Employment Contracts in India: Enforceability of the Non-Compete Clause

Foreign firms doing business in India often seek to enforce restrictive agreements, such as a non-compete, against their employees, associates, vendors, or other business partners. However, unlike in many Western countries, such types of restrictive agreements are considered unlawful under Indian law, and may not be enforceable in India.

A non-compete is essentially an agreement entered into between two parties whereby one party is prohibited from joining another competing business by virtue of being employed or associated with the other party. Such agreements are typically included in an employment contract, either as a clause in the contract or as a separate agreement.

This article outlines the enforceability of non-compete clauses in employment agreements in India. It also provides guidance to foreign firms doing business in India about the limitations in negotiating, drafting, and implementing non-compete agreements with their employees and other third parties.

Legality of ‘non-compete’ in India

While non-compete restrictions imposed during the period of employment are legal, post-employment restrictions are generally considered unlawful as they violate the ex-employee’s fundamental right to engage in a trade, profession, or business. Agreements that restrain trade are also deemed void under Indian contract law. However, an exception arises in cases where a sale of goodwill is involved, that is, where the reputational aspects of the business undertaking are also sold or transferred. In the context of mergers and acquisitions (M&A), this exception safeguards the acquiring company by ensuring that the exiting promoters of the target company do not start a competing business, post-merger.

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Legal & Financial Due Diligence

Non-compete agreements between partners in a partnership firm, which restrict the right of outgoing partners from carrying out a competing business, within reasonable geographical boundaries or time periods, is also permissible. However, all non-compete clauses are subject to the ‘reasonability test’, and will be enforceable only if it appears reasonable and necessary to the court. The ‘reasonability test’ is a standard used by India’s courts to determine whether a non-compete clause is legal or illegal.

In essence, the courts consider all surrounding facts and circumstances of a particular case and the nature of restriction imposed on the involved party. In the past, India’s courts have considered geographical limits or time limits while evaluating the validity of a non-compete clause. A ‘garden leave’ clause is conceptually similar to a non-compete clause as it seeks to restrict an employee from joining a different organization for a specified period of time. The only difference is that in the case of a garden leave, the employee is required to stop coming to their workplace and carrying out duties during the notice period. This does not impact salary payment of the employee.

Such arrangements also ensure that the employee does not come into contact with any trade secrets or confidential information immediately prior to the termination or resignation from the organization. In the absence of specific laws protecting trade secrets in India, employers are advised to incorporate ‘garden leave’ clauses in employment agreements. It must be emphasized that while such arrangements are ostensibly reasonable, they can be held unlawful by Indian courts if their terms appear unconscionable or unreasonably restrictive.

Utility of the non-compete clause in employment contracts

Although many employers are aware of the potentially contested enforceability of post-employment non-compete agreements and ‘garden leave’ clauses, these boilerplates remain popular in the employment agreements of several firms operating in India. The main reason behind their continuity is more psychological than legal.

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A majority of employees in India remain unaware or unsure about the legalities of their employment agreements, and are generally reluctant to initiate time-consuming legal proceedings against their employers. Consequently, they perceive the non-compete clause as binding; many abide by it fearing legal repercussions. Therefore, although not legally binding, such clauses in employment agreements often serve their intended purpose by exploiting the psyche of employees.

Drafting non-compete agreements in India: Key considerations

Reasonableness is the core issue to be considered while drafting non-compete agreements. Geographical and time limits are considered relevant factors while determining whether a particular non-compete clause is enforceable or not.

Firms doing business in India should note that Indian courts will always consider the specific facts and circumstances of the case and the conflicting interests and rights of the involved parties while determining legal validity.

In M&A transactions, non-compete clauses are typically accompanied with a non-compete fee, which is paid to the promoters of the target company as consideration for not starting a competing business within the prescribed geographical and time limits. However, in case the target company is a listed company in India, such a non-compete fee is prohibited under Indian securities laws.

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