In the domain of employment contract, competent clause plays an important role inorder to protect the right of the employers. The competent clauses serve as foundational document that define the right and responsibility of both employer and employees. It is a legal agreement or clause and is a legally binding contract which prohibits an employee from engaging in competitive activities with their employer once the employment period has ended. These clause further forbids the employee from disclosing confidential or classified information to any other party during or after their employment.[1] It can encompass the act of revealing confidential information or trade secrets that were acquired while working for the company. [2] In countries such as United Kingdom, USA, India, Nepal non-compete clauses are applied with different levels of enforceability.
Non-compete clause in USA
Non-compete clause are generally permissible in most states, as long as the limitation imposed by the agreement are deemed to be fair. The characterization of what is fair is often left upon the courts. For instance, in the case of Karpinski v Ingrasci[3] the Court examined temporal, geographical, and subject-matter limitations to assess the reasonableness of a noncompetition agreement between dentists. In the end, the Court determined that the time and geographical features were appropriate. However, the subject-matter limitation was deemed too wide since the agreement encompassed both oral surgery and dentistry, rather than only oral surgery.
However, several states prohibit the majority of non-competition agreements due to public policy consideration. The California’s Business and Professional Code §16600, known as the invalid Contracts provision, stipulates that any contract that restricts an individual from participating in a legal profession, trade, or business is considered invalid, unless otherwise specified in this chapter. Consequently, non-compete agreements are considered invalid in the State due to their unreasonable restriction on commerce.[4]
Federal Trade Commission (FTC)
FTC is an independent, bipartisan agency of US government tasked with protecting consumers and ensuring a strong competitive market. Its principal purpose is to enforce non-criminal, antitrust laws in US and it seeks to protect consumers from misleading business practices. [5] The organization lacks the power to impose penalties on those who break the rules. However, it is capable of overseeing adherence to trade regulations, carrying out lawful inquiries, issuing orders to stop certain activities, organizing public hearings, initiating civil lawsuits in U.S. district courts, and ensuring compliance with court rulings.[6]
The Federal Trade Commission (FTC) published a final regulation on April 23, 2024, which prohibits the use of non-compete provisions. The purpose of this rule is to safeguard the ability of workers to switch employment, foster innovation, and stimulate the creation of new businesses.
The Federal Trade Commission (FTC) initially implemented the proposed prohibition on January 5, 2023. The prohibition is expected to benefit around 30 million individuals. According to this new regulation, non-competition agreements now in place will not be legally binding for most employees, although they may still be enforced for high-level executives. Companies are prohibited from imposing new non-competition agreements on any employee, regardless of their position as a senior executive or not. The commission found that employers have several alternatives to non-competes such as trade secret laws and non-disclosure agreements.
Several parties have pledged to promptly filing judicial challenges against the regulation, and lengthy legal proceedings might result in a delay of several years before a definitive decision is reached regarding the rule’s constitutionality or eventual implications. These challenges are expected to involve questioning the FTC’s ability to make rules, as indicated by a previous FTC commissioner’s disagreement when the rule was initially suggested, and by remarks made by the two opposing commissioners during the public Commission meeting.[7]
In the case of Edwards v Arthur[8] it was held Non-competition agreements are considered illegal according to the law, regardless of how specific they are, unless they meet the specific exclusions outlined in the laws.
Non-compete clause in UK
The UK government is now considering a proposal to restrict non-compete agreements to a maximum duration of three months. The outcome of this, especially considering the next election, remains uncertain. However, the government’s intervention has made it clear that even restrictive covenants are not exempt from meddling. Employers must implement enough protections to maintain a robust approach to company protection, regardless of any potential reforms that may be implemented.[9]
Non-compete provisions are not included in the UK employment statutory framework, even in Northern Ireland where employment law is devolved. There is currently no legally defined explanation for this. Non-compete agreements are governed by the common law notion of “restraint of trade”. The principle states that a worker should have the freedom to pursue their profession and utilize their skills without excessive interference. Consequently, any contractual term, such as a non-compete clause, that aims to limit the worker’s ability to work for other employers or engage in their trade or business is considered invalid unless it meets two conditions:
1 It is intended to safeguard legitimate business interests,
2 It is not broader than reasonably necessary.
Therefore, in cases where non-compete clauses are included in employment contracts, their enforceability is not guaranteed unless a court determines that the condition is intended to safeguard a “legitimate business interest” and is not overly restrictive. Merely demonstrating that the employer would experience more competition is not considered a valid business interest.
Generally, the courts have acknowledged that a valid business interest may involve safeguarding trade relationships (with customers, clients, or suppliers) and, more broadly, goodwill; trade secrets and other classified information; and ensuring the stability of the workforce. Relevant criteria that a court may consider while determining the reasonableness of a provision include the worker’s employment role and level of influence. The spatial extent of any limitation, The duration of the post-termination limitation, The specific interest and characteristics of the enterprise being safeguarded
It is important to acknowledge that a court will evaluate each disagreement individually, taking into account the specific circumstances of each employee. In the United Kingdom, employers and employees have the freedom to negotiate and choose the terms of an employment agreement. Since a result, each contract may vary since it is tailored to the unique circumstances of each worker. The validity of a non-compete provision cannot be determined by a fixed formula, and thus, there is no definitive checklist for employers to guarantee the success of such restrictions. [10]
Non-compete clause in India
Section 27 of the Indian Contract Act, 1872 pertains to agreements that restrict commerce. According to this provision, any agreement that limits someone from practicing their legal profession, trade, or other form of business is considered invalid to that extent. This clause is founded on the idea that every individual possesses the entitlement to secure a means of subsistence, and any contractual arrangement that limits this right is deemed contrary to the interests of the general public. As to Section 27 of the Indian Contract Act 1872, any agreement that restricts someone from engaging in a legal profession, trade, or business of any sort is partially invalid. Non-compete provisions are deemed unenforceable in India since they are viewed as impeding commerce and violating Section 27 of the Indian Contract Act. Nevertheless, there are some exceptions and situations in which a non-compete provision may be deemed legal and enforceable, including:
During the employee’s tenure, you have the authority to prohibit the employee from participating in any action that directly or indirectly competes with the employer’s lawful interests.
Following the end of employment, an employee may be prohibited from using or revealing any trade secrets, confidential information, or proprietary data of the employer, provided that the duration, extent, and geographic area of the restriction are reasonable and do not pose a threat to the employee’s ability to make a living. Courts apply the idea of “the rule of reasonableness” to determine the validity of limits.
A non-compete clause can be considered valid and enforceable if it is included in a transaction involving the transfer of goodwill or a partnership agreement. In such cases, the seller or outgoing partner agrees not to engage in a similar business within a specific geographic area and time period. This provision is intended to safeguard the buyer or remaining partners from unfair competition.
Courts possess the authority to individually assess each case and determine whether a non-compete provision is justifiable and essential for safeguarding the lawful interests of the parties concerned.
In the case of Superintendence Company of India (P) Ltd. vs. Krishan Murgai[11] This landmark judgment established a crucial legal standard, stating that non-compete agreements should be customized to achieve a just equilibrium between the employer’s demand for safeguarding and the employee’s entitlement to follow their occupation.
In the case of Percept D’Mark (India) Pvt. Ltd. vs. Zaheer Khan & Anr (2006)[12] this is a recent case in India that pertains to the non-compete clause. The primary matter in this case was on the validity of the non-compete clause for a duration of 3 years as per Section 27 of the Indian Contract Act of 1872. The Bombay High Court ruled that a non-compete provision, which prohibited a cricketer from promoting any rival brands of the company for a period of three years after the contract’s termination, was legally binding and enforceable. The court deemed it reasonable and essential to safeguard the company’s exclusive rights to the endorsement.
In the case of Niranjan Shankar Golikari vs. The Century Spinning and Manufacturing Co. [13](1967), the Supreme Court ruled that a contractual agreement where an employee is obligated to work exclusively for their employer and refrain from engaging in any other business activities is not considered a restraint of trade. Therefore, such agreements are not governed by Section 27 of the Indian Contract Act.
Non-compete clause in Nepal
There is no provision in Nepalese legislation which directly talks about non-compete clause, however, if we closely analyse the National Civil Code, 2074, especially Section 517, we can deduce the essence of non-compete clause from it.
Section 517 deals with the Void Contracts. It lists down the contracts which shall be void. In its Subsection 2 (a) a contract that restraints anyone from exercising any profession, trade or business which is not prohibited by law shall be void. However, in the Proviso it lists out the circumstances where a contract will not be considered to restraint anyone from exercising any profession, trade or business. Such circumstances are dealt in detail below:
Section 517 (2) (a) (2) of the National Civil Code, 2074 says that a contract concluded between the partners to restrain them from doing the same profession, trade or business as that of the partnership firm or any other profession, trade of business toegther with other persons who are competitors of the profession, trade or business of the same nature other than the profession, trade or business of the partenrship firm until the partnership exists.
Subsection 2 (a) (3) of the same Section states that a contract between partners restraining them from practicing a profession, trade, or business of the partnership firm for a reasonable term or in a specified location following separation.
Similarly, Subsection 2 (a) (4) states a contract so concluded between a person and any person, firm, company or body that the person is restrained from accepting the servcice of another person, firm, company or body who is the competitor of such other person, firm, company or body until the person is in the service of, or for a specifiede period after retirement from the service of, such other person, firm, company or body.
Thus, the National Civil Code, 2074 does not explicitly defines ‘non-compete clause’, however, it does acknowledge and regulates them wihtin the above mentioned frameworks.
Section 535 of the National Civil Code 2074 talks about breach of contract. This section states that if any party to a contract fails to fulfill the obligation under the contract or gives a notice to the other party that he or she will not perform the act to be performed by him or her under the contract or his or her action and conduct demonstrate that he or she is incapable of performing the act under the contract, the party shall be deemed to have breached the contract.
In Section 537 of the National Civil Code, 2074 entitles the aggrieved party the right to receive compensation for the breach of contract. It states that, in the case of a breach of contract under Section 535, the aggrieved party shall be entitled to recover the actual loss or damages incurred from the breach of contract, or any loss or damages that the contracting parties knew about when they made the contract, from the party who breaches the contract. In addition, when parties designate a sum for breach of contract at the time of contract, the aggrieved party can recover the same amount without exceeding it from the other party. If the contract does not provide for compensation, the party claiming such compensation shall be entitled to recover a reasonable amount for the direct and actual loss or damage resulted from the breach of contract.
With respect to compensation, the Supreme Court of Nepal has interpreted that the court has broad discretion in determining compensation for breach of contract, requirig an accurate assessment of actual damages.
Further, Labour Act, 2017 (2074) Section 11 says that no one should enter into employment without employment contract. Further sub-section 3 of the same section states, While entering into an employment contract, remuneration, benefits to be received by the labour, conditions of employment and other matters as prescribed shall be set out in such a contract.
Analysis
A non-compete clasue is a provision in contract that restricts one party, typically an employee from engaging in certain activites that could compete with the other party’s, mostly employer, business after the contract ends or during the validity of the contract. In Nepal, contract is governed by the National Civil Code, 2074. While the Code generally invalidates contracts that restrict individuals from engaging in lawful professions, trades. or businesses, it makes exceptions that prevent individuals from working with competitors i.e. non-compete clause. These clauses can apply in both employer-employee and partnership contexts, reflecting a broad scope of application. If such clause is breached, the aggrieved party may seek compensation under the Code, making these provisions enforceable and legally significant.
To conclude, the legal framework surrounding non-compete clauses in Nepal is open to interpretation and lacks definitive clarity. By interpreting the National Civil Code and the Labour Act, one could argue that non-compete clauses not only restrict employees from working in the same business as their former employer but also implicitly prohibit them from disclosing trade secrets and soliciting clients. However, it is important to note that non-disclosure and non-solicitation agreements are not specifically mentioned in Nepalese law. This ambiguity presents challenges for employers in enforcing such clauses and leaves employees without clear guidelines on their rights and obligations. To ensure legal clarity and protect the interests of all parties involved, Nepal would benefit from enacting specific legislation that governs non-compete clauses, including potential limitations on their duration and scope. This would foster a more balanced and predictable legal environment for businesses operating in Nepal.
[1] Adam Hayes, What is non-compete Agreement? Its purpose and requirement, Investopedia, https://www.investopedia.com/terms/n/noncompete-agreement.asp
[2] Non- competition agreement, Cornell Law School, https://www.law.cornell.edu/wex/noncompetition_agreement
[3] Karpinski v. Ingrasci, 268 N.E.2d 751 (1971)
[4] Non- competition agreement, Cornell Law School, https://www.law.cornell.edu/wex/noncompetition_agreement
[5] Adam Hayes, Federal Trade Commission: What it is and What it does, https://www.investopedia.com/terms/f/ftc.asp
[6] Connolly-Ahern, C. (2024, August 8). Federal Trade Commission. Encyclopedia Britannica. https://www.britannica.com/money/Federal-Trade-Commission
[7] Daniel Turinsky, FTC issues final rule banning noncompete clauses, https://www.dlapiper.com/en/insights/publications/2024/04/ftc-final-rule-banning-noncompete-clauses
[8] Edwards v Arthur, 44 Cal. 4th 937, 189 P.3d 285, 81 Cal. Rptr. 3d 282
[9] Non-compete reform and the impact on business protection strategies, Farrer & co., https://www.farrer.co.uk/news-and-insights/non-compete-reform-and-the-impact-on-business-protection-strategies/#:~:text=A%20non%2Dcompete%20(or%20non,reasonableness%20established%20by%20case%20law.
[10] Department for business innovation and skill, non competence clauses, https://assets.publishing.service.gov.uk/media/5a7f68b440f0b6230268f53d/bis-16-270-non-compete-clause-call-for-evidence.pdf
[11] Superintendence Company of India (P) Ltd. vs. Krishan Murgai , 1980 AIR 1717
[12] Percept D’Mark (India) Pvt. Ltd. vs. Zaheer Khan & Anr (2006), AIR 2006 SUPREME COURT 3426
[13] Niranjan Shankar Golikari vs. The Century Spinning and Manufacturing Co, 1967 AIR 1098