Negative Covenants have become a common feature in employment agreements. Even though Section 27 of the Indian Contract Act, 1872, which states that any agreement by which a person restrained from exercising a lawful profession or trade or business of any kind is to that extent void, prohibits an employer from obstructing his employee from joining a competitor, negative covenants have become a necessity in light of recent occurrences in the corporate world.
It’s not uncommon today that employees, while leaving an organization often take with them the company’s precious intellectual property, trade secrets, client details, business strategies and documents of confidential nature to their new employers, who are usually competitors of the present company. Any employee who deals with a company’s data, in physical or digital form, documents, drawings, blueprints, plans, computers, secondary storage devices is a potential offender, who, at the time of leaving the organisation may take away with him such information. These offenses are unfortunately beyond the purview of Indian employment laws and thus companies to protect themselves have started insisting on placing strong negative covenants in their employment agreements and even taking lump sum deposits from their employees before allowing them to join.
Position of law
In Niranjan Shakar Golikari V/s The Century Spinning and Manufacturing Company Ltd, (as decided on 17.01.1967) the respondent company, manufacturing tyre cord yarn offered the appellant the designation of Shift Supervisor in the tyre cord division stating that if the appellant were to accept the said offer he would be required to sign an agreement in standard form for a term of five years. According to the negative covenants in the employment agreement; he would not be permitted, before the expiry of the term of the agreement, to engage directly or indirectly in any business or serve whether as principal, agent, partner or employee or in any other capacity either full time or part time in any business whatsoever other than that of the company. Further, the agreement mandated it that he shall keep confidential and prevent divulgence of any and all information, instruments, documents, etc., of the company that might come to his knowledge. Lastly, the agreement stated that if the employee left, abandoned or resigned from the services of the company in breach of the terms of the agreement before the expiry of the said period of five years, he shall not directly or indirectly engage in or carry on of his own accord or in partnership with others the business at present being carried on by the company and he shall not serve in any capacity, whatsoever or be associated with any person, firm or company carrying on such business for the remainder of the said period and in addition pay to the company as liquidated damages an amount equal to the salaries the employee would have received during the period of six months thereafter and shall further reimburse to the company any amount that the company may have spent on the employee’s training.
In the Golikari case the Hon’ble Supreme Court observed that the inhibitions contained in the clauses containing the negative covenants were not blanket restrictions as alleged by the appellant, and that the prohibition applied only in the event of the appellant leaving, abandoning or resigning his service during the term of and in breach of the said agreement. The Court held that;
“On this reasoning it held that Clause 17 was a reasonable restriction to protect the interests of the respondent company particularly as the company had spent considerable amount in training, secrets of know-how of specialised processes were divulged to him and the foreign collaborators had agreed to disclose their specialised processes only on the respondent company’s undertaking to obtain corresponding secrecy clauses form its employees and on the guarantee that those processes would be exclusively used for the business of the respondent company. Furthermore, Clause 17 did not prohibit the appellant even from seeking similar employment from any other manufacturer after the contractual period was over.”
Further, “…a restraint by which a person binds himself during the term of his agreement directly or indirectly not to take service with any other employer or be engaged by a third party has been held not to be void and not against section 27 of the Contract Act.”
Lastly, the Apex Court laid down that;
“Negative covenants operative during the period of the contract of employment when the employee is bound to serve his employer exclusively are generally not regarded as restraint of trade and therefore do not fall under section 27 of the Contract Act. A negative covenant that the employee would not engage himself in a trade or business or would not get himself employed by any other master for whom he would perform similar or substantially similar duties is not therefore a restraint of trade unless the contract as aforesaid is unconscionable or excessively harsh or unreasonable or one-sided…the negative covenant in the present case restricted as it is to the period of employment and to work similar or substantially similar to the one carried on by the appellant when he was in the employ of the respondent company was reasonable and necessary for the protection of the company’s interests and not such as the Court would refuse to enforce. There is therefore no validity in the contention that the negative covenant contained in clause 17 amounted to a restraint of trade and therefore against public policy.”
Now, in Jet Airways (I) Ltd V/s Mr Jan Peter Ravi Karnik, as decided on 17.04.2000 the Hon’ble Bombay High Court took a different view –
In the Jet Airways case, the plaintiff company made it clear that in consideration of the plaintiff making the arrangement for the training of the defendant trainee pilot, the defendant should agree and undertake that during a period of 7 years from the date of completion of training in India and abroad and on resuming actual services with the plaintiff as First Officer, he would not accept employment, similar in nature, either in full time or part time with any other em ployer. Further, In the event the defendant resigned from the services, he would make good to the plaintiff company, the entire cost in respect of training and/or damage, if any. The Hon’ble Court observed that, the total cost of training, which was approximately Rs 15 lakhs was actually to be paid for by the trainee pilots themselves in installments from their salaries, so the expenditure for training the pilots was actually not of the company’s.
The Hon’ble Court, in determining the main question, whether the negative covenant was in restraint of trade and therefore falling under the bar of Section 27 of the Indian Contract Act or not, held that;
“The negative covenant is not to protect any proprietary interest of the plaintiffs, for they have none. It has already been narrated in the facts above that the defendants have in fact financed their own training. The plaintiffs have merely advanced a loan which was being recovered from the defendants in installments…..I am of the considered opinion that the negative covenant is unconscionable, one sided, unreasonable and not for the protection of any proprietary interest of the plaintiff. Thus the negative covenant cannot be enforced by way of injunction.”
Further, the Hon’ble Court held that;
“Looking at the facts and circumstances of these cases it cannot be held that the restriction is reasonable and fair and not one sided. In spite of the fact that the defendants have not divulged any trade secret or information which is not available to the general public, they are sought to be restrained from exercising their profession. The defendants have undergone extensive specialised training and spent huge sums of money. Now they are sought to be prevented from making any use of this training merely because the training would be used whilst they are in the employment of the competitor of the plaintiffs. A negative covenant, the sole purpose of which is to avoid competition, cannot be treated to be a covenant by which the covenantee seeks to protect its proprietary interest. Whether or not a contract is reasonable has to be seen by examining as to what is the purpose of the restraint and as to whether it is justified.”
Lastly, the Hon’ble Court opined that;
“Furthermore, the plaintiffs can be suitably compensated by award of damages in the event the suit is finally decreed against the defendants and in favour of the plaintiffs. In my view, the plaintiffs have failed to show prima facie any legal or equitable right for the grant of injunction…”
In M/s Gujarat Bottling Co. Ltd. & Ors V/s The Coca Cola Co. & Ors., (Civil Appeal Nos. 6839-6840 of 1995, decided on 04.08.1995) the Hon’ble Supreme Court focused it’s attention entirely on the legality of negative covenants. It held that;
“A covenant in restraint of trade must be reasonable with reference to the public policy and it must also be reasonably necessary for the protection of the interest of the covenantee and regard must be had to the interests of the covenantee and regard must be had to the interests of the covenantor. Contracts in restraint of trade are prima facie void and the onus of proof is on the party supporting the contract to show that the restraint goes no further than is reasonably necessary to protect the interest of the covenantee and if this onus is discharged the onus of showing that the restraint is nevertheless injurious to the public is on the party attacking the contract. The court has to decide, as a matter of law, (i) whether a contract is or is not in restraint of trader, and (ii) whether, if in restraint of trade, it is reasonable.”
In Sandhya Organic Chemicals P. Ltd V/s United Phosphorous Ltd. & Anr., (Appeal From Order Nos. 19 with 20 of 1997, decided on: 04.02.1997) defendant No. 3, the Plant Manager was bound by certain negative covenants to the effect that he shall not disclose, divulge or publish during the tenure of his employment with the plaintiff or subsequently any confidential or secret information, including secret process and formulae acquired during the course of the employment with the company and upon termination of the employment or resignation, defendant No. 3 will return all papers and documents of the Company which may at that time be in his possession relating to the business of affairs of the company and he will not retain any copies or extracts there from.
The plaintiff claimed that it had invented a new process for manufacturing Aluminium Phosphide, in whose development the defendant No. 3 was involved. Therefore, when the defendant No. 3 joined the defendant No.1 Company, the plaintiff¸ apprehensive that the defendant 3 would divulge the trade secret and/or the new process for manufacturing Aluminium Phosphide to the defendant No.1 Company.
It therefore sought a permanent injunction against the defendants restraining them from adopting, using and resorting to, in any manner whatsoever, forming a new process as invented by the plaintiff for the manufacture of AIP and ZnP by using any information, knowledge, know-how relating thereto or any drawing or material relating thereto and from selling such products in the open market or secretly and from divulging, passing on any information, documents, drawing descriptions etc. The plaintiff, aside from this, claimed damages to the tune of Rs. 10 crore from the defendants alleging that they have committed illegal and wrongful act, breach of contract and breach of trust and thereby caused wrongful loss and damages to the plaintiff.
The Hon’ble Court in this matter found no ground to pass an injunction against the defendants, as it found that the defendants were manufacturing the product even before the defendant No.3 joined them.
Additionally, the Hon’ble Court also opined that;
“If at all the case of the plaintiff is believed that the process in question has been invented by it, it could have got it registered with the appropriate authorities. In absence of the same, I can only say that one cannot gel the proprietary right without the process being patented.”
Finally, an employment agreement must make provisions for suitable remedial measures in the event any dispute arises between the employer and the employee with regard to the agreement. It is beneficial to provide that in the event disputes arise, they should be referred to Arbitration under the provisions of Arbitration & Conciliation Act of 1996. Civil remedies are also available but they tend to take too long, in which case, suitable provisions under the Indian Penal Code pertaining to criminal misappropriation of property and provisions under the Information Technology Act of 2000 may be taken recourse to.