Wednesday, September 17, 2008

Non-Compete and Non-Disclosure Agreements: Are They in Restraint of Trade?

(In the following post, Venugopal Mahapatra and Gautam Bhatia discuss the Indian legal position regarding non-compete and non-disclosure clauses in employment and similar contracts in the context of a Bombay High Court decision. They also compare and contrast the Indian law on this topic with the position that prevails in the U.K.)

V.F.S. Global Services Ltd. v. Mr. Suprit Roy is a December 2007 decision of the Bombay High Court. It is notable for some interesting observations of the Court upon the matters of restraint of trade and protection of trade secrets.

The controversy arose because of a condition in the contract of employment between the company and the employee whereby the employee was not permitted to participate with any other company carrying on similar business, and was also restrained from commencing similar business during the period of employment or for a period of two years after. Subsequently, a covenant of confidentiality was entered into by the parties, whereby the employee was not permitted to disclose or make use of any confidential information of the company, whether during the period of employment or after, except under certain special circumstances; and also that in the event he left service, or was terminated from service, he would not enter into the service of any employer who had a conflict of interest with the business of the plaintiff. Finally, there was a review of these conditions, and the insertion of a “Garden Leave Clause,” whereby the company, among other things, reserved the right to require the employee to remain away from work or employment after termination or resignation, and to comply with the conditions laid down by the company at such time.

In the instant case, the plea was for enforcement of this negative covenant. The Court first examined the Garden Leave Clause. It observed that the clause intended to operate after the cessation of employment. On this ground the defendant (employee), citing a number of previous judgments, had pleaded that it violated Section 27 of the Indian Contract Act, and was therefore void. The Court, following the seminal case of Niranjan Shankar Golikari, drew a distinction between a restrictive condition in a contract of employment which was operative during the period of employment and one which was to operate after the termination of the employment. The latter amounted to restraint of trade, while the former did not. On this basis, the Court held that the Garden Leave Clause was hit by Section 27, observing that neither the principle of reasonableness of restraint, nor the fact that the restraint was partial, was of any relevance.

At this point, it would be instructive to briefly discuss the position of Indian law with regard to negative employment covenants and restraint of trade. Indian law underwent a well-marked departure from the common law jurisprudence following the apex Court ruling in Krishna Murgai. The Supreme Court, giving an extremely narrow construction to Section 27 of the Indian Contract Act (which deals with restraint of trade), firmly rejected the importing of the common law doctrine of ‘reasonability’. In the recent high-profile cases involving Indian Cricketing superstars Zaheer Khan and Yuvraj Singh, the apex Court reaffirmed the strict construction of Section 27 and struck down the ‘right of first refusal’ clauses which were due to take effect after the end of the contractual period. The UK position, in this regard, allows for post-service covenants provided they are reasonable as to time, market and geographical limits. However, Indian law provides for no such scope, and validates only those agreements which are necessary for protection of ‘goodwill’. Thus, in the V.F.S. Case, the Bombay High Court toed the line drawn by the apex Court.

The Court then examined the contentions based on the agreement of confidentiality. The Court held, straightforwardly enough, that a clause prohibiting an employee from disclosing commercial or trade secrets was not in restraint of trade, as the effect of such a clause was not to restrain the employee from exercising a lawful profession, trade or business within the meaning of Section 27 of the Contract Act. It rejected the defendant’s contention that the exact nature and scope of the confidential information had not been precisely defined.

At this juncture, it is again pertinent to cast a glance at the UK’s legal position on the aspect of confidential information. After the landmark case of Faccenda Chicken, information is graded into 3 tiers. The first tier includes information which is already in the public domain and could be used by the employees post-service. The second tier covers confidential information which the employee cannot use or disclose during the period of employment without breaching his duty of fidelity to his employer, but which, in the absence of an express non-disclosure term, could be used post-service. The third tier includes only specific trade secrets which the employee cannot disclose or use during or after employment even in the absence of an express non-disclosure agreement. Thus, the law balances the interests of employers by preserving confidential information and trade secrets on one hand and those of the employees by protecting their ‘skills’ and assets. The decision in V.F.S., while pointing to the need for protecting trade secrets, goes no further. It is submitted that it is essential to incorporate such guidelines in Indian law to ensure clarity and predictability.

Thus, though the Indian position on this aspect has been consistent, it has nevertheless witnessed strong criticism on more than one count. While the Bombay High Court pronouncement introduces much needed protection to trade secrets by taking it out of the ambit of restraint of trade, nevertheless much ground needs to be covered in order to ensure security to trade secrets. In V.F.S., the Court had the chance to do just this, as the defendant expressly pleaded that the nature of the confidential information was vague and so could not be sustained; however, this plea was rejected. Therefore, it is submitted that V.F.S. is an important step in this regard, but needs to be developed further, with the U.K. position being a possible model.

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