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08. Restrictive Covenants
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08. Restrictive Covenants

Definition and Types of Restrictive Covenants

Definition of Restrictive Covenants

Companies in the ‘knowledge industry’ place high value on their intellectual and human capital. Key employees who develop the intellectual property of the company, and those who have close interactions with customers and suppliers (such as sales staff), are critical to the growth and development of the company, and on many occasions, the company may be reliant on the personal attributes and market knowledge of such employees in order to improve its market base. Therefore, companies look to protect their business interests by prescribing certain restrictions for their employees – these clauses in employment contracts which place restrictions on certain activities of employees, either during or after their employment, are ordinarily referred to as ‘restrictive covenants’.

Types of Restrictive Covenants

  • Non-Compete Clauses

A non-compete clause is typically a restriction placed by the employer on an employee, pursuant to which the employee cannot indulge in any activity that would be in direct competition with the business of the employer. In nearly all employment contracts, such restrictions are stipulated for as long as the employee is employed by the company; however, some employment contracts may also contain clauses which will prevent the employee from joining a competitor company, or starting a competing business for a certain period, after the employment with the company comes to an end. These clauses attain greater significance in case of promoter and/or founder’s separation from the company.

  • Non-solicitation of Customers and Suppliers

A non-solicitation clause is intended to ensure that an employee does not induce the employer company’s customers, suppliers, or clients away from the company, typically after such employee leaves his/her employment.

  • Non-solicitation of Employees

A non-solicitation clause may also prevent an ex-employee from inducing any current employees to resign from employment with the company and join the company where such ex-employee is currently employed (or any other company), at his/her direction (including any competitor of the company).

Enforcement of Restrictive Covenants – Process and Remedies

As described in the earlier sections, the Constitution guarantees every Indian citizen, a fundamental right to practice a trade or profession. Further, as per the Contract Act, any contract which restrains trade, business or profession of any kind will be void. In light of this, any restrictive covenant that extends beyond the tenure of employment will not be looked upon favourably by Indian Courts (but in any case, are often incorporated into employment contracts as a deterrent measure). The courts are generally guided by the presumption that the employer is in a stronger bargaining position in comparison to the employee, and the employee has no choice but to typically accept the employer’s terms.

However, there are certain principles laid down by India’s judiciary that enable employers to protect their legitimate business interests:

  • employers can contractually restrict their employees from misusing or disclosing the employer’s trade secrets or confidential business information and practices (and the enforceability concerns with respect to restrictive covenants as outlined above, will typically not apply in these instances). Similarly, where the employee has a motive to cheat or cause irreparable harm to the employer, a restrictive covenant beyond the term of employment would be enforceable.
  • non-solicitation clauses may be valid if reasonable restrictions (such as distance, time limit and location) regarding non-usage of trade secrets and goodwill are imposed on former employees, depending on their designation and access to confidential information. Courts have also held that merely approaching customers of a previous employer would not amount to ‘solicitation’ until orders are placed by customers based on such approach.

Use and Limitations of Garden Leave

The concept of ‘garden leave’ is becoming common in India. Typically, garden leave involves a situation wherein an employee gives notice or is given notice of termination, and during such notice period is directed to stay away from work and/or the office premises, whilst continuing to receive his normal remuneration. Courts have held that while it is not possible to stop an employee from leaving, he can be restricted from joining a competitor during the term of employment (i.e. during the garden leave period). However, the garden leave provision should not be unreasonable and should typically not extend to inappropriately long periods of time.

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