The case for non-compete clauses

The non-compete clause has been troubling people for over six hundred years. Back in 1414, one Mr. John Dyer signed a contract not to ply his trade in the same town as that of his master for six months after his apprenticeship concluded.

When the master attempted to enforce this contract, the judge had none of it. In his conception, “the condition is against the common law”. Individuals should be free to make a living in any profession they choose, whatever piece of paper they may sign. Such was the Court’s wrath that the master would be sent “to prison until he had paid a fine to the King” [1414) 2 Hen. V, fol. 5, pl. 26].

That legal principle weakened in interceding centuries. In 1711, in the case of Mitchel v Reynolds, the English Courts held that agreements in restraint of trade may be legal depending on how reasonable or unreasonable they may be. Today, several jurisdictions (including the United States and the United Kingdom) permit companies to use non-compete clauses whereby employees may agree not to join rivals that are in core competition with their ex-employer for a specified period.

Restrain the restraints

Indian law disagrees. India’s Contract Act established in 1872 incorporated Section 27, which states in no uncertain terms 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”. According to India’s early jurists, the law is philosophically unjustifiable. In 1931, a Division Bench of the Allahabad High Court trenchantly remarked,

“[i]t is unfortunate that Section 27 of the Indian Contract Act… seriously trenches upon the liberty of the individuals in contractual matters affecting trade” [Bholanath Shankar Dar v. Lachmi Narain].

At the time, defenders of non-compete agreements put forward several arguments. One is that companies are disinclined to invest in workers if newly skilled employees can take their skills to competition. Another is that non-compete clauses encourage innovation as they prevents rivals from dancing off with trade recipes. A third argument, and perhaps most importantly, is that people should be free to contract as they please.

It is for these reasons that the Law Commission of India in its 13^th Report (1959, Para 55) noted that Section 27 “…was enacted at a time when trade was yet undeveloped and the object underlying the section was to protect the trade from restraints…but today, trade in India does not lag far behind that in England or the United States and there is no reason why a more liberal attitude should not be adopted…we recommend that Section 27 be suitably amended to permit reasonable restrictions”.

The wisdom of India’s early jurists was not enough to effectuate change, either at the legislative or the jurisprudential level. In 1967, in the case of Niranjan Shankar Golikari v. The Century Spinning And Mfg Co, the Supreme Court refused to uphold a non-compete clause that prevented a shift supervisor in a tyre cord factory from joining a competitor for a higher salary. Similarly, in 2006, in Percept D'Mark (India) Pvt Ltd vs. Zaheer Khan and Ors, the Apex Court refused to enforce a media management company’s non-compete clause that prevented prominent Indian cricketer Zaheer Khan from joining their rivals for a specified period, once the agreement came to an end. These precedents have effectively bound Indian courts against enforcing non-competes, reasonably restricted or otherwise.

Incumbency we trust

Unfazed, companies have found other methods to prevent employees from rushing to their nearest rivals. After all, not all ‘restrictions on trade’ are illegal. Embargos on the use of confidential information, for example, remain enforceable. In a bitter dispute between the partners of law firm, the Delhi High Court granted Diljeet Titus an injunction against his former partners from using his confidential data which included “…confidential documents, legal opinions, legal action plans, computerized database containing client information, proprietary client list, proprietary potential client list and other related information” [Mr Diljeet Titus vs Mr Alfred A Adebare And Ors]. Once such an order is passed, any usage of this information would constitute contempt of court.

Equally, non-solicitation clauses that prevent companies from soliciting each other’s employees, clients, and customers are legally justified. The Delhi High Court in the case of Wipro Limited v. Beckman Coulter International SA, held that such a clause “does not amount to a restraint of trade, business or profession and would not be hit by Section 27…”

Other grey areas remain. Would, for instance, a clause that forces ex-employees to pay their employers liquidated damages towards training costs if they join a direct competitor constitute an unreasonable restriction on trade, or the lawful application of liquidated damages? One such case is pending before the courts, and a judgment is soon to be rendered.

It is easy to see why firms love applying these provisions and engage expensive lawyers to enforce their terms. Businesses can lose supremely valuable knowledge and contacts when a senior executive is hired by a rival. They can lose substantially more if the executive happens to have their trade secrets. It is equally easy to see why employees hate them. Non-compete clauses prevent people from selling their intellectual capital in their desired field for long intervals during which skills atrophy and networks fade.

In the end, competing claims between employers and employees must be reconciled. Making all non-compete clauses illegal tramples upon individual liberty and discourages businesses from investing in their people. India’s legislature should give companies leeway to execute reasonable restrictions on post-employment opportunity if they are going to expend resources in developing talent.

That said, the gains in training must naturally be set against wider costs. A free market for skilled people benefits the economy as a collective. If the company does take its former employee to court, it should demonstrate genuine harm to the business. Absolute bars against non-competes were considered a bad idea in the 18^th century. They still are.

The author is a practicing lawyer at the Gurgaon-based law firm N South, Advocates.

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect those of Bar & Bench.