Is a lock-in period for employees a restraint of trade?

Recently, in Lily Packers Private Limited v Vaishnavi Vijay Umak, Delhi High Court held lock-in periods in employment agreements to be legally valid. The petitions by the employer were in respect of three employees who signed onto lock-in periods for three years from their joining. One of the three went on unauthorised leave, while the other two resigned. Each acted in violation of the lock-in conditions. The employer consequently invoked arbitration under the Arbitration and Conciliation Act, 1996. The employees argued that the lock-in provisions violated their rights to life and employment under the Constitution of India, 1950, and that disputes involving violations of fundamental rights are not arbitrable. The employees also contended that the lock-in conditions contravened section 27 of the Indian Contract Act, 1872, which provides that agreements that restrain the exercise of a lawful profession, trade or business are void. The court rejected these arguments and held that lock-in conditions that apply during the term of employment are lawful.

In determining the case, the court traced the judicial position on the validity of lock-in provisions in employment agreements, particularly through the Calcutta High Court’s decision in The Brahmaputra Tea Co Limited v E Scarth and Delhi High Court’s earlier judgment in BLB Institute of Financial Markets Limited v Ramakar Jha. Both matters dealt with covenants of exclusivity that bound the employees to serve their employers for a definite term. These were held to be valid as they served to provide due protection to the employers’ interests during the subsistence of the employment agreements.

The court in Brahmaputra also held that a covenant restraining an employee from engaging in a similar business for a certain period of time after the termination of the employment agreement is void. The Supreme Court’s reasoning in Niranjan Shankar Golikari v Century Spinning and Manufacturing Company distinguished between the considerations against restrictive covenants that apply during the term of the contract and those after its termination. It held that negative covenants operating during the period of employment are usually not regarded as a restraint of trade unless found to be unreasonable or excessively harsh. Percept D’Mark (India) Private Limited v Zaheer Khan also noted the settled position of law that the doctrine of restraint of trade does not apply during the continuance of the agreement. In the case of VFS Global Services Private Limited v Suprit Roy, the Bombay High Court held that a garden leave clause applicable after the termination of employment of an employee is unenforceable as it would be in restraint of trade. However, in some instances, courts have allowed employees to be restrained from approaching the employer’s customers and suppliers for the purpose of soliciting business in direct competition even after the termination of employment.

On whether such provisions violate the fundamental rights of employees, the court in Lily Packers held that lock-in periods applying during the term of employment are not violative of the fundamental rights of the employees because such agreements are subject to negotiation between the parties and are entered into with individual consent and volition.

While the right of livelihood of employees tends to prevail in disputes relating to restrictive covenants that operate after the termination of employment, Delhi High Court’s decision in Lily Packers has reaffirmed employers’ rights to enforce restrictions on employees during the course of their employment. This protects an employer’s investment in its employees through upskilling as well as learning and development initiatives. Employers are also entitled to reasonably protect their confidential information, intellectual property and trade secrets to which employees may gain access during the course of their employment.

Such entitlements help employers ensure business continuity and stability, particularly in executive positions. Lily Packers also serves as a reminder to employers and employees alike to ensure that they assess the terms of the employment agreement before making an informed decision. Reasonableness of covenants, paying due regard to the interests of both parties, is essential to be considered at the negotiating table itself.

Agrima Awasthi is a counsel and Shivanshu Sharma is an associate at Wadhwa Law Offices.