Non compete

Sri LakshmiSri Lakshmi

AttorneyAttorney

Altacit GlobalAltacit Global

Non-Compete AgreementNon-Compete Agreement

1

DefinitionDefinition

A non-compete clause or covenant not to A non-compete clause or covenant not to compete (CNC), is a term used in compete (CNC), is a term used in contract/agreements under which one contract/agreements under which one party agrees to not pursue a similar party agrees to not pursue a similar business/profession/trade in competition business/profession/trade in competition against another party.against another party.

2

HistoryHistory As far back as 1415, English common law had already been As far back as 1415, English common law had already been

"old and settled" that restraint on trade was "old and settled" that restraint on trade was unenforceable. The same remained unchanged until 1621, unenforceable. The same remained unchanged until 1621, when a restriction that was limited to a specific geographic when a restriction that was limited to a specific geographic location was found to be an enforceable exception to the location was found to be an enforceable exception to the previously-absolute rule. Almost a hundred years later, the previously-absolute rule. Almost a hundred years later, the exception became the rule with the 1711 watershed case exception became the rule with the 1711 watershed case of Mitchell v/s Reynolds which established the modern of Mitchell v/s Reynolds which established the modern framework for the analysis of the enforceability of non-framework for the analysis of the enforceability of non-compete agreements.compete agreements.

3

Case LawCase Law

In Mitchell v. Reynolds (1711) Lord Smith L.C. said:In Mitchell v. Reynolds (1711) Lord Smith L.C. said:

"it is the privilege of a trader in a free country, in all "it is the privilege of a trader in a free country, in all matters not contrary to law, to regulate his own mode of matters not contrary to law, to regulate his own mode of carrying it on according to his own discretion and choice. If carrying it on according to his own discretion and choice. If the law has regulated or restrained his mode of doing this, the law has regulated or restrained his mode of doing this, the law must be obeyed. But no power short of the general the law must be obeyed. But no power short of the general law ought to restrain his free discretion."law ought to restrain his free discretion."

4

Common Law PerceptionCommon Law Perception

Restraint of trade is a common law doctrine relating to the Restraint of trade is a common law doctrine relating to the enforceability of contractual restrictions on freedom to enforceability of contractual restrictions on freedom to conduct business. The common law has evolved to reflect conduct business. The common law has evolved to reflect changing business conditions. The restraint of trade changing business conditions. The restraint of trade doctrine's current use is small, given modern and doctrine's current use is small, given modern and economically oriented statutes of competition law in most economically oriented statutes of competition law in most countries. Its approach was based on the two concepts of countries. Its approach was based on the two concepts of prohibiting agreements that ran counter to public policy, prohibiting agreements that ran counter to public policy, unless the reasonableness of an agreement could be unless the reasonableness of an agreement could be shown. A restraint of trade is simply some kind of agreed shown. A restraint of trade is simply some kind of agreed provision that is designed to restrain another's trade.provision that is designed to restrain another's trade.

5

Case StudyCase Study

In Nordenfelt v. Maxim, Nordenfelt Gun Co., a Swedish arm inventor promised on In Nordenfelt v. Maxim, Nordenfelt Gun Co., a Swedish arm inventor promised on sale of his business to an American gun maker that he "would not make guns or sale of his business to an American gun maker that he "would not make guns or ammunition anywhere in the world, and would not compete with Maxim in any ammunition anywhere in the world, and would not compete with Maxim in any way. way.

Lord Macnaghten ruled that while one could validly promise to "not make guns Lord Macnaghten ruled that while one could validly promise to "not make guns or ammunition anywhere in the world" it was an unreasonable restraint to "not or ammunition anywhere in the world" it was an unreasonable restraint to "not compete with Maxim in any way.“This approach in England was confirmed by the compete with Maxim in any way.“This approach in England was confirmed by the House of Lords in Mason v. The Provident Supply and Clothing Co, wherein House of Lords in Mason v. The Provident Supply and Clothing Co, wherein Mason was a salesman for a clothing company which had branches all over Mason was a salesman for a clothing company which had branches all over England. He agreed not to assist in a similar company for 3 years within a 25 mile England. He agreed not to assist in a similar company for 3 years within a 25 mile radius from London. It was decided the area was to much. The court noted radius from London. It was decided the area was to much. The court noted Mason had only a minor role in a small part of London and he had been working Mason had only a minor role in a small part of London and he had been working with a two week notice period. This was void. i.e. restrictions in area and time with a two week notice period. This was void. i.e. restrictions in area and time that must not be wider than is reasonably necessary for protection of the that must not be wider than is reasonably necessary for protection of the business.business.

6

Restraining WorkersRestraining Workers A business might abuse a non-compete covenant to A business might abuse a non-compete covenant to

prevent an employee from working elsewhere at all. Most prevent an employee from working elsewhere at all. Most jurisdictions in which such contracts have been examined jurisdictions in which such contracts have been examined by the courts have deemed CNCs to be legally binding so by the courts have deemed CNCs to be legally binding so long as the clause contains reasonable limitations as to the long as the clause contains reasonable limitations as to the geographical area and time period in which an employee of geographical area and time period in which an employee of a company may not compete. Courts have held that, as a a company may not compete. Courts have held that, as a matter of public policy, an individual cannot be barred matter of public policy, an individual cannot be barred from carrying out a trade in which (s)he has been trained from carrying out a trade in which (s)he has been trained except to the extent that is necessary to protect the except to the extent that is necessary to protect the employer.employer.

7

Indian Context - Restraint on TradeIndian Context - Restraint on Trade

Press Note 18 & Press Note 1Press Note 18 & Press Note 1 Press Note 18Press Note 18: Introduced in 1998 which banned all foreigners : Introduced in 1998 which banned all foreigners

with existing joint ventures (technology transfer/trade mark with existing joint ventures (technology transfer/trade mark agreement) in India from establishing new ones under the agreement) in India from establishing new ones under the 'automatic route' without a No Objection from their partner and in 'automatic route' without a No Objection from their partner and in its absence, a specific FIPB approval. its absence, a specific FIPB approval.

Press Note 1Press Note 1: Introduced in 2005 which replaced Press Note 18, : Introduced in 2005 which replaced Press Note 18, wherein a foreign entity has an existing joint venture or technology wherein a foreign entity has an existing joint venture or technology agreement, any further investment in the same field in India by agreement, any further investment in the same field in India by such foreign entity cannot be made under the automatic route, and such foreign entity cannot be made under the automatic route, and that the foreign partner would have to obtain approval of the that the foreign partner would have to obtain approval of the Foreign Investment Promotion Board (FIPB). The Parties may Foreign Investment Promotion Board (FIPB). The Parties may contractually safeguard their interests in JVs through provisions in contractually safeguard their interests in JVs through provisions in JV/collaboration agreements which tackle 'conflict of interest' JV/collaboration agreements which tackle 'conflict of interest' situations.situations.

8


Section 27 of the Indian Contract Act, 1872 (“IC Act”) stipulates that an Section 27 of the Indian Contract Act, 1872 (“IC Act”) stipulates that an agreement, which restrains anyone from carrying on a lawful profession, trade agreement, which restrains anyone from carrying on a lawful profession, trade or business, is void to that extent. The reasoning behind this section is that or business, is void to that extent. The reasoning behind this section is that agreements of restraint are unfair, as they impose an undue restriction on the agreements of restraint are unfair, as they impose an undue restriction on the personal freedom of a contracting party. personal freedom of a contracting party.

However, as an exception, if a party sells his goodwill to another he can agree However, as an exception, if a party sells his goodwill to another he can agree with the buyer that he will not carry on a similar business within the specified with the buyer that he will not carry on a similar business within the specified local limits. local limits.

Indian law is rigid and invalidates all restraints, whether general or partial. Indian law is rigid and invalidates all restraints, whether general or partial. Neither the test of reasonableness, nor that of partial restraints applies to a Neither the test of reasonableness, nor that of partial restraints applies to a case governed by Section 27 of the IC Act, unless the restraint falls within the case governed by Section 27 of the IC Act, unless the restraint falls within the exception of that section. Upon a literal construction, Section 27 of the IC Act exception of that section. Upon a literal construction, Section 27 of the IC Act invalidates all agreements that impose a total bar on the exercise of a lawful invalidates all agreements that impose a total bar on the exercise of a lawful business.business.

The question whether an agreement is void under Section 27 of the IC Act shall The question whether an agreement is void under Section 27 of the IC Act shall be decided upon the wording of that Section alone.be decided upon the wording of that Section alone.

9


In Gujarat Bottling Company Ltd. v. Coca Cola Company, AIR 1995 SC In Gujarat Bottling Company Ltd. v. Coca Cola Company, AIR 1995 SC 2372, the Court ruled that a negative stipulation contained in a 2372, the Court ruled that a negative stipulation contained in a franchise agreement restraining the franchisee from dealing with franchise agreement restraining the franchisee from dealing with competing goods was to facilitate the distribution of the goods of the competing goods was to facilitate the distribution of the goods of the franchiser and could not be regarded as a restraint of a right to trade.franchiser and could not be regarded as a restraint of a right to trade.

However, in However, in Parasulla Mallick v. Chandra Kanta Dass, AIR 1918 Cal Parasulla Mallick v. Chandra Kanta Dass, AIR 1918 Cal 546, 546, where the defendant and the plaintiff used to carry on the where the defendant and the plaintiff used to carry on the business of ferrying boats and arrived at a business settlement business of ferrying boats and arrived at a business settlement whereby the defendant promised to pay a certain amount to the whereby the defendant promised to pay a certain amount to the plaintiff in order that the plaintiff abstain from carrying on his boat plaintiff in order that the plaintiff abstain from carrying on his boat business for a period of three (3) years, the court ruled that the business for a period of three (3) years, the court ruled that the agreement was void as the restraining covenant was a vital part of the agreement was void as the restraining covenant was a vital part of the agreement and did not fall under the “goodwill exception” to section agreement and did not fall under the “goodwill exception” to section 27 of the IC Act.27 of the IC Act.

10

11

Indian Context: Restraint on EmploymentIndian Context: Restraint on Employment

The law has, as a matter of public policy, always opposed any interference with The law has, as a matter of public policy, always opposed any interference with the freedom to contract and restraints on the liberty of an individual, unless the freedom to contract and restraints on the liberty of an individual, unless injurious to the interests of the state. This principle is not confined to injurious to the interests of the state. This principle is not confined to restraints of trade in the ordinary sense of the word “trade,” but includes restraints of trade in the ordinary sense of the word “trade,” but includes restraints on the right of being employed.restraints on the right of being employed.

The Supreme Court in the case of The Supreme Court in the case of Niranjan Shankar Golikari v. Century Spg. & Niranjan Shankar Golikari v. Century Spg. & Mfg. Co. Ltd.Mfg. Co. Ltd. reported in AIR 1967 SC 1098 held that when an employee for a reported in AIR 1967 SC 1098 held that when an employee for a term binds himself not to take employment during that term it will not be hit term binds himself not to take employment during that term it will not be hit by section 27 and restrained the employee from serving anywhere else for the by section 27 and restrained the employee from serving anywhere else for the duration of the agreement.duration of the agreement.

In Superintendence Co. of India Pvt. Ltd. v. Krishan Murgai, AIR 1980 SC 1717, In Superintendence Co. of India Pvt. Ltd. v. Krishan Murgai, AIR 1980 SC 1717, the contract of employment placed the employee under a post-service the contract of employment placed the employee under a post-service restraint preventing him from serving in any other competing firm for two restraint preventing him from serving in any other competing firm for two years within the local limits of his last posting. As such, the restraint was years within the local limits of his last posting. As such, the restraint was operative for a period of two years after he left the company. The two operative for a period of two years after he left the company. The two substantial questions involved were:substantial questions involved were:

Contd….Contd…. Whether a post-service covenant in restraint of trade between the parties was void Whether a post-service covenant in restraint of trade between the parties was void

under section 27 of the IC Act; andunder section 27 of the IC Act; and Whether the said restrictive covenant, assuming it to be valid, was on its terms Whether the said restrictive covenant, assuming it to be valid, was on its terms

enforceable at the instance of the employer against the employee?enforceable at the instance of the employer against the employee? The court concluded that the negative covenant during the term of the contract was not The court concluded that the negative covenant during the term of the contract was not

in restraint of trade, and that the doctrine of restraint of trade could never apply during in restraint of trade, and that the doctrine of restraint of trade could never apply during the continuance of the contract. However, a restrictive covenant extending beyond the the continuance of the contract. However, a restrictive covenant extending beyond the term of service was void.term of service was void.

The court further observed that employee covenants in agreements should be carefully The court further observed that employee covenants in agreements should be carefully scrutinized, because there was an scrutinized, because there was an inequality of bargaining power inequality of bargaining power between the parties; between the parties; and, more often than not, no bargaining power, especially in cases where the employee and, more often than not, no bargaining power, especially in cases where the employee was presented with a standard form of contract that he had to accept or reject.was presented with a standard form of contract that he had to accept or reject.

M/s. Sociedade de Fomento Indl. Ltd. v. Ravindranath Subraya Kamath, AIR 1995 Bom M/s. Sociedade de Fomento Indl. Ltd. v. Ravindranath Subraya Kamath, AIR 1995 Bom 158, the employer filed a case against the employee,158, the employer filed a case against the employee, seeking to enforce an agreement to seeking to enforce an agreement to restrain the employee from adopting and using any of the processes invented by the restrain the employee from adopting and using any of the processes invented by the former employer in a subsequent employment, the court held that the agreement was former employer in a subsequent employment, the court held that the agreement was void, because an employee could not be restrained from using knowledge which he void, because an employee could not be restrained from using knowledge which he gained during the course of his previous employment, forever.gained during the course of his previous employment, forever.

12

ConclusionConclusion The Indian courts have in cases of “non-compete clause” in employment agreement The Indian courts have in cases of “non-compete clause” in employment agreement

differentiated them as in during the term and after the term of employment.differentiated them as in during the term and after the term of employment. Terms which restrict employment after the expiry of the agreement the courts have Terms which restrict employment after the expiry of the agreement the courts have

applied the ‘reasonableness’ test and the view has been that the livelihood cannot be applied the ‘reasonableness’ test and the view has been that the livelihood cannot be taken away and therefore would be hit by section 27.taken away and therefore would be hit by section 27.

Further covenants that prohibit employees from engaging in a business similar to or Further covenants that prohibit employees from engaging in a business similar to or competitive with that of the employer beyond the term of employment are invalid. The competitive with that of the employer beyond the term of employment are invalid. The same applies to non-compete agreements between companies, except franchise same applies to non-compete agreements between companies, except franchise agreements, notwithstanding that, the popular view is that non-compete arrangements agreements, notwithstanding that, the popular view is that non-compete arrangements between companies are valid.between companies are valid.

In Taprogge Gesellschaft MBH v. IAEC India Ltd., AIR 1988 Bom 157, the Bombay High In Taprogge Gesellschaft MBH v. IAEC India Ltd., AIR 1988 Bom 157, the Bombay High Court held that a restraint operating after termination of the contract to secure freedom Court held that a restraint operating after termination of the contract to secure freedom from competition from a person who no longer worked within the contract, was void. from competition from a person who no longer worked within the contract, was void. The court refused to enforce the negative covenant and held that, even if such a covenant The court refused to enforce the negative covenant and held that, even if such a covenant was valid under German law, it could not be enforced in India.was valid under German law, it could not be enforced in India.

13

Recent DevelopmentsRecent Developments With the change and development in trade and economic thought, the general With the change and development in trade and economic thought, the general

principle applicable to agreements in restraint of trade needs to be suitably principle applicable to agreements in restraint of trade needs to be suitably modified. In this regard, the Law Commission of India has recommended in its modified. In this regard, the Law Commission of India has recommended in its 13th report that Section 27 of the IC Act should be amended so as to allow 13th report that Section 27 of the IC Act should be amended so as to allow restrictions and contracts in restraint of trade, if they are in the interest of the restrictions and contracts in restraint of trade, if they are in the interest of the parties as well as of the public. However, no action has been taken so far.parties as well as of the public. However, no action has been taken so far.

Under recent amendments to the Income-Tax Act, 1961, any sum received or Under recent amendments to the Income-Tax Act, 1961, any sum received or receivable in cash or kind under an agreement for not carrying out any activity receivable in cash or kind under an agreement for not carrying out any activity in relation to any business or for not sharing any know how, patent, copyright, in relation to any business or for not sharing any know how, patent, copyright, trademark, license, franchise or any other business or commercial right of trademark, license, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture similar nature or information or technique likely to assist in the manufacture or processing of goods of provision for services, will now be chargeable to tax or processing of goods of provision for services, will now be chargeable to tax as profits or gains from business or profession. Therefore, the revenue as profits or gains from business or profession. Therefore, the revenue authorities seek to tax payments received by companies for entering into non-authorities seek to tax payments received by companies for entering into non-compete covenants as business profits. compete covenants as business profits.

14

Thank YouThank You

15

Business

Non compete