Non-Compete and Non-Solicit Clauses: Enforceable Under Section 27?

Employment contracts, partnership deeds, founder agreements and sale agreements often contain clauses that stop someone from working for a competitor, starting a rival business or approaching clients and staff. Businesses draft these clauses expecting them to be enforced, and individuals sign them assuming they are binding. In India, the law on these restraints is different from many other countries, and understanding it can save considerable cost.

What Does Section 27 Say?

Section 27 of the Indian Contract Act, 1872 provides that every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind is, to that extent, void. There is one statutory exception: a person who sells the goodwill of a business may agree with the buyer to refrain from carrying on a similar business within specified local limits, so long as the buyer carries on a like business, provided the limits are reasonable. Unlike in English law, Indian courts do not apply a general reasonableness test to save restraints outside that exception.

What About Restrictions During Employment?

A restriction that applies during the term of employment or the term of a contract is treated differently from one that applies after it ends. In Niranjan Shankar Golikari v. Century Spinning & Manufacturing Co. (1967), the Supreme Court upheld a covenant that stopped an employee from working for others during the period of employment, reasoning that such a negative covenant, operating during the contract, was not a restraint of trade. Courts will generally enforce exclusivity and confidentiality obligations that apply while the relationship subsists, and the same logic is applied to notice periods.

What About Restrictions After the Contract Ends?

Here Section 27 bites. In Superintendence Company of India v. Krishan Murgai (1981), the Supreme Court held that a post-termination restriction on an employee competing with the former employer was void under Section 27. In Percept D'Mark (India) v. Zaheer Khan (2006), the Court held that a post-termination restraint in an agency agreement was void. The reasoning is that a person should not be kept from earning a livelihood. As a result, a typical clause that says an employee cannot work for a competitor for two years after leaving is very unlikely to be enforced by an Indian court, however reasonable its terms appear.

What Restraints Are More Likely to Be Upheld?

The courts have been more willing to accept restraints in a few settings:

• During the term of the contract, including a notice period or garden leave
• On the sale of goodwill of a business, within reasonable limits of area and time
• For an outgoing partner, where the Partnership Act permits a restraint within specified limits
• Where the clause protects confidential information or trade secrets, as distinct from competition itself

The sale of business exception is relevant to corporate transactions. A founder who sells the business, or a majority stake together with its goodwill, can agree to a non-compete that the buyer can enforce, if the restraint is tied to protecting the goodwill acquired and is limited in area and time. A clause attached to a sale of a few shares where no goodwill is transferred is on much weaker ground. Courts also examine whether a clause in a shareholders' agreement that binds a founder after exit is really a protection of the investment or an attempt to restrain trade. Our note on co-founder disputes discusses exit terms.

What About Non-Solicitation and Confidentiality?

Non-solicitation of customers and employees after termination is treated cautiously. Some courts have held that a narrowly drawn non-solicitation clause is not a restraint on the ability to carry on a trade, while others treat it as void under Section 27, so the outcome depends on the wording and facts. A safer route for businesses is to rely on protection of confidential information and trade secrets. Courts can restrain a former employee or partner from using confidential material, customer data or proprietary information, whether or not there is a non-compete, under the law of confidence and contract. The business must be able to identify what is confidential, and to show that it took steps to protect it.

What Other Laws Can Apply?

Competition law can also be relevant. Agreements among competitors or in a joint venture that restrain competition can fall within the Competition Act, 2002 if they cause an appreciable adverse effect on competition. In a deal with significant market impact, the restraint should be assessed under that statute as well.

How Should Businesses Draft Protections?

Because non-competes are fragile, a drafter should use a layered approach. Use strong confidentiality and intellectual property assignment clauses. Include notice periods and garden leave that keep key staff bound while they are still employees. Tie non-competes to the sale of goodwill in acquisition documents, with limits of time and place. Offer retention incentives, such as deferred bonuses or vesting, which encourage staff to stay without relying on a void restraint. And keep records of what information is confidential.

For an individual who has signed a non-compete, the position is generally better than the document suggests, but the specific clause, the stage and the confidential information involved all matter. Our Contract & Arbitration practice advises on restraint clauses for businesses and individuals, and you can request a consultation. If a breach has led to loss, see our guide to breach of contract and damages.