Visiting the mythical notion of non-compete in the Indian contractual scenario

It is a common perception amongst entrepreneurs and businessmen that inclusion of a clause in any agreement restraining the other party from competing with itself is an effective protection. While no surprise to those initiated in the ways of the law, it comes as a shock to the others when you tell them this is just a myth.

To understand this, one must visit the genesis of it all – Section 27 of the Indian Contract Act, 1872. It provides that – every agreement that restrains anyone from exercising a lawful profession, trade or business of any kind is to that extent void. The only exception is to a case of a sale of goodwill and even then not all restraint is enforceable.

Non-compete clauses are common in everyday agreements, such as vendor supplier agreements and employee contracts. A lot of time, energy, and resource is spent in negotiating them. However, their enforceability is not only questionable but mostly unlikely. So, if you are wondering if your employee (whom you have trained and nurtured and who is in possession of your trade secrets) can just walk out and start the very same business next door – the simple answer is yes.

The Indian courts, however, offer some respite to the wailing business souls. A singular exception was created. It is hard to determine the basis of this exception. A deeper look therein would point towards the courts having succumbed to applying a reasonableness test to the provision that is otherwise absolute in its application (this is where Indian law significantly differs from English law, which allows reasonable restrictions).

An array of decisions from 1967 onwards have laid down the principles pertaining to Section 27 of the Indian Contract Act i.e. the jurisprudence of non-compete. Below is a summary of the non-compete principles applicable in India.

 Firstly, negative covenants operative during the period of contract of employment are valid. Also, clauses imposing exclusivity during the period for which the contract is in operation are valid.

Therefore, non-compete provisions in employee contracts operating during the term of the agreement are clearly enforceable.

As a corollary therefore, any agreement where the restraint of trade operates beyond the termination of the contract is void in toto. Neither the test of reasonableness nor the principle that the restraint being partial is reasonable are applicable to a case governed by Section 27 of the Contract Act, unless it falls within the exception dealing with sale of goodwill.

Therefore, any non-compete in your employee contracts that are intended to and/or by their very nature operate beyond the term of such contract is not enforceable post-termination – even with such termination was wrongful or not in accordance with the terms of the contract

In 1995, the Supreme Court extended the principle of valid restraint in contracts for personal service to commercial agreements as well. This position was upheld and further extended to a right of first refusal that is operative during the term of the contract. This same principle was used to determine that the right of first refusal contained in the commercial contract couldn’t offer a right in perpetuity to the supplier of services to have the agreement renewed with his customer.

In 2012, the Calcutta High Court threw light upon the principles on which break away firms i.e. firms started by ex-employees of an organization can conduct a business similar to the business of the ex-employer. The conditions are as follows:

  • There is no active solicitation of the ex-employers customers
  • There is no infringement of the ex-employers’ intellectual property rights
  • Such business is conducted without using any proprietary information of the ex-employer.

Thus, in order for a non-solicitation clause to be enforceable, one would have to prove at least one of the three points provided above. Also protection under Section 27 is not available to any one who conducts business in violation of another’s intellectual property or trade secrets and /or on the basis of confidential proprietary information of that other.

In a nutshell, the principle is that if a negative covenant in the contract is in furtherance of business (such as exclusivity as long as the joint business lasts) – such a covenant is valid. However, any negative covenant that is in restraint of trade or carrying out of any business is void under Indian law without any scope to test its reasonableness.

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