What is restraint of trade in an employment agreement

Introduction

Agreements in restraint of Trade, as the term suggests, refer to those agreements wherein one-party consents to restrict or refrain himself/herself from carrying on a particular trade, employment or profession in collaboration with a third party or individually without the express consent or permission from the first party in exchange of a consideration. According to Section 27 of the Indian Contract Act, 1872, every agreement whereby one party is restricted from carrying out a lawful trade, profession, or business of any kind is void to that particular extent.

In context of employment agreements under the Indian Contract Act 1872, it refers to numerous arrangements and obligations between the relationship of employers and employees wherein employees are expected to abide by the regulations, rules and guidelines set by the employers and the failure to observe and do so results in violation of the contract which may result in initiation of legal actions or other compliance mechanisms, seeking compensation or damages for the losses caused or even termination of employment of the employee. Therefore, employment agreements carry a vital importance for determining the relationship between the employers and employees along with adjudicating the disputes between both of them.

Restraint of Trade in Employment Agreements

The clauses of restraint of trade in employment agreement refers to those terms which restrict or prohibit the employee either partially or completely from engaging in certain economic activities which may include engaging oneself in the same line of business, working for competitor organizations, carrying on similar trade or soliciting employees of the organization for a particular period of time. The rationale behind these clauses in an employment agreement is to protect the legitimate business interests of the employers by preventing the erstwhile employees from undertaking potentially harmful activities such as indulging in unfair competitions or disclosing information which may be detrimental to the functioning of the employer’s business.

Many a times, in the Indian context various organizations have adopted to ‘non-compete clauses’ in employment agreements which provide for an absolute prohibition upon the employees from engaging in identical business or professions in the course of employment or a stipulated period of time post termination or cessation of employment in the organization. In reference to Section 27 of the Indian Contract Act 1872, courts have held that non – compete agreements are unenforceable and impermissible post termination of employment as they would lead to denial or deprivation of right to livelihood to the employees and bar them from their fundamental right to earn a living.

Moreover, according to Article 19(1)(g) of the Constitution of India, every citizen has been empowered with the right to practice any profession, trade or business subject to reasonable restrictions enumerated under Article 19(2). However, a mere threat to loss of business due to competition from other individuals cannot be termed as a reasonable restriction and such restrictions would be against public policy.

In the landmark judgment of Precept D’Mark (India) Pvt. Ltd. V. Zaheer Khan and Anr.,[1] the Hon’ble Supreme Court clarified upon the issue of agreements in restraint of trade under Section 27 of the Indian Contract Act 1872 and held the following:

• Any agreement restricting trade and employment beyond the term in which the contract remains in force is unenforceable and void ab initio.
• The doctrine of restraint of trade is applicable only when the contract comes to an end and is not applicable during the continuance of the contract.
• The doctrine of restraint of trade is not restricted to employment agreements/contracts but is also applicable to numerous other contracts.

Therefore, this judgment has laid down the jurisprudence pertaining to enforceability of non – compete clauses in Indian employment scenario and held that such agreements or clauses are only applicable/enforceable during the period in which employee carries on employment in the organization and post cessation of the employment, such agreements come to an end.

In case of post – termination non-compete clauses wherein the employees consent to not enter into competition with the employer in the same sector of services/trade following the termination of employment, it was held by the Hon’ble Supreme Court in Superintendence Company of India (P). Ltd. V. Krishna Murgai[2] that such agreements fall under the scope of Section 27 of the Indian Contract Act and therefore are expressly enacted to restrain trade and violate Article 19(1)(g) and cannot be deemed valid. Hence, such post – termination restrictive trade contracts which absolutely restricts an employee from pursing a trade or profession of are void and unenforceable in the courts of law. That said, the employee will remain to be bound by his/her confidentiality obligations towards the employer.

Conclusion

The jurisprudence behind restraint of trade under employment agreements highlights the responsibilities of the employees towards fulfilling the duties towards the employer and engage in ethical and legal activities. Indian Courts on numerous occasions held that pre – termination clauses in an employment agreement are distinct from a post – termination clause wherein an attempt has been made to balance the rights of the employees to earn their livelihood and income while maintaining the sanctity of the employer’s business by protecting their business interests, intellectual property rights and trade secrets. This balance would also lead to ensuring a legal and fair framework for organizations to create a balanced environment for both the employer and employee to grow in their professional pursuits while ensuring the sanctity of each other’s rights and liabilities.

Frequently Asked Questions

[1] https://indiankanoon.org/doc/571375/

[2]https://indiankanoon.org/doc/1186410/#:~:text=After%20filing%20the%20suit%20the,1979%20after%20hearing%20the%20respondent.

King Stubb & Kasiva,
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