India does not have a legal framework with respect to trade secrets and, therefore, companies in India have to rely on non-compete agreements to protect its trade secrets. The inherent interest of the employer to protect his trade secrets tends to conflict with the right of an individual for unhindered, effective occupation and livelihood. Read on to know more
Non-compete agreements often are a part of a basic employment contract, or are included as a separate document that is reviewed and signed at the beginning of a term of employment. Essentially, the non-compete agreement ensures that upon the termination of the employment period, the former employee will not engage in activities that places him or her in direct competition with their former employer. While the exact terms of a non-compete agreement may vary and are subject to local laws regarding employment, the noncompete agreement is generally seen as an effective means to ensure that former employees do not make use of proprietary information to lure away customers and thus damage their former employer.
Most non-compete contracts will usually specify a specific time frame that the former employee will be expected to refrain from engaging in employment that will place him or her in direct competition with a former employer. Generally, the time frame ranges from one or two years to up to five years. There are two basic reasons for this strategy. First, even if the individual has intimate knowledge about the inner workings of the company, that knowledge becomes increasingly obsolete over time. Second, the accuracy of such important matters as the contact information for the top ten clients of the company will also decrease with time. The end result is a former employee will not be able to utilize proprietary information to steal away customers and thus hurt the profitability of the company.
Non-compete agreements are contractual in nature. Valid covenants not to compete may prevent a former employee from working for a competitor seeking out clients or copying ones product for a specified time and geographic region. In some instances the former employee does not even have to disclose the trade secret but merely be in a position where ‘inevitable disclosure’ of the trade secret would occur. The US case of IBM v Papermaster No. 08-9078, 2008 U.S. Dist. LEXIS 95516 (S.D.N.Y. Nov. 21, 2008) is a classic example of the use of this argument while enforcing non-compete agreements. In this case IBM claimed thatbecause of the nature of information Papermaster (leaving employee) had access to, including trade secrets, there was “substantial risk of Papermaster disclosing this information to IBM’s detriment” which would result in irreparable harm. They argued inevitable disclosure, stating that because of Papermaster’s position and responsibilities at Apple( the new employer ), it was inevitable for him to apply knowledge learned at IBM to his work at Apple, thus aiding a competitor and harming IBM. Papermaster claimed that he could recall only two inconsequential areas in which Apple was, and only temporarily, in direct competition with IBM. Industry analysis disagreed and found Apple and IBM to be direct competitors. Papermaster had signed the Noncompetition Agreement which clearly stated that any breach of the agreement would cause irreparable harm.
Every corporate (employer) and individual (employee) must understand and appreciate the clear distinction between trade secret and trade knowledge. Trade secret comprises know-how exclusively designed/ developed/ created by a company like specific product designs, product formulas, product testing mechanism etc. Very often these are also protected under Patent & Trademark laws. And at times, even though these trade secrets are not protected under Trademark or Patent laws, a corporation would go to great lengths to protect the confidentiality of it. For example, media often reports about great measures adopted by some cola giants to protect the unique formula of its drinks or a FMCG company adopting exhaustive measures to protect formulas of its products etc. Trade secret is thus owned exclusively by the employer and it is entitled to restrict any employee (present or ex) from use/ misuse of its trade secret.
Trade knowledge on the other hand is what an employee gathers during his course of employment. Often, it is pertaining to a specific industry like banking, advertising, etc., and at times going further and specializing in a distinct function of the said industry. As a result, while an individual may have switched employment, he may have gathered experience and expertise of a specific industry and/or function of it. It is therefore imperative for him to seek future employment within the specialised industry and function, which is very likely to take him to the competitor of the present employer. In the given situation, any restrictive covenants in his current employment contract stopping him from joining a competitor may amount to a violation of his fundamental right to livelihood. We already know of various judgments passed in recent history, which upholds this view.
Therefore, a more healthy approach is now being adopted by many corporates, mainly for its senior management, by inserting provision of “Garden Leave” in their employment contracts. This is nothing but a cooling off period of about 3 to 6 months and in some cases even a year, during which time the outgoing employee is on fully paid leave and can take up fresh employment only on completion of “Garden Leave”.
The Court found that, “Because Mr. Papermaster has been inculcated with some of IBM’s most sensitive and closely guarded technical and strategic secrets, it is no great leap for the Court to find that Plaintiff has met its burden of showing likelihood of irreparable harm.” This is also despite an employment agreement Papermaster signed with Apple which stated explicitly that he would not disclose trade secrets from prior employers. The Court insisted that it didn’t believe Papermaster would act “dishonourably” but that he couldn’t help but inadvertently share some information that could be considered a trade secret.
The Court also considered whether or not the noncompetition agreement itself was reasonable and therefore enforceable. It found that, given IBM’s international business, the geographic scope was necessary and the time restriction of one year was reasonable. Additionally, becauseof the similarity of the position at Apple to the work at IBM, the agreement was needed to prevent incidental misappropriation of IBM trade secrets. One wonders if such an opinion could have repercussions such as “expanding inevitable disclosure doctrine” to the detriment of anybody attempting to further their career in a particular field by moving to another company in the same industry
In considering whether or not the noncompete clause was caused undue hardship to Papermaster, the Court weighed the agreement with IBM against the once-in-a-lifetime opportunity of the SVP position. It concluded that, since intellectual property is IBM’s most valued asset, the cost of trade secret disclosure to IBM outweighed the cost to Papermaster in delaying the opportunity. The matter went on to trial. However Papermaster’s lawsuit with IBM was finally settled. The settlement required that Papermaster make two scheduled court to testify that he will protect IBM trade secrets. In a similar manner, in India most cases regarding disclosure of trade secrets have been solely decided on the basis of the violation of the contract between the employer and employee.
Non-compete agreements usually take the form of a restrictive covenant. Otherrestrictive covenants in these agreements include non-solicit agreements, nondisclosure agreements and confidentially covenants. In India, non-compete agreements have to withstand the scrutiny of Section 27 of the Indian Contract Act 1872, whereby any agreement that restrains a party from exercising a lawful profession, trade or business is void. The section sets out an exception applicable to cases where a party sells the goodwill of a business. In such cases, the seller of the goodwill of the business may agree with the buyer to refrain from carrying on a similar business within a specific geographical area provided that the buyer or any person deriving title to the goodwill from the buyer is carrying on similar business in that area. However, such limits must appear reasonable to the court given the nature of the business. Where the goodwill of a business is sold without an express non-compete agreement, the vendor may set up a rival business but is not entitled to canvass customers of the old firm.
Right from the days of Supreme Court’s ruling in Niranjan Shankar Golikari to the more recent decision in Percept D’Mark, the apex court has been grappling with the policy issues related to employer employee conflict. The inherent interest of the employer to protect his trade secrets tends to conflict with the right of an individual for unhindered, effective occupation and livelihood. There are valid socio-economic arguments in favour of both parties. The society as a whole benefits from leaps in technology. Business needs to protect these assets in the form of their intellectual property (IP). Economic growth and development necessitates thatbusinesses delegate and entrust confidential information to relevant employees. However, undertaking a level of risk of loss of IP through potential breach of trust is the need of the hour. While at the same time, any form of post-employment restrictions reduces economic mobility of employers and entails limiting personal freedom to pursue preferred course of livelihood. Employees are paradoxically restrained because of his increased expertise, and potentially shackled from advancing further in the industry in which he is most productive.
Is it correct to say that enforceability of a non-compete agreement depends upon an employer's legitimate business interest?
Under Indian law, a non compete agreement between an employer and an employee is valid only to the extent of protection of the employer’s confidential and copy righted data which may include an employer’s customer / client base after an employee has left the employment of the employer. To this extent it can be said that the enforceability of such an agreement will depend upon an employer’s legitimate business interests. Section 27 of the Indian Contract Act, 1872 provides that any agreement by which a person is restrained from exercising a lawful profession, trade or business of any kind is to that extent void. The only exception is that when a person sells the goodwill of abusiness, he may agree with the buyer to refrain from carrying on similar business within specified local limits so long as the buyer carries on a like business. Further, such limits should appear reasonable to the court given the nature of the business. It may be noted that a negative covenant restraining the right of an employee, during the subsistence of his employment contract with an employer, to engage in any business similar to, or competitive with that of the employer, cannot be construed to be a restraint of trade for obvious reasons. Such a covenant is enforceable and not hit by Section 27 of the Indian Contract Act. However, covenants restraining an employee from seeking employment with a competitor in future or setting up a competing business after the termination of employment are void and hit by Section 27 of the Indian Contract Act. Such a service covenant extending beyond the termination of service is void. The courts have made it clear that any attempt by an employer which amounts to curbing an employee’s right to livelihood is per se bad in law.
When such an agreement comes into force, can it be executed even after the employee has already started his employment? Is such practice valid?
Yes, a separate non-compete agreement may be executed between an employer and an employee even after the employee has commenced his employment with the said employer.
If the employee wants to go into his own business, can he get out of it?
Yes. He can terminate his employment and non-compete agreement and set up his own business. However, the employer can still restrain such an employee from using the employer’s confidential information andcopyrighted data including the employer’s client / customer base.
What if the agreement restricting employee's employment is more than necessary to protect his employer?
As stated earlier, a non compete agreement between an employer and an employee is valid only to the extent of protection of the employer’s confidential and copy righted data which may include an employer’s customer / client base after an employee has left the employment of the employer. Further, a negative covenant restraining the right of an employee, during the subsistence of his employment contract with an employer, to engage in any business similar to, or competitive with that of the employer, cannot be construed to be a restraint of trade for obvious reasons. Such an agreement is enforceable and not hit by Section 27 of the Indian Contract Act unless it is unconscionable or excessively harsh or unreasonable or one sided. Therefore, covenants that restrict an employee’s employment more than is necessary to protect the employer would not be enforceable against the employee.
What happens if the employee tries to compete despite a valid agreement?
If during the subsistence of his employment contract an employee an employee seeks to compete with his employer then in such an event the employer can file a suit for injunction against the said employee as well as claim damages from him. Post termination of his employment if the employee sets up a competing business, the employer can seek an injunction from the courts against the exemployee in the event he uses the employer’s exclusive data which was not in the public domain and which was the employer’s copyrighted information.
In Percept D’Mark (p) Ltd v Zaheer Khan (2006) the SupremeCourt elaborated on the distinction between enforceability of such covenants during the term of an employment contract and post-termination of an employment contract as follows:
When the contract is in force, judicial precedent has established that restraints, both general and partial, are permissible unless they are contrary to public policy. For example, during the period of employment an employer has the exclusive right to the services of theemployee. Therefore, a negative covenant (e.g. that the employee may not engage in a trade or business or take up employment with another employer to perform similar or substantially similar duties) is reasonable and not a restraint of trade.
The court’s decision also confirms that all covenants existing beyond the contract are void. The sole exception to this rule is where a covenant exists for non solicitation. It has been held by both the Supreme Court and the Delhi High Court that non-solicit covenants are covenants that essentially prohibit either party from enticing each other’s employees away from their respective employers. This restriction is imposed on the contracting parties and not on the employees. The restriction relates to inducements offered to the other party’s employees to change employer. By itself, the clause imposes no restriction on the employees and is viewed more liberally than a similar restriction in an employer-employee contract. Therefore, a non-solicit clause does not amount to a restraint of trade, business or profession and will not be declared void under Section 27 of the act.
Thus, where a contract imposes a noncompete covenant during the term of the contract, that covenant will be enforced unless a court deems it to be contrary to public policy. However, if a contract imposes a non-compete covenant that extends beyond the term of the contract, the covenant is enforceable only if it relates to non-solicitation.
The tussle between freedom of action and the right to contract freely needs to be revisited in light of the rapid development of a free market economy in India. In this regard, the cue may be taken from developments in England and Wales, where parties are free to agree not to compete after the contract term expires provided that the limits imposed are reasonable. The Indian courts have touched upon this issue time and again and have highlighted their inability to push forward reform in light of the explicit legislative provisions, which leaves little room for judicial activism. Therefore, it is up to the legislature to deal with this issue by amending the act to recognize that employers have a legitimate interest in protecting financial and time investments in employees. The law needs to protect an employer’s reasonable business interests without unduly limiting an employee’s other work opportunities. Until such legislation is drawn it remains a challenge to balance such conflicting interests.
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