Non-Compete Restrictive

Covenant
Approaches and Perspectives

Non-Compete Agreement
A Non-Compete Agreement seeks to protect the interests of the

employer by restraining the employees from working for competitors

(or even client) after the termination of employment relationship
A Non-Compete Agreement could be
Part of Valid Employment Contract which is signed by the employee

during the inception of employment relationship

Or ancillary to a valid employment contract which is signed by the
employee upon change in employment conditions such as taking up
higher responsibilities during a promotion or salary increase etc.,
A Valid Non-Compete Agreement could be ancillary to other types of

agreements like
A valid non-compete clause can be ancillary to other types of
agreements such as
Pension Agreement
Independent contractor agreements
Change of control (CoC) agreements
Shareholder agreements
Settlement agreements
Lease agreements or
As part of the sale of a business

Freedom of Occupation Approach to NonCompete Agreement

Principle Freedom of Occupation
Factors Employee Mobility, Freedom to Pursue a Lawful

Profession or Trade
For example, in Pepsi Vs Coke case, the Delhi High Court

ruled that, Injunction cannot be granted to create a

situation such a "Once a Pepsi employee, always a
Pepsi employee
Outcome Cannot Be Enforced or Should not be enforced
Others Article 19(g) of Constitution of India and Section

27 of the Indian Contract Act, 1972

Freedom of Occupation in India

Freedom of Occupation

is guaranteed under the Constitution of India

i.e., Article 19 (g) to practise any profession, or to carry on any
occupation, trade or business

Under

Section 27 of the Contract Act, a service covenant

extended beyond the termination of the service is void.

Agreement in restraint of trade void.- Every agreement by which any

one is restrained from exercising a lawful profession, trade or business

of any kind, is to that extent void. Saving of agreement not to carry
on business of which goodwill is sold. (Section 27, The Indian
Contract Act, 1872)
Exception 1: 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.

Non-Compete Covenant Is per se

Invalid
Principle - Mutuality of Obligation
For example, the story of Merill Lynch where the NY jurisdiction

held that, An essential aspect of the employment relationship is

the employers willingness to employ the party covenanting not to
compete. Where the employer terminates the employment
relationship without cause, however, his action necessarily
destroys the mutuality of obligation on which the covenant
rests as well as the employers ability to impose forfeiture
Factors Considered - Exit (Voluntary / Involuntary), Cause (With or

Without Cause)
Outcome - May or May Not Be Enforceable
Others Non-Compete Agreement in the context of Constructive

Discharge

Presumption For or Against Enforcement of

Non-Compete
Principle Mutuality of Obligation (Shadow Principle)
Factors Worth (Performance) / Ability of Employee to Compete
For example, in the story of Insulation of Corporation America it was held

by the court that, the employer who fires an employee for failing to

perform in a manner that promotes the employers business

interests
deems
the
employee
worthlessUnder
such
circumstances, we conclude that it is unreasonable as a matter of
law to permit the employer to retain unfettered control over that
which it has effectively discarded as worthless to its legitimate
business interests. . However, it must be kept in mind that
reasonableness is determined on a case-by-case basis
Outcome May or May Not Be Enforceable
Others Change of Control Contracts (Single Trigger, Modified /

Delayed Single Trigger , and Double Trigger Contracts and

Assignability Related issues)

Change of Control Contracts (COC)

The employment contracts specify pay and benefits that the

executive will receive if the executive loses his or her

position following a defined change of control (COC).

A) a specific percentage of the voting shares that have

been acquired by a person or organization (typically not

less than 20 percent)
B) a merger
C) a sale of a stated portion of companies assets
D) a specified change in the composition of the board of
directors
E) Liquidation or dissolution of the company
Typically these are called Golden Parachutes

Types of Golden Parachutes

Single Trigger Contract
The merging companies or the acquiring company may identify the roles

which would be redundant post merger / acquisition and would ask the
executives occupying the position to leave voluntarily within a month
following a change in control. These executives would be provided with
necessary severance compensation and benefits as negotiated under
the single trigger contract.

Modified (or Delayed) Single Trigger Contract

The merging companies or the acquiring company may decide to retain

a key executive for a specific period, typically 1 year, through a modified

single trigger contract which seeks voluntary exit of the executive after
a one year anniversary of the defined change of control i.e., acquisition
or merger. This delayed single trigger contract ensures a smooth
transition of leadership roles in the merged / acquired entities.

Double Trigger Contract

Double Trigger Contract period ranges between two to three years where

post merger / acquisition, the executives may be terminated for a good

cause, like overlapping roles etc., or they may leave voluntarily with
necessary severance compensation and benefits.

Good or Bad Faith Approach

Principle Mutuality of Obligation (Shadow Principle)
Factors Intent / Motive / Conduct of Employer or

Employee
For example, in the story of Rao Vs Rao, it was held by
the court that , Haris work performance was
satisfactory and that he was terminated by Mohan
because Mohan did not want him to exercise his
contractual right to obtain a 50% percent stake in the
corporation. In every contract, both parties act in
good faith. The implied promise of good faith modifies
Mohans discretionary right to dismiss Hari and then to
invoke the RC.
The absence of good faith may be construed as the

presence of bad faith.

Balancing Equities Approach to NonCompete

Principle Balance of Equities for all the stakeholders
Factors Exit (Vountary or Invountary), Standard of Reasonableness,

the effect of enforcement on the discharged employee; and the

public interest in the employee being able to continue in the field.
For example, in Ma & Pa Inc Vs Kelly, the employer terminated a
salesman of petroleum products during the 1982 recession due to
change in market conditions and unprofitable commission
arrangement. The Supreme Court of Iowa held that the Non-Compete
Agreement was not enforceable due to
The discharge by the employer (Involuntary Exit)
The hardship to the employees family if the injunction were
upheld
The employees limited skills in other fields
His attempts to find other jobs without success
The fact that his employment was terminated during a
recession (public interest)
A well-known field of potential customers in the industry; and

The former employers uncompetitive pricing

Others Standard of Reasonableness, Blue Pencil Doctrine

Standard of Reasonableness
Standard of Reasonableness will be scrutinized by the extent of
restraint including;
Non-compete Duration (Time or Temporal Dimension);
Territorial Scope (Geographical Dimension),
The nature of Business or Profession involved, including the
employees position and duties:
The effect of enforcement of non-compete agreement on the
discharged employee; and
The Public Interest in the employee being able to continue in
the field;
In a nutshell, The standard of reasonableness of Restrictive
Covenants could be determined by examining the three factors
1. Whether the restriction is greater than necessary to protect
the business and goodwill of the employer
2. Whether the employers need for protection outweighs the
economic hardship which the covenant imposes on the
departing party; and
3. Whether the restriction adversely affects the interests of the
public

Blue Pencil Doctrine

The court determining that the restrictive covenant is

overbroad and modifying them using the standard

of reasonableness so that they are narrowly tailored to
protect the employers interest

Freedom of Contract Approach

Principle

Freedom of Contract

This

approach assumes contracting parties, as rational individuals, have the

capacity the contract and protect their legitimate interests. This essentially
means that parties even have the choice not to contract or contract with
adequate measures to protect their interests under different circumstance.
Thus it implies that the party breaching the contract, therefore, should face
the consequences of breach as agreed irrespective of the hardship of the
individual.

The

underlying presumption in this approach is that there is a balance of

power between contracting parties i.e., between the employer and the
employee, often which is not the case in Employment Relations. Thus, this
approach could be recognized as a pro-employer approach as organizations
draft the contract to protect their interests whereas individual employees
rarely negotiate to make changes to the contract to protect their interests.

Factors

Only Reasonableness with reference to temporal and

geographic limitations need to be considered as relevant and not to
balance the equities i.e., unlike the Balancing Equities Approach. Not to
consider whether the exit was voluntary or involuntary or even the effect of
enforcement of non-compete which would lead to unjust result (for the
employee). Thus, this is also known as Discharge is Not A Factor to
Consider approach.

Chinese Approach to Non-Compete

Agreement
An employment agreement may include provisions intendedto

protect the trade secretsof the employer. A non-competition

agreement may be included in support of such protections.
Non-competition agreements arelimited to
Executives,
Technical personnel, and
Other personnel who have access to trade secrets.

Cases have held that senior sales staff are included in this

category. On the other hand, blanket agreements that apply to

all employees are invalid.
The terms of the restrictionmust be reasonable in length
of restriction, business scope and geographic area.
A term in excess of two years is prohibited.
The scope requirement is strictly interpreted. It is not sufficient
that the employee is working in the same general area as the
former employer.Competition must be specific and direct.

Chinese Approach to Non-Compete

Agreement
Theemployer must pay reasonable compensation

on a monthly basisto the employee during the term of

the non-competition period. There is no definition of
reasonable compensation. Commentaries suggest
employees should be compensated in a manner
equivalent to their salary with the company. Others
suggest that compensation is only required at the level
of the current minimum wage in the relevant jurisdiction.
If the employee violates the terms of the non-compete
agreement, theemployee can be held liable for a
payment of contract damagesto the employer. The
amount of contract damages must be reasonable.
Excessive damages that are clearly punitive will be
rejected.