Restrictive covenants in India: Evolving trends in employment law

Restrictive covenants remain central to Indian employment law debates, given that the country's persistently high attrition rate - 17.4% in 2024 - marginally improved but remains a significant concern for businesses and corporations. Beyond the statistics, high attrition leads to the loss of valuable talent and may harm an organisation’s external reputation.

In response, many organisations have increasingly begun incorporating such clauses into their agreements to address the rising challenges of employee turnover, moonlighting as well as the loss of expertise, creativity and investment in employee training.

While potentially useful, such clauses are counterproductive if not inadequately worded, considering that their enforceability is subject to judicial scrutiny under Section 27 of the of the Indian Contract Act 1872 (“ICA”), which voids agreements in restraint of trade except in the sale of goodwill.

This underscores the importance of crafting restrictive covenants with careful precision from the outset, not only to enhance their likelihood of being upheld but to also avoid protracted and costly litigation, which has the potential to compound the expenses associated with attrition.

In the prevailing business climate, employers often include restrictive covenants in employment contracts to protect proprietary information, trade secrets, and client relationships. Among the most used are non-compete and non-solicitation clauses.

A non-compete clause prohibits or limits an employee from working with a competitor or a rival organisation upon expiry of their employment. A non-solicitation clause prevents a former employee from soliciting employees, clients, suppliers, distributors and other business associates engaged with the company after termination.

Employees often tend to have unequal bargaining power when it comes to signing standard form employment contracts. Notably, Indian law does not recognise restrictions on trade or business. Nevertheless, Indian Courts have upheld such restrictions in limited cases.

Indian Courts have consistently held that post-employment non-compete clauses are unenforceable as they constitute a restraint of trade. While the non-compete clause is valid and reasonable during the term of the agreement, it is considered a restraint once the agreement ends.

In a recent ruling, the Delhi High Court held post termination employment restrictions are void and contrary to Section 27 of the ICA. Further, while assessing enforceability, the Court observed that negative covenants can only be inserted to protect the confidential and proprietary information of the employer or to restrain client solicitation. Broadly worded non-compete clauses are often deemed to be unenforceable.

Courts have varied in interpreting these clauses. In the case of Niranjan Shankar Golikari v. The Century Spinning and Mfg. Co. Ltd., the Court held that,

“A negative covenant that the employee would not engage in a trade or business or not get himself employed by any master for whom he would perform similar or substantially similar duties is not a restraint of trade, unless the contract is unconscionable or excessively harsh or unreasonable or one sided.”

Businesses have often circumvented the limitations of restrictive covenants by including garden leave provisions in employment contracts, requiring employees to stay away from work for a set period while receiving salary and benefits. The underlying rationale is that even after employment, the employee remains unavailable to competitors and is restricted from disclosing trade secrets and confidential information acquired during employment.

Courts have adopted divergent views on the enforceability of garden leave clauses, with some holding that such clauses, if intended to operate post termination of employment would prima facie fall foul of the ICA, being regarded as a restraint of trade, and employers cannot sidestep the law to further their own interests.

In the case of VFS Global Services Private Limited v. Mr. Suprit Roy, a garden leave clause intended to apply after the employee had served the notice period or upon cessation of employment was deemed unenforceable, constituting a restraint of trade. Conversely, in M/s. Kuoni Travel (India) Pvt. Ltd. v. Mr. Ashish Kishore, the Court upheld such a clause to protect trade secrets, noting that post-employment restrictions can be valid if tied to trade secret protection and if the employee is duly compensated.

Courts have evolved a nuanced interpretation for non-solicitation clauses, especially where these clauses are reasonable and serve to guard against legitimate business interests, including confidential and proprietary information, trade secrets or client relationships. These clauses are enforceable where they are reasonable and are not contrary to public policy.

For a non-solicitation clause to be valid, it must pass the test of reasonableness, that demands that restrictions placed are reasonable and proportionate to the protected interests. A non-solicitation clause would be reasonable if it is reasonable in terms of the restrictions placed on (i) Geographical Scope; (ii) Time Limit; (iii) Trade Secrets; and (iv) Goodwill.

Evolving work practices have introduced challenges such as job-hopping. To combat this, employers insert lock-in clauses to prevent an employee from resigning for a set duration from their appointment date. Lock-in periods operative during the term of a contract are not subject to Section 27 of the ICA; the only issue that remains is determining the quantum of damages that may be claimed.

In K Tapas K. Behera v. MD, O.H.P.C. and Ors, the Court held that employment bonds are enforceable if four key criteria are met: (i) the employer proves investment in the employee (e.g. Training); (ii) the investment is tied to a service commitment; (iii) loss results from the employees premature departure; and (d) the bond amount is reasonable and proportionate to the loss incurred.

In cases where the bond amount was unreasonable and the employer was unable to prove significant loss or damage, the courts have lowered the damages. Similarly if the employer could show they spent an equivalent amount on training, the court awarded damages.

To ensure the enforceability of such clauses, employers must ensure that the terms are reasonable, they should be clearly drafted and should only operate during the term of the employment rather than post-termination and a detailed record of investment made in the employee in terms of training and development should be maintained, in the event the need arises.

Standard form employment contracts prima facie shows unequal bargaining power and are scrutinised through the lens of undue influence and public policy concerns. Employers must keep in mind that the onus to prove a restrictive covenant is not in restraint of trade or opposed to public policy lies on them, not the employee.

About the authors: Rahul Deodhar is a Partner and Rencie Rodrigues is an Associate at Phoenix Legal.

Disclaimer: The opinions expressed in this article are those of the author(s). The opinions presented do not necessarily reflect the views of Bar & Bench.

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