Non-compete clause: Can employer impose restraint upon former employees?

The employment contracts of employees are governed by the Contract Act 1872, and section 27 of this Act declares all the agreement in restraint of trade, lawful profession or business as void, except in the cases specified in the exception. Although an agreement of service by which an employee ties himself during the period of his employment, not to compete with his employer directly or indirectly, is not in restraint of trade, profession, or business.

The contract of service may have a negative clause by which employee may be restrained from participating in any business in direct competition with that of his/her employer during the employment period. In the case of Niranjan Shankar Golikari v The Century Spinning and Mfg. Co. Ltd. (1967), the Supreme Court of India ruled that “a contract of service preventing an employee from working elsewhere during the course of employment, is not void. The employee shall abstain from taking up other employment for the remainder of the fixed term period.” In another case of Charlesworth v Macdonald (1898), the Court explained, “an agreement of this class does not fall within section 27. If it did, all contracts of personal service for a fixed period would be void. An agreement to serve exclusively for a week, a day, or even for an hour, necessarily prevents the person so agreeing to serve from exercising his calling during that period for anyone else than the person with whom he so agrees.” However, it is to be noted that, the decision of these cases should be considered as an exception of section 27 of the Contract Act 1872.

Nevertheless, an agreement of service which restrains an employee from competing with his employer after the end of the employment period may not be allowed by the court. While, post-employment restraint is assumed to be unenforceable and void under section 27 of the Contract Act 1872 unless the employer who is looking to enforce it, it is enough competent to illustrate that the non-compete clause was reasonable and logical at the occasion when it was agreed. In the case of Buckley v Tutty (1971), the High Court of Australia states that, “Unreasonable restraints are unenforceable as it is contrary to public welfare that a person should be unreasonably prevented from earning a living in whichever lawful way he chooses and that the public should be unlawfully deprived of his services.”

A non-compete clause should not be used as a weapon to impose a restraint upon former employees and to protect the employer from the competition. Although, if the employee holds confidential information or has personal contract with employer’s customers, then the employer is entitled to get reasonable protection against exploitation of trade secrets [Younger LJ in Attwood v Lamont (1920)]. To establish the reasonableness of the non-compete clauses, the employer needs to prove the legitimacy behind the restraint, and the period of restraint should be measured in a sensible manner. The English Court observed in the case of Herbert Morris Ltd v Saxelby (1916) that, “a restrictive covenant will not be enforced unless the protection sought is reasonably necessary to protect trade secrets or to prevent some personal influence over customers being abused in order to entice them away.”

Recently, the Federal Court of Australia held the post-employment restraint as reasonable and enforceable in the case of HRX Holdings Pty Limited v Pearson (2012). The Court identified some factors upon which the success of the enforcement of post-employment restraint depends. According to the Court, the employer should conduct a formal discussion with the employees regarding non-compete clause and monetary or other compensation, which will be provided. Prior to signing the contract obtaining legal advice from experts in relation to the restraint is vital because it shows that the employee took enough time to think and the employer did not put stress upon him/her to sign the contract. Additionally, the non-compete clause should be carefully worded, and reasonable restrictive provisions are required to draft an employment contract.

The writer is Trainee Lawyer, Rahman & Rabbi Legal.