation. An employer can protect trade secrets, customer data and internal documents through a confidentiality clause, and a court may restrain the misuse of information in an appropriate case. The confidentiality clause should define the information, the permitted use and the return or deletion of material at the end of employment. It should not be used as a substitute for a non-compete.

The usual remedy sought against a departing employee is an injunction. Section 36 of the Specific Relief Act, 1963 makes preventive relief discretionary, and Section 38 allows a perpetual injunction to prevent the breach of an obligation. Section 41(e) prohibits an injunction to prevent the breach of a contract the performance of which would not be specifically enforced.

Section 14(1) lists contracts that cannot be specifically enforced, including a contract that depends on the personal qualifications or volition of the parties, and a contract whose performance involves a continuous duty the court cannot supervise. Section 42 preserves the court's power to grant an injunction to perform a negative agreement where a contract contains an affirmative promise coupled with a negative one, provided the plaintiff has performed the contract so far as it is binding.

Percept D'Mark shows how these provisions interact. The Court refused an injunction that would have compelled the performance of a personal, confidential and fiduciary service contract, because specific performance was not available and Section 41(e) barred the injunction. Golikari and Gujarat Bottling show the other side: an injunction can be granted where the negative covenant operates during employment and is properly limited. The timing and scope of the clause therefore decide the application.

Draft the restriction around the period it is meant to cover. A covenant that operates during employment should describe the employee's duties, the exclusive service obligation and the legitimate interest the employer is protecting. A covenant that is meant to operate after employment should be reviewed against Section 27 before it is included, because a broad non-compete is unlikely to be enforced.

Separate the clauses. A confidentiality clause, a non-solicitation clause, a notice-period clause and a non-compete clause protect different interests and should not be bundled into one paragraph. If one clause is challenged, the others should still be identifiable. Each clause should state its scope, duration, geography and the interest it protects.

Consider what the employer actually needs. If the concern is customer relationships, a carefully limited non-solicitation clause may address it. If the concern is confidential information, a confidentiality and return-of-material clause is the direct tool. If the concern is competition during the notice period, a garden leave or notice-period clause may be used, but it should be drafted as part of the employment relationship and not as a disguised post-termination non-compete.

The sale-of-goodwill exception should not be stretched. It applies where the goodwill of a business is sold, and the restraint must be within specified local limits that the court considers reasonable. An employment agreement that recites a sale of goodwill without a genuine sale is unlikely to bring the clause within the exception.

The first problem is a clause that is wider than the interest it protects. A restriction on working for any competitor, anywhere, for two years is the standard example. It is also the clause most likely to be void after employment ends.

The second problem is relying on English cases that uphold reasonable restraints. Indian courts have declined to apply that approach because Section 27 is statutory. A draft that assumes a reasonableness review will not match the Indian position.

The third problem is treating a non-solicitation clause as automatically enforceable. A clause that stops a former employee from dealing with customers can operate as a restraint of trade. The clause should be limited to the relationships the employee actually handled and to a period tied to the employer's legitimate interest.

The fourth problem is the absence of a record. An employer that seeks an injunction should be able to show the clause, the employee's role, the access to confidential information, the notice given and the steps taken to protect the information. A well-drafted agreement is the starting point, not the whole case.