Should companies consider scrapping the non-compete clause?’

The ‘Non-Compete Clause’, which many companies have as part of their employment contract, is not a rarity. In fact, it is used to safeguard the interests of the organisation. It serves as a tool to protect vital information or trade secrets from getting leaked to competitors.

As per the ‘Non-Compete Clause’, post termination, the employee is not allowed to work for the direct competitors of the company for a reasonable period of time.

In the past, companies have used this policy to protect and preserve confidential information from rivals. However, with the recent case of Infosys grabbing headlines, questions are now being raised as to whether the clause should exist at all.

It is being alleged that companies have been using the ‘non-compete clause’ to deprive people of their livelihood. After all, if talent with specialised and niche skills are barred from working with other companies in the same domain, how will they earn their living?

“I am not a believer of ‘no competes’; I would rather get my house in order and ensure no poacher can strike my key people. But many companies still believe they are doing talent a favour. And such clauses will only keep the best away”

Prabir Jha, founder, Prabir Jha Advisory

“As a senior hire had once told me, ‘my entire life and experience is in the industry. I cannot sign myself out if it. It is like asking a doctor never to practise medicine,’” recalls Prabir Jha, founder, Prabir Jha Advisory.

So can we state that a policy which was formulated to safeguard the interests of the company is being used as a tool against the employees to scare them off so that they cannot resign or move on?

What is the real purpose of the non-compete clause?

As per the HR leaders, the non-compete clause’ in India is quite weak. In most cases, it does not stand any ground in a court of law in India. In fact, as per section 27 of the Indian Contract Act, 1872, “Every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void,” says the law. As per the law, any such agreement is against the public policy of the nation which deprives people of their fundamental right to earn a living.

Talking to HRKatha, Anil Bhat, employment law specialist & principal partner, LEX n CRAFT — who has been practising law for close to three decades and specialises in employment law — confirms that in most of the cases he has seen, the non-compete clause is never imposed on an employee. “In India, the law is employee friendly. The non-compete clause clearly breaches the fundamental rights of the employees to work freely in any profession or trade and goes against the public interest of working professionals,” shares Bhat.

If companies cannot legally enforce the non-compete clause on employees, then why do they have this policy at all in the first place? What purpose does this clause serve in an organisation?

“Originally, the non-compete clause was created to safeguard vital information of the company from reaching competitors. After all, it was possible for employees in roles which allowed them access to vital company information and trade secrets, to compromise that information and pass it on to the rival company on crossing over,” says Adil Malia, CEO, The Firm.

“Companies have been misusing the ‘Non-Compete Clause.’ They do not want to take care of their employees or engage with them, but when the employees decide to leave, they try to enforce the non-compete clause”

Adil Malia, CEO, The Firm

Now, however, Jha points out that this clause has been reduced to being a tool to restrict talent movement from crossing over to a rival firm. “Companies used these to stave off competition, from accessing their talent. One can still have IP protection for one’s products and processes but one worries about tacit knowledge leaking to competition through employees crossing over,” states Jha.

The non-compete clause can be enforced!

There have been multiple rulings by the Supreme Court and state High Courts of India, which have gone against the employers, and where the courts have said that such agreements are null and void when they clash with the fundamental rights of the people.

There is, however, a catch. Section 27 of the Indian Contract Act, 1872 also comes with an exception, which states, “One who sells the goodwill of a business may agree with the buyer to refrain from carrying on a similar business, within specified local limits, so long as the buyer, or any person deriving title to the goodwill from him, carries on a like business therein, provided that such limits appear to the Court reasonable, regard being had to the nature of the business.” In simple words, this means that such agreements can be enforced if the restrictions are reasonable and consistent with public interest.

“There are some special cases where the non-compete clause’ can be enforced,” says Bhat. For instance, let’s take the case of a company working on a very critical project amidst which an employee decides to leave the company and cross over to a rival firm. In such a case, if the rival firm is also working on some similar project, and if there is a possibility that the employee who has crossed over can leak vital information and trade secrets, the clause can definitely be enforced, provided that such a condition is mentioned in the employment contract.

Bhat points out yet another challenge here. “The company will have to first prove this scenario in the court, which will require it to reveal a lot of information about the project, which will get documented,” warns Bhat.

“Companies need to compensate people for the time period they remain unemployed due to the agreement, to make the non-compete clause’ enforceable”

P Dwarakanath, former chairman, GSK Consumer Healthcare

The ethical way

As per HR leaders, there is an ethical way to enforce the non-compete clause on people.

P Dwarakanath, former chairman, GSK Consumer Healthcare, believes that one can enforce the non-compete clause if one does it the right way.

1. Be specific and clear: The contract should be very clear. When the company mentions competitors, it is essential to clarify who these competitors are. “The word ‘competitor’ cannot encompass the entire universe,” says Malia.

Therefore, the HR leader suggests, that the organisation will need to specify exactly who all the competitors are. The best practice is to list the names of those specific companies in the contract.

2. Mention reasonable time period: The time period of the restriction post termination should be reasonable. That means, the contract will have to mention for how long the employee cannot join a competitor in the similar domain post resignation from or termination of employment. This time period can range from six months to two years.

3. Compensate: The company should compensate the employees for the time period they remain unemployed, at the rate of their last drawn monthly salary. “Companies need to compensate people for the time period they remain unemployed due to the agreement, to make the non-compete clause’ enforceable,” insists Dwarakanath.

“The employees are losing out on another opportunity due to the non-compete clause enforced on them. Therefore, it is the company’s responsibility to make sure that the employees are compensated for the same,” mentions Malia.

However, as per Bhat, even if the employees are compensated for the time period for which they are forced to remain unemployed, there may be instances where an employee may still choose to break the contract and join a competitor.

“One cannot stop or restrict a person from joining a competitor. However, in such a case, the employee will simply be asked to pay back the compensation amount with interest as mentioned in the employment contract or agreement,” clarifies Bhat.

“HR leaders are definitely aware that the non-compete clause is not a one-way street for the employers. It has a cost attached to it. Some companies just try to be smart and get away without compensating employees. However, people are now aware of their rights and are protesting”

Nihar Ghosh, former president – HR, Emami

Is the non-compete clause being misused by organisations?

Generally, the non-compete clause is meant for certain key roles or positions where the employees have access to confidential / vital information which also constitutes some of the critical talent for the company.

For instance, for a pharma company, people working as part of the R&D team and developing drugs and formulas, can come under the purview of the non-compete clause.

“I see that nowadays, companies have started covering even people from the middle management under the non-compete clause. One has to specify in advance which roles will be covered under the clause. One cannot just suddenly state one day that a person is bound by the clause,” asserts Malia.

Very often, “companies use the ‘non-compete clause’ to actually scare their employees, so that they do not resign and leave them,” says Nihar Ghosh, former president – HR, Emami.

“Companies have been misusing this clause. They do not want to take care of their employees or engage with them, but when the employees decide to leave, they try to enforce the non-compete clause,” alleges Malia.

Dwarakanath believes that organisations and HR professionals have simply tried to copy and paste the policies of some MNCs without clearly understanding the clause.

Ghosh, however, says that all organisations in India have competent and experienced HR leaders as part of their leadership team. Therefore, it is hard to believe that they may be unaware of the nuances and complexities pertaining to this clause.

“In India, the law is employee friendly. The non-compete clause clearly breaches the fundamental rights of the employees to work freely in any profession or trade and goes against the public interest of working professionals”

Anil Bhat, employment law specialist & principal partner, LEX n CRAFT

He points out that “HR leaders are definitely aware that the non-compete clause is not a one-way street for the employers. It has a cost attached to it. Some companies just try to be smart and get away without compensating employees. However, people are now aware of their rights and are protesting,” says Ghosh.

Should companies do away with the non-compete clause?

Clearly, the non-compete clause is not very strong in India, and companies cannot really restrict anybody from moving to another company, even if they happen to be their competitors. Does that mean this clause can be scrapped altogether?

Jha shares that during his stints as a CHRO, he actually decided to scrap the non-compete clause in many companies. “I believe it is a free world and there are many surrogate ways of beating a system. Strengthen the character and loyalty for your organisation rather than worry about what unending assassins could do!” advises Jha.

Personally, Jha is not in favour of a non-compete clause. “I believe tacit knowledge will outlive any time clause. I am not a believer of ‘no competes’; I would rather get my house in order and ensure no poacher can strike my key people. But many companies still believe they are doing talent a favour. And such clauses will only keep the best away,” adds Jha.

As a legal advisor, Bhat suggests that companies should not scrap the clause altogether as “this clause has the potential to safeguard the interests of the company in some special cases”.

The above discussion raises questions on the very existence of the non-compete clause in India. It is high time organisations brainstormed and gave a thought to whether this clause is ‘actually’ serving any purpose in terms of providing a strategic edge in business. If this clause is carried on with, will companies be using it in the right spirit? These are some of the questions that HR leaders will need to seek answers to.