Non-compete clauses: Unenforceable under law, but companies love them

Bengaluru/Mumbai: Non-compete clauses are still very much part of employment contracts in India, despite being unenforceable under the law, according to legal experts. Earlier this week, the US Federal Trade Commission banned such clauses for US workers. These typically restrict a worker’s ability to join a competitor for a certain period after quitting and are aimed at dissuading employees, particularly those at the senior level, from going over to rivals.

Companies also say such clauses are needed to ensure security of data.

While Indian law is clear on the unenforceability of a non-compete clause operating beyond the term of employment, companies still include it in contracts, particularly for senior executives, as it’s seen as a soft deterrent, said Jay Parikh, partner at Luthra and Luthra Law Offices. Employees would rather comply than bear litigation costs and carry the burden of being sued by their previous employer.

“Indian employees are not inherently litigious and therefore they tend to be compliant with their non-compete obligations, especially since the consequence of breach set out under their agreements is generally severe,” said Parikh.

In November 2023, for instance, Wipro filed a lawsuit against former CFO Jatin Dalal, seeking damages of Rs 25.15 crore plus interest for violating the non-compete clause in his employment contract. Dalal, who joined Cognizant as CFO in December, submitted a counter-application and the matter was referred to arbitration.

Some Deny ESOPs, Other Incentives
In 2022, Nascent Information Technology Employees Senate (NITES), an organisation representing IT workers, filed a complaint with the labour ministry against Infosys for including a non-compete clause, calling it illegal under the Indian Contract Act.

“Non-compete clauses keep wages low, suppress new ideas, and rob the American economy of dynamism, including from the more than 8,500 new startups that would be created a year once non-competes are banned,” said FTC chair Lina M Khan on April 23. “The FTC’s final rule to ban non-competes will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.”

Khaitan & Co. partner Vinay Joy attributes the inclusion of non-competes to two main reasons. One is the view that some employees may not know their rights, leading to these clauses acting as a curb. The other is the expectation that Indian courts may allow for covenants to stand if they look to protect legitimate business interest, as has happened in the UK.

Post-employment non-compete covenants are also being used to deprive employees of accrued stock options and other contractual incentives.

“We have seen some companies issuing legal notices and threatening to cancel options of employees who look to join competitors,” Joy said. “A number of senior employees cave in to some of their demands as they would rather not get embroiled in such situations.”

Where companies have issued legal notices, some employees have delayed joining dates by three to six months to try and placate the former employer.

“However, in situations where the employee pushes back, the employer has little realistic chance of success before a court. But they may still take the employee to court to cause inconvenience,” said Joy.

A partner at a professional services firm said that legal notices are often issued as a warning to others. “We did it recently with a senior employee who left us to join a competitor, despite knowing that nothing will come of it,” he said.

Data privacy
Industries where non-compete clauses are more .prevalent include information technology (IT), IT-enabled services (ITeS), tech, finance, healthcare and professional services where employees often deal with sensitive information, client relationships and there’s intense competition for talent. Lately, it has spilled over to micro, small and medium enterprises (MSMEs) as well.

“At senior levels, these kinds of terms and conditions become more important to be highlighted to ensure that, to the extent possible, companies create barriers to any leaks of competitive, strategic information,” said Anandorup Ghose, partner, Deloitte India.

Sangeeta Gupta, senior VP of IT industry lobby group Nasscom, said: “The concerns are around data privacy, client confidentiality etc.”

Such situations can arise in the consulting sector, where entire teams move from one company to another. Or in IT, where an employee moves to a competitor and works on the same customer’s projects.

A primary motivation for including non-compete clauses is to protect trade secrets, proprietary information and intellectual property, said Vikram Singh, senior partner at law firm Circle of Counsels. “By restricting former employees from joining competitors, companies aim to safeguard their valuable assets and maintain a competitive edge.”

In highly competitive industries with limited talent pools, non-compete clauses help companies maintain their market share by restricting the movement of skilled employees to rival firms.

“This is particularly important in industries where talent acquisition and retention are critical for success,” Singh said.