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Validity of Restrictive Covenants in Contracts
The inclusion of such negative covenants is either barred or highly restricted in their scope of operations by way of provisions in statutes or through various judicial pronouncements. The Indian Contract Act, 1872 (“Act”), imposes such a restriction on the applicability of negative covenants under Section 27 which stipulates that agreements in restraint of trade are considered void. The aim of Section 27 is to deem unlawful any agreement that prevents or restricts a person from engaging in trade, business, or lawful profession, unless such restriction is valid or reasonable.
The judicial interpretation of whether agreements or covenants are in restraint of trade under Section 27 has evolved over the years. Although the Constitution of India guarantees to every citizen, the right to practice any business, trade or profession, the said right is not absolute. Reasonable restrictions can be placed on such rights in the interest of the public at large. Such restrictions/restrictive covenants have time and again been subject to judicial review and interpretation and the courts have upheld such restrictions depending upon the facts and circumstances of each case. This article aims to analyse the validity of such negative/restrictive covenants, in view of the various judicial interpretations.
The first case in which the need for examining the scope of Section 27 arose was in Madhub Chunder Poramanick v. Rajcoomar Doss and Ors. [1] before the Calcutta High Court. The Court observed that Section 27 was intended to prevent not merely a total restraint from carrying on trade or business, but a partial restraint as well. In light of this, the court held that an agreement whereby one of the parties agrees to close his business within a particular locality in consideration of a promise by the other party to pay a certain sum of money is in restraint of trade and hence, void.
While there are various kinds of restrictive covenants, the analysis in this article is limited to non-compete and non-solicitation clauses which are some of the most commonly used restrictive covenants in contracts.
Non-compete
A non-compete clause aims at avoiding competition between contracting parties by restraining the other party from pursuing a similar competing profession, trade or business or prohibiting a party from working for a competitor. Such a covenant usually manifests itself in contracts to prevent misuse of trade secrets, confidential information and other knowledge acquired by a party during the term of the contract. Non-compete clauses are also widely used in commercial agreements to protect business interests of parties which may suffer irreparable harm owing to dilution of competitive advantage.
While non-compete provisions find their place in both employment agreements as well as commercial agreements, they have been treated differently by the courts owing to the nature of the relationship between the contracting parties and the consequential losses that may be suffered by the party under the non-compete obligation. Therefore, it is imperative that the validity of non-compete clauses in employment agreements and commercial agreements be dealt with separately.
Authors:
Krishnamurthy & Co. (K Law) Mumbai Office Address: 3rd floor, Piramal Tower, Peninsula Corporate Park, Ganpatrao Kadam Marg, Lower Parel, Mumbai – 400 013 Phone: (+91) 22 6235 5000 Bengaluru Office Address: 4th Floor, Prestige Takt, No. 23, Kasturba Road Cross, Bangalore – 560 001 Phone: +91 80 4175 7500 Email: [email protected] Website: https://www.klaw.in/
Krishnamurthy & Co. (“K Law”) is one of the premier full-service law firms in India providing top-notch, comprehensive legal and regulatory advisory, transactional legal services, and dispute resolution support across a broad spectrum of practice areas and sectors. Established in 1999, K Law has, in a relatively short spell of just over two decades, transformed itself into a national player with a rapidly expanding practice footprint in M&A, Private Equity, Banking & Finance, Dispute Resolution, Intellectual Property, Media & Entertainment, Projects, and Real Estate. With over 85 lawyers, the firm has offices in Bengaluru, Mumbai, New Delhi and Chennai.
[1] Madhub Chunder Poramanick v. Rajcoomar Doss and Ors, (1874) 14 Beng LR 76 [2] Niranjan Shankar Golikari v. The Century Spinning and Manufacturing Company Ltd, 1967 SCR (2) 378 [3] Percept D’Mark (India) Pvt. Ltd. vs. Zaheer Khan & Anr, (2006) 4 SCC 227 [4] Superintendence Company of India (P) Ltd. vs. Krishan Murgai, 1981 SCC (2) 246 [5] Pepsi Foods Ltd. and Ors. vs. Bharat Coca-cola Holdings Pvt. Ltd. and Ors, (1999) ILR 2 Delhi 193 [6] Gujarat Bottling Co. Ltd. and others vs. Coca Cola and Ors, 1995 SCC (5) 545 [7] GEA Energy System India Ltd. v. Germanischer Lloyd Aktiengesellschaft, (2009) 149 Comp Cas 689 [8] Niranjan Shankar Golikari v. The Century Spinning and Manufacturing Company Ltd, 1967 SCR (2) 378 [9] Affle Holdings Pte Limited v. Saurabh Singh, 2015 SCC OnLine Del 6765 [10] Wipro Ltd. v. Beckman Coulter International SA, 2006 (131) DLT 681 [11] Embee Software Private Limited vs. Samir Kumar Shaw, 2012 (3) CHN 250 [12] Dessicant Rotors v Bappaditya Sarkar, 2009 (161) DLT 574 [13] FL Smidth Pvt. Ltd. v M/s. Secan Invescast (India) Pvt.Ltd, (2013) 1 CTC 886. [14] E-merge Tech Global Services P. Ltd. vs. M.R. Vindhyasagar and Ors., C.S.No.258/2020
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- Employment agreements
- Commercial agreements
- Distance: Suitable restrictions can be placed on employee to not practice the same profession within a stipulated distance, the stipulation being reasonable.
- Time limit: If there is a reasonable time provided in this clause then it will fall under reasonable restrictions.
- Trade secrets: The employer can put reasonable restrictions on the letting out of trade secrets.
- Goodwill: There is an exception under section 27 of the Indian Contract Act on the distribution of goodwill.
- Negative covenants during the subsistence of a contact, irrespective of the nature of the contract, would not normally be regarded as being in restraint of trade, business of profession unless the same are unconscionable or wholly one-sided.
- Post termination negative covenants in employment contracts, which restrict an employee's right to seek employment and/or to do business in the same field as the employer would be in restraint of trade and void to that extent.
- While determining whether a negative covenant is in restraint of trade, business or profession or not, the courts take a stricter view in employment contracts than in other commercial contracts, since in an employment contract, the balance of convenience lies in favour of the employer whereas in commercial contracts, the parties are, more or less, on an equal footing.
- The question of reasonableness and also the question of whether the restraint is partial or complete is not required to be considered at all whenever an issue arises as to whether a particular term of a contract is or is not in restraint of trade, business or profession.
Authors:
- Chandan P. Kini
- Nikhil Sharma
- Sonali Shendge
- Nidhi Acharya
Krishnamurthy & Co. (K Law) Mumbai Office Address: 3rd floor, Piramal Tower, Peninsula Corporate Park, Ganpatrao Kadam Marg, Lower Parel, Mumbai – 400 013 Phone: (+91) 22 6235 5000 Bengaluru Office Address: 4th Floor, Prestige Takt, No. 23, Kasturba Road Cross, Bangalore – 560 001 Phone: +91 80 4175 7500 Email: [email protected] Website: https://www.klaw.in/
Krishnamurthy & Co. (“K Law”) is one of the premier full-service law firms in India providing top-notch, comprehensive legal and regulatory advisory, transactional legal services, and dispute resolution support across a broad spectrum of practice areas and sectors. Established in 1999, K Law has, in a relatively short spell of just over two decades, transformed itself into a national player with a rapidly expanding practice footprint in M&A, Private Equity, Banking & Finance, Dispute Resolution, Intellectual Property, Media & Entertainment, Projects, and Real Estate. With over 85 lawyers, the firm has offices in Bengaluru, Mumbai, New Delhi and Chennai.
[1] Madhub Chunder Poramanick v. Rajcoomar Doss and Ors, (1874) 14 Beng LR 76 [2] Niranjan Shankar Golikari v. The Century Spinning and Manufacturing Company Ltd, 1967 SCR (2) 378 [3] Percept D’Mark (India) Pvt. Ltd. vs. Zaheer Khan & Anr, (2006) 4 SCC 227 [4] Superintendence Company of India (P) Ltd. vs. Krishan Murgai, 1981 SCC (2) 246 [5] Pepsi Foods Ltd. and Ors. vs. Bharat Coca-cola Holdings Pvt. Ltd. and Ors, (1999) ILR 2 Delhi 193 [6] Gujarat Bottling Co. Ltd. and others vs. Coca Cola and Ors, 1995 SCC (5) 545 [7] GEA Energy System India Ltd. v. Germanischer Lloyd Aktiengesellschaft, (2009) 149 Comp Cas 689 [8] Niranjan Shankar Golikari v. The Century Spinning and Manufacturing Company Ltd, 1967 SCR (2) 378 [9] Affle Holdings Pte Limited v. Saurabh Singh, 2015 SCC OnLine Del 6765 [10] Wipro Ltd. v. Beckman Coulter International SA, 2006 (131) DLT 681 [11] Embee Software Private Limited vs. Samir Kumar Shaw, 2012 (3) CHN 250 [12] Dessicant Rotors v Bappaditya Sarkar, 2009 (161) DLT 574 [13] FL Smidth Pvt. Ltd. v M/s. Secan Invescast (India) Pvt.Ltd, (2013) 1 CTC 886. [14] E-merge Tech Global Services P. Ltd. vs. M.R. Vindhyasagar and Ors., C.S.No.258/2020