Analysis of restrictive covenants within employment agreements

By Jivesh Chandrayan, HSA Advocates

Employment agreements, especially at senior management level, are becoming increasingly complex considering the ever-increasing need for protecting trade secrets and business know-how. Consequently, boards and senior management have been imposing restrictive covenants in employment agreements that restrict employees by using non-disclosure, non-compete, non-solicit, non-poaching and garden leave clauses.

Jivesh Chandrayan Partner HSA Advocates
Jivesh Chandrayan
HSA Advocates

Employment contracts contain either positive covenants (agreements to do something that restrict the employee) or direct restrictive covenants (agreements not to do something, which are meant to keep employees contractually bound even post-termination). Stakeholders remain divided on the enforceability and efficacy of restrictive covenants.

While interpreting section 27 of the Indian Contract Act, 1872, and article 19(1)(g) of the constitution, courts have strived to draw a fine balance between industry requirements and personal rights, in deciding the enforceability of restrictive covenants. For example, restraining an employee from future employment opportunities through a non-compete clause can be considered unenforceable under public policy. However, the argument for enforcing non-compete through non-solicit and non-disclosure of the know-how and trade secrets learned while using the resources of the employer is equally compelling.

In India’s highly competitive job market, employers are selective when examining the knowledge and additional value an employee can bring, especially in IP-driven sectors. Therefore, is it possible to justify employment agreements prohibiting the employability of an employee for a defined period, or restricting the sector of employability, thus preventing use of proprietary knowledge and trade secrets? There is no straitjacket formula, though the Supreme Court has provided clarity to a large extent.

The court in Niranjan Shankar Golikari v The Century Spinning and Manufacturing Co Ltd held that restrictive covenants are not in restraint of trade unless the terms of such restraints are unreasonable, unconscionable, excessively harsh, unreasonable or one-sided. However, in Percept D’Mark (India) Pvt Ltd v Zaheer Khan & Anr, the court held that a restrictive covenant is not in restraint of trade during the term of employment, but, it becomes unenforceable post-employment. In Superintendence Company of India v Krishan Murgai, the court held, “a contract of this class [restraint of trade] is prima facie void, but it becomes binding upon proof that the restriction is justifiable in the circumstances as being reasonable from the point of view of the parties themselves”.

The Delhi High Court in Le Passage To India Tours & Travels Pvt Ltd v Deepak Bhatnagar, in considering the validity of such restrictive clauses held, “the court is required to give a construction to the covenant so as not to be greater than necessary to protect the employer nor be unduly harsh and oppressive on the employee.”

Judicial precedents reflect that restrictive covenants must provide a safety net to employers to protect their businesses, while upholding employees’ fundamental rights. Employers must follow certain equity-based principles in weighing the enforceability of restrictive covenants. First, non-compete clauses should be territorially limited or should be for a reasonable duration. Second, employees may be given monetary benefits during the restraint period. Third, mentioning liquidated damages in employment agreements could be a valuable deterrent preventing breach of restrictive covenants. Fourth, the employer must urge the employee to obtain independent legal advice regarding the implications of the employment agreement and its covenants and give the employee a list of competing businesses prior to their joining. Finally, but perhaps most importantly, the employer must not use a boilerplate, one-sided take-it-or-leave-it agreement for every class of employee.

While there is an inherent lacuna in the codified law, with a limited capacity for determining the validity and enforceability of such restrictive covenants, employers have been urging the increasing need to enforce restrictive covenants through ever more ingenious methods. A strong argument in favour has been the vital need to guard enterprise value through reasonable methods.

Jivesh Chandrayan is a partner at HSA Advocates

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