The Ambiguous Treatment of Non-Compete Covenants in Joint Venture Agreements

[Anubhuti Maithani is a 2nd year B.A. LL.B. (Hons.) student at NALSAR University of Law in Hyderabad, India]

A non-compete clause (NCC) is a restrictive covenant, frequently found in combination agreements like mergers and acquisitions (M&A) and joint venture agreements, that prohibits one party from competing with the other on terms stipulated therein. In other words, it restricts one party from conducting a similar trade or business to the other party’s trade or business for a given time within a prescribed geographical area. Even though such a covenant is claimed to be an essential safeguard of the parties’ interests, it is generally regarded as restrictive on an individual’s freedom and right to trade as enshrined in the Constitution and is deemed void under section 27 of the Indian Contract Act, 1872.

However, the Indian courts have held the non-compete clause to be valid if it is “ancillary” to the trade agreement, meaning that if the restriction is directly related and necessary to the implementation of the combination, then such a non-compete clause will be a valid restriction. An ancillary restraint is one that complies with the Guidance on Non-Compete Restrictions issued by the Competition Commission of India (CCI). To understand it another way, a non-compete clause is valid if it is economically related to the main combination and is intended to allow a smooth transition to the post-combination scenario. However, it has also been pointed out by the CCI that if a restraint is not found to be ancillary to the combination, it does not automatically mean that it is in violation of the Competition Act, 2002. In a joint venture agreement, which is an agreement by which two or more companies come together to form a single and separate entity to perform specific functions, a non-compete clause prohibits either party from carrying out trade activities individually that may pose competition to the joint venture. The position regarding the operation of non-compete clauses specifically in a joint venture agreement in the Indian context has been unclear.

By and large, the operation of a non-compete clause in India is governed by section 27 of the Indian Contract Act, 1872 which deals with the doctrine of restraint of trade. The general interpretation of the courts with regards to the operation of section 27 on non-compete clauses in all forms of agreements (including joint-venture agreements) has been that any restriction that travels beyond the term of the agreement, or a post-contractual restraint, is illegal and is considered as non-existent for all practical purposes. The leading cases in this regard are Gujarat Bottling Company Ltd. & Ors. vs Coca Cola Co. & Ors., which examines the scope and enforceability of a non-compete covenant, and Percept D’ Markr India (P) Ltd. vs. Zaheer Khan and Anr., which reiterates the general interpretation and states that the doctrine is also applicable to contracts other than that of employment, indicating that the doctrine is applicable to joint venture agreements as well.

This interpretation has also been mirrored in two of CCI’s orders: Myland/Strides Acrolab, where the CCI says that a non-compete covenant is void when it covers more than those products which are either being presently manufactured/sold or are under development, by the target enterprise, and Power and Energy International (Mauritius) Limited, where the CCI held that when a non-compete clause goes beyond what is necessary for the implementation of the proposed combination, it becomes void. The general stance of the CCI is that how a non-compete obligation is to be treated is decided on a case-to-case basis, keeping in view the economic realities. The non-compete clause should, however, be “ancillary” to the agreement, as set out in the Guidance note issued by the CCI. In the Guidance note, the CCI has laid down the standard of ancillary restraint based on the dual-factors of necessity and proportionality. The Guidance note has provided much needed clarity regarding the scope and ambit of non-compete covenants in M&A transactions and joint venture agreements. Largely, though, the law in India regarding treatment of a non-compete clause in a joint-venture agreement appears to be ambiguous.

The magnitude of the issue can be gauged by comparing the laws affecting non-compete clauses in a joint venture agreement existing in India and in other developed jurisdictions such as those in Europe. The following differences can be carved out. In Europe, the relevant law is well-settled and is facilitated by specific mandatory guidelines and legislation. A non-compete covenant in a joint venture’s shareholder’s agreement that extends until the lifetime of the joint venture is considered ancillary to the combination, as it is necessary to ensure good faith during negotiations, proper utilization of the joint venture’s resources, and to allow the joint venture to assimilate the know-how and goodwill transferred to it by the parties. Such ancillary restraints are, by default, allowed by any merger clearance and, unlike non-ancillary non-compete covenants, are not caught within the prohibition of restrictive agreements under Article 101 of the Treaty on the Functioning of the European Union (TFEU).  The European Commission’s long-standing practice has been to never regard a non-compete covenant that extends beyond the lifetime of the joint venture to be an ancillary restriction. But this position changed in a recent decision of 2012 by the European Commission, which related to the non-compete clause in a joint venture agreement between Siemens and Areva, where it held that a post-term non-compete covenant can also be considered ancillary with regards to the dissolution of the joint venture, if it is not ancillary to the creation of the joint venture. In other words, a post-term non-compete clause may be necessary for regulating the parties’ interests on the dissolution of a joint venture where one party buys the other out, and in such a case, it will be considered as an ancillary restraint. 

On the other hand, in the Indian context, the CCI’s position has evolved on a case-by-case basis and has proved to be wholly ambiguous and uncertain. However, in 2012, the CCI had, for the first time, showed signs of conforming to international standards and took an unprecedented and unambiguous stance in the case of Hospira Healthcare India Pvt. Ltd. vs. Orchids Chemicals and Pharmaceuticals Ltd., where it laid down a standard on which non-compete clauses were to be assessed. It dealt with non-compete clauses in M&A agreements and stated that a non-compete clause must be “reasonable” to be enforceable. The standard of reasonableness was to be assessed in consideration with the spatial and geographical limits of the non-compete restraint. Such a standard was in sync with the international treatment of the non-compete clauses in joint venture agreements. A suggestive (and not mandatory) set of guidelines was also issued by the CCI later, to ensure clarity and legal certainty in the treatment of non-compete clause in a business combination (including joint venture) agreements. It is pertinent to note here that Indian legislators have enlisted specific conditions under which a restraint shall be termed antithetical to domestic competition. However, the basic classification of an ‘ancillary restraint’ has never been crystallized by the CCI.

Now, even though there has been some improvement in terms of addressing the ambiguity and development in the Indian law regarding the treatment of non-compete covenants in joint venture agreements, there still exists a plethora of concerns that remain unaddressed. Issues of uncertainty as to whether a post-term restriction can be considered ancillary to joint venture agreements, or whether there is a distinction between a non-compete covenant that is ancillary to the creation of a joint venture and the one that is ancillary to its dissolution, or whether non-compete covenants that are not in accordance with the Guidance note are considered to not be ancillary, et al, persist and there seems to be a long way to go until a definite position regarding these uncertainties is taken by the Commission. Keeping in view that the Commission’s decision in Hospira Healthcare India and its Guidance note have an altering effect on the Indian competition regime with regards to how non-compete covenants in joint venture agreements are to be interpreted and treated, there is now a pressing need for clarity to be provided by the CCI in order to fill the lacuna that exists.

– Anubhuti Maithani

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