[By Dhananjay Dubey]
The author is a student of Institute of Law Nirma University, Ahmedabad.
Introduction
A Non-Compete Agreement is a legally enforceable agreement in which the “Restricted Party” agrees not to participate in any competitive activities during and for a set period after the termination of their commercial relationship with the “Protected Party.” It is a common tool used by businesses to retain valued employees, protect secret information and customers, and prevent unfair competing activities. Employment terminations, contractor or consultant engagements, corporate partnerships, and mergers or acquisitions are all scenarios that use non-compete agreements. In exchange for accepting the constraints, the Restricted Party must be given consideration, such as job offers or monetary recompense. The Agreement prohibits the publication of confidential information, even after the termination of employment.
FTC’s Ban on Non-Compete Agreements: A Shift in Competition Law
Recently in the month of January 2024, the (Federal Trade Commission) FTC issued a rule to ban non-compete agreements to protect competition across the country. On 23rd April 2024, the proposed rule came into effect after much deliberation. The said rule bans all types of non-compete agreements as violative of Section 5 of the FTC Act which prohibits unfair or deceptive practices affecting commerce. The framework of the rule is broad, prohibiting not only non-compete agreements but also other parallel arrangements that serve similar goals. This rule applies to any agreement that prevents or penalizes employees from exploring opportunities with competing companies.
Under the final regulation, new non-compete agreements for top executives earning more than $151,164 per year and holding major policymaking roles, such as presidents or CEOs, are forbidden, although existing agreements are still lawful. This differs significantly from the proposed regulation, particularly in terms of the treatment of existing agreements and notice obligations. Existing non-compete agreements do not require a formal termination. Firms must notify non-senior executive staff with existing agreements that they will no longer be enforceable once the law is implemented, allowing them to pursue other alternatives. The FTC provides a sample notice for clarity and uniformity, emphasizing employees’ ability to pursue their professional goals unrestricted.
Exception to the Final Rule
Exceptions to the rule exist for certain settings and entities. Firstly, non-solicitation and non-disclosure agreements are exempted, although employers should exercise caution as overly restrictive clauses may still breach the law if they unduly limit individuals from working in the same field. Secondly, the rule does not cover in-term non-compete agreements, which restrict competition during employment. Additionally, entities excluded from the FTC Act, like banks and insurance companies, are not bound by the regulation. Franchisee/franchisor contracts are also exempt, though workers of both parties remain protected. Crucially, the final regulation includes an exception for the sale of a business, allowing non-competes in bona fide sales without mandating a minimum ownership stake, as initially proposed. This exception ensures that genuine commercial transactions are not impeded by the rule.
Referenced assessment with Competition Law in India.
This development marks a significant comprehension of competition law in India. The rationale behind proposing such a rule is that it impedes labor mobility and stifles competition, thereby hindering innovation and the establishment of new businesses. The pertinent question here is whether such a development can be anticipated within the Indian Competition law framework. To address this, a brief examination of existing jurisprudence is necessary. Under Indian Law restrictive covenants such as the non-compete clauses fall under the domain of Section 27 of the Indian Contract Act, which asserts that any agreement pursuance of which prevents or restrains a person from practicing a lawful profession, trade, or business is void to that extent, with an exception for the sale and purchase of goodwill. While non-compete agreements seemingly fall within this provision, the Supreme Court, in the landmark case of Niranjan Shankar Golikari v. Century Spinning, scrutinized the validity of such clauses under section 27 of the Indian Contract Act, 1872, which invalidates agreements restraining trade. Justice J.M. Shelat stressed that while restraints on trade are not inherently against public policy, they must be reasonably necessary to safeguard the employer’s interests, placing the burden of proof on the party advocating the contract. The key factor in this case was the reasonability of the non-compete clauses.
It was further held in the case of Larry Lee Maccllister vs. Pangea Legal Database Solutions by CCI that negotiating conditions at the start of employment, including any constraints on future employment, is a standard procedure that does not pose competition problems. Employees consider these conditions when negotiating salary, demonstrating that such agreements are typical employment practices that have little impact on competition. The CCI determined that limits in employment contracts prohibiting employees from joining rivals after termination do not raise competition concerns. Such limitations are regarded as appropriate in preventing trade secret exposure or harm to businesses. Employment contracts are thorough agreements that lay down the rights and duties of both the parties i.e. the employer and the employee. Restrictive covenants such as non-solicitation, non-disclosure, and non-competition agreements are critical for safeguarding employers’ interests and ensuring contractual balance. It was also reasoned that section 3 of the Competition Act addresses service agreements such as exclusive dealing agreements rather than employment issues. The Act’s purpose is to safeguard rights in rem rather than prohibit them in personam. Personam remedies are provided by CCI to individuals but the dependence of the same is through a problem in rem.
Analysis
The inclusion of restrictive covenants in an employment agreement is critical for preserving integrity and efficacy, benefiting both the employer and the employee by establishing defined boundaries. These provisions ensure that rights and duties are understood by both parties. Non-compete agreements, while necessary, do not meet the standards of section 3 of the Competition Act, 2002, which requires a clear delineation of the market that would bear the impact of the adverse appreciable effect created due to the competition concerns arising out of the said employment agreement. In case a defined market is not outlined, on a bare perusal of Section 3, the adverse appreciable effect cannot be ascertained. Without achieving these standards, the case remains a contractual one as no effect on competition can be shown without identifying the market where anti-trust injury is impacted. In employment agreements, no such delineation is possible as these agreements are individual in nature. However, in the case of Competition Commission of India (CCI) v. Coordination Committee of Artist and Technicians of West Bengal Film and Television Industry the apex court has clarified that for any agreement to fall under the ambit of section 3, market delineation is not a mandatory requirement. It is also to be taken into account that employment agreements do not fulfil the conditions established under section 2(h) of the Competition Act, which defines the term “enterprises” because employees bound by the employment agreement give individual knowledge and input rather than engaging in production, supply, distribution, storage, and so on, as specified in section 3(1) of the Act.
There are two competing viewpoints: non-compete clauses as either contractual shields for employers or as regressive restrictions that impede labor mobility and stifle innovation. In today’s technologically sophisticated world, anyone with the necessary abilities may quickly start a business. In this atmosphere, non-compete agreements prohibit employees from participating in other enterprises or beginning their endeavors in the same sector for the long term. The Golikari decision did not declare such agreements illegal under Section 27, but it did address their reasonableness. However, the FTC ruling implies that the very presence of such agreements is fundamentally inappropriate in today’s reality. However, if non-compete agreements are dropped, There might be concerns about trade secret misappropriation since people with critical information may quit their professions for greater possibilities. In the case of V.N Deshpande v. Aravind Mills Co. Ltd. Hon’ble Justice Kania AG CJ asserted that confidentiality and trade secret protection agreements are not one-sided, unfair, or unreasonable. Breaching such clauses by employees can be considered misconduct, and the aggrieved party must be compensated for any breach. The ruling, by invalidating non-compete agreements, has effectively created a loophole that might lead to breaches of confidentiality agreements and other arrangements intended to safeguard employers’ interests. The US Chamber of Commerce has expressed its concern, contesting the FTC regulation based on this reasoning.
Conclusion
The saga of non-compete agreements has taken two sharp turns in the two different legal systems. Where the Indian Competition regime does not identify employment matters under the garb of section 3 based on a technical requirement of difference between employment agreements and provision of service agreements and difficulty in market delineation section 5 of the FTC Act has wide ambit powers to act against unfair practices in the market.
The proposed regulation eliminates employers’ negotiated rights during employment initiation, following the precedent set by the McCallister v. Pangea decision. Relaxing non-compete clauses will increase labor mobility and innovation while raising concerns about corporate espionage and trade secret protection. Without non-compete agreements, there is no way of safeguarding the dissemination of confidential information. Competition legislation gains, while confidentiality and trade secret protection suffer. Companies must depend more on confidentiality agreements and trade secret protection to preserve intellectual knowledge, emphasizing the difficult balance required between competition and confidentiality regulations governing non-compete agreements. The new ruling has sparked a clash between protecting employers’ rights and promoting competition, introducing a dynamic tension that demands careful navigation in the business landscape.