Parties must take care not to have unreasonable or one-sided non-compete clauses in agreements, as these can be rendered ineffective by the courts, writes Kunal Mehta
It is well-settled law that a non-compete obligation in an employment contract in India is unenforceable after termination of the employment. However, an acquirer in an M&A transaction can require a promoter to not compete with the business that he is selling. Such non-compete obligations are now an integral part of M&A transactions involving change of control.
In the past few years, control deals have gained popularity in India. Both private equity and strategic investors are now favouring control deals so that they have the ability to control the management. Similarly, many family-run businesses that face succession issues are willing to sell their entire business. In such a scenario, where the sellers of a business possess valuable customer relationships, intellectual property, knowhow or skills, acquirers are insisting on non-compete obligations from the sellers. Strong non-compete clauses can be a source of significant value for businesses.
Non-compete obligations in India derive their enforceability from the exception to section 27 of the Indian Contract Act, 1872, which allows a person who sells the goodwill of a business to agree with the acquirer to refrain from carrying on a similar business, within reasonable limits. Various judicial precedents have also held that negative covenants such as non-compete, non-solicit and non-disclosure would not generally be regarded as being in restraint of trade, unless they are unreasonable or completely one-sided.