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Employer-Employee Non-Compete Agreements: Time for the CCI to examine them as Vertical Anti-Competitive Agreements

[Ms. Aditi M. Verma and Mr Aman Yuvraj Choudhary are second-year and fourth year students respectively at the National University of Study and Research in Law, Ranchi]

 

 

Introduction

                                      

Non-compete covenants restrict employees from joining competing businesses for a set period after leaving their employer. Traditionally used for high-level executives with access to trade secrets, these agreements aim to prevent the “hold-up problem” - employees walking away with valuable proprietary information. However, non-competes also limit labour mobility and employment opportunities.

 

While mature antitrust regimes like the United States have begun cracking down on such restrictive covenants, India has seen a contrasting trend. Very recently, the US Federal Trade Commission (FTC), Chaired by Lina Khan, banned non-compete clauses, freeing an estimated 30 million American workers. But in India, major IT firms like Wipro and Infosys have been enforcing and even expanding the use of such agreements.

 

Wipro recently filed a lawsuit against a former employee, Jatin Dalal, seeking over Rs. 25 crore in damages for allegedly violating his non-compete by joining a rival company. The Indian government itself issued a notice to Infosys in 2022 regarding its six-month non-compete policy for employees. Non-competes are increasingly commonplace in employment contracts for fresh IT graduates as well.

 

Indian courts have traditionally treated non-compete agreements as routine “restraint of trade” issues under the Indian Contract Act of 1872 (Contract Act). However, this narrow contract law approach fails to account for the potential anti-competitive effects of such clauses on labour markets and industry competition. Despite the Competition Commission of India's (CCI or the Commission) reluctance, we argue that employment non-competes can and should be evaluated as anti-competitive vertical agreements under Section 3(4) of the Competition Act of 2002 (The Competition Act). Essentially, India already has the framework for regulating non-compete agreements, we just need to choose the right lens to examine it.

 

How has India Inc. dealt with non-competes?

 

Non-competes have been addressed by civil courts, under the purview of Section 27 of the Contract Act. In Jet Airways v. Jan Peter Ravi Karnik, the Bombay High Court evaluated non-competes imposed by Jet Airways upon its pilots under Section 27 of the Contract Act. It was held that restraints like non-compete agreements could be used only to the extent of protecting the “proprietary rights” of the employer. The HC also observed that to prevent pilots from leaving, the plaintiffs could provide better conditions of service rather than imposing negative constraints.

 

The CCI has had something to say about the intersection of Competition and Employment Law. In Kapoor Glass Pvt. Ltd. v. Schott Glass India Pvt. Ltd,, the issue of predatory hiring and poaching of employees was not dealt with for want of a particular charge under the Competition Act. However, the CCI iterated its stance on labour mobility by holding that labour is a key factor of production, the movement of which must be unrestricted. In Air India v. InterGlobe Aviation Ltd, where in Air India alleged predatory hiring by InterGlobe, the information was dismissed on the ground that the matter seemed “more of an employment issue than a competition issue”.

 

In Dr. Sudheesh Goel v. Metropolis Health Care Ltd., in light of the fact that Dr. Goel incurred the inability to compete with OP-Metropolis Health by virtue of a non-compete, the CCI noted that the issue is an antithesis to the spirit of competition as enshrined under the Act. The objective of the Act is to protect the process of competition “not the individual competitors”.  In Anand Moudgil v. Orbit Aviation Pvt. Ltd.     , Anand was restricted by the OP-Orbit Aviation from re-entering the business of running buses between IGI Airport Delhi via a non-compete clause. The CCI observed that in absence of entry barriers resulting from the non-compete and the contractual nature of the issue, there was no case of Section 3 or 4 to be made out.

 

The treatment of non-competes under the antitrust lens across different jurisdictions:


The United States


Traditionally, non-compete clauses have been      governed by state laws, which generally allow only those restraints which are necessary to protect the legitimate interests of a business. However, in 2022, the FTC           took a federal stance, affirming its intention to regulate non-competes as “unfair conduct”. In 2023, the State of New York became the first to pass a law prohibiting non-competes and has created a private right of action for workers. However, the law itself is being reconsidered after a Governor’s veto. Most recently, in April 2024, the FTC imposed a ban on non-compete clauses. Lina Khan, the FTC Chairperson has said that non-compete clauses “keep wages low, suppress new ideas, and rob the American economy of dynamism”.


The European Union


The European Union (EU) competition rules assess anti-competitive behaviour with respect to agreements between undertakings. Curiously, the definition of undertakings does not include workers or employees. As will be addressed in the forthcoming section,     , this is in contrast with India where an employee can qualify as an “enterprise” under the Competition Act given the way “enterprise” and “service” have been defined in the Act. Despite an EU notice that addressed non-competes in concentrations, employer-employee non-competes have received little attention.


Post-employment non-competes in the EU are subject to the respective national employment laws. However, member countries of the EU still enforce different limitation periods for non-competes. For instance, Spain allows a limitation of 2 years on non-competes for skilled workers and six months for other employees. Similarly, Italy mandates non-competes to be limited to a period of five years (applicable on employees in executive positions) and three years (for others). 


The United Kingdom

 

In the United Kingdom (UK), non-competes have been scrutinised through the lens of employment law. The CMA released its report and found that restrictive covenants “may also distort labour supply and production decisions, reducing economic efficiency and possibly worsening consumer outcomes”. In May 2023, the UK government announced its intention to limit the length of non-compete clauses in employment contracts to three months.


Non-compete agreements can be examined through the lens of Vertical Anti-Competitive Agreements in India


A non-compete agreement is entered between an employer and their employee who are at different stages of the production chain–the employee renders specialised services to the employer, who in turn utilises such services (and labour) as a factor of production. Therefore, in the opinion of the authors, such an agreement can be argued to be a vertical anti-competitive agreement under Section 3(4) of the Competition Act.


Section 3(4) of the Competition Act is applicable on agreements between enterprises. An employee can be understood to be an enterprise, as per Section 2(h) of the Competition Act, he is a person engaged in an economic activity relating to the provision of services. Further, the explanation to Section 2(h) of the Competition Act stipulates that an “economic activity” includes profession or occupation. Additionally, as per Section 2(u) of the Competition Act, an employee provides a “service” to a “potential user” i.e., the employer. A non-compete therefore, is a vertical agreement between  the employer and the employee wherein, the employee is in the upstream market providing services to the employer in the downstream market, who uses it as input.


Non-compete covenants can be understood to be an exclusive dealing agreement or a refusal to deal agreement under Section 3(4) of the Competition Act. It can be understood as an exclusive dealing agreement as it restricts the employee from dealing with any person other than their employer even during the post-termination period. It can further be understood to be a refusal-to-deal agreement wherein, post-employment, an employee is forced to refuse to deal with a competitor for a set duration. Non-competes cause appreciable adverse effects, as per Section 19(3) of the Competition Act, on competition as it limits the free movement of labour as a factor of production, prohibits employees from offering their services to another employer and also causes artificial scarcity of talent for other competitors.


The Defence of Ancillarity

 

The CCI released a Guidance Note addressing non-compete agreements in 2017. However, the Guidance Note only addressed non-competes regarding provision of product or service in a territory or market. While the Guidance Note of 2017 did not contemplate employment non-competes, its recommendations are nevertheless useful to evaluate the reasonability of restrictive covenants in employment contracts.

 

As per CCI’s Guidance Note, a negative covenant like a non-compete can be justified on the basis of reasonability of scope and duration. In order to avail the defence of reasonability, two necessary conditions must be met: firstly, that the non-compete must be ancillary to a broader pro-competitive and legitimate arrangement or interest; and secondly, that the non-compete must be necessary to achieve the pro-competitive objective of the broader arrangement. This defence of ancillarity has also been adopted by the FTC and the EC.

 

However, the defence of ancillarity is not a sufficient defence in itself, and does not excuse the non-compete until it is further put through the rule of reason test. The rule of reason doctrine evaluates the anti-competitive and pro-competitive effects of an agreement. This test has also been interpreted by the Supreme Court in Tata Engineering and Locomotive Co. Ltd. v. The Registrar of Restrictive Trade Agreements., wherein three determinants were highlighted–facts peculiar to the business and the conditions pre and post-restraint and the effect of such restraint. Therefore, only upon fulfilling the conditions of the defence of ancillarity and further crossing the threshold of the rule of reason test, can employment restraints be excused from scrutiny under Section 3 of the Competition Act.

 

Conclusion

 

Under Section 61 of the Competition Act, the CCI ousts the jurisdiction of civil courts which have conventionally dealt with non-competes as negative restraints in employment contracts as in personam proceedings. Seeing how non-competes eliminate labour mobility in the market, and limits opportunities for employees and potential employers, their anti-competitive effects are too damning to ignore and must be adjudicated through in rem proceedings by the CCI.

 

Non-compete agreements must be allowed only in instances where it protects the proprietary interest of the employer, including their trade secrets and intellectual property. Considering that non-competes are vertical agreements under Section 3(4) of the Competition Act, their pro-competitive effects must necessarily be demonstrated.  Looking at non-competes as vertical anti-competitive agreements may also give impetus to the CCI (and policy makers) to come-up with guidelines to regulate it. Further, the authors suggest a threshold or test of reasonability (as discussed above) against the backdrop of which, non-competes must be assessed.

 

Now, while an employer-employee non-compete has not been contemplated by the 2017 Guidance Note, they can be dealt with in the manner proposed therein–firstly, that the post employment non-compete must be backed by a strong pro-competitive rationale and secondly, it must be reasonable in its scope and duration. These reasonability criteria must take inspiration from the defence of ancillarity and the rule of reason test.

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