INTRODUCTION

Non-compete clauses and agreements in the life sciences industry are often seen in commercial, transactional and employment arrangements. Is it necessary and what is intended of such arrangements? 

Non-compete provisions are added primarily to protect intellectual property and trade secrets, and secure the interests of companies from employees, sellers, vendors and customers exploiting proprietary and confidential information to the disadvantage of the company. Counterparties to such agreements often have access to sensitive, proprietary and confidential information, disclosure or use of which can negatively impact the economic interests of a company. It is therefore imperative in certain cases to build robust non-compete clauses to protect the interests of such companies with the help of life sciences law firms and most importantly ensure that such clauses are enforceable. This note is a short comparative analysis of the enforceability of non-compete clauses in the life sciences industry in India, the United States of America and the United Kingdom.

TEST OF REASONABLENESS

The standard adopted by courts in enforcing non-compete clauses is based on the principle of reasonability. While it may differ in each factual situation, the test of reasonableness applied across jurisdictions is largely similar. Courts across jurisdictions have considered the following factors to determine reasonableness:

(a) is it necessary for protection of the company’s legitimate interests;

(b) is it restricted to a specific duration and geographic location;

(c) does it impose any undue hardship on the counterparty (balance of convenience); and

(d) is it against the public interest?¹

INDIA

This segment will delve into the legality and enforceability of non-compete clauses in India and is divided into two parts. While the first part refers to statutory provisions in India with respect to non-compete clauses, the second part discusses the practical application of the clause across transactional, commercial and employment agreements.

(a) STATUTORY PROVISIONS

(i) Indian Contract Act, 1872

The primary provision with respect to non-compete clauses is provided under section 27 of the Indian Contract Act, 1872, which prohibits agreements in restraint of trade. However, there is an exception to section 27, which is to not carry on a similar business within reasonable limits when there is a sale of goodwill. 

(ii) Competition Act, 2002

Under the Competition Act, 2002 (“Competition Act”), non-compete clauses become relevant for business transactions under sections 5 and 6 of the Competition Act. The Competition Commission of India (‘CCI’) in its process of approving business transactions or combinations, previously required companies to report their non-compete obligations. Currently, the obligation to furnish non-compete obligations has been omitted but yet CCI can scrutinise non-compete clauses. In 2017, CCI issued a ‘Guidance Note on Non-Compete Restrictions’ which stated that non-compete clauses should be directly related and essential to the combination as well as be reasonably restrictive in terms of its duration, subject matter, geographic field of application and scope of application.

Sections 3 and 4 of the Competition Act governing anti-competitive agreements and abuse of dominant position respectively, enable CCI to scrutinise non-compete clauses for any anti-competitive effect. The determining factor under the Competition Act is whether such clauses can cause any appreciable adverse effect on competition, which is provided under section 19(3) of the Competition Act and is broadly divided into two parameters, first being the benefit accrued to the consumers and second is the impact on the existing market and its competitors. 

With respect to the abuse of a dominant position, section 19(4) of the Competition Act provides the factors to determine the dominance of a company in its relevant market. Once a dominant position is established, non-compete clauses are then evaluated under section 4 of the Competition Act to determine if the company has abused its dominant position while entering into such arrangements.

(iii) Foreign Direct Investment Policy

The Foreign Direct Investment policy requires prior permission of the Foreign Investment Facilitation Portal (FIFP) (previously the Foreign Investment Promotion Board) for non-compete clauses in the pharmaceutical sector.² The application of this condition is limited to drugs and pharmaceutical companies. This condition is premised on ensuring the affordability of generic drugs to consumers who lack the financial ability to purchase branded and patented medication.

(b) PRACTICAL APPLICATIONS

The statutory provisions, as discussed above, are restrictive in nature. However, the legality and enforceability of non-compete clauses have evolved through judicial precedents. The usage of non-compete clauses differs in different kinds of agreements as discussed below:

(i) Transactional Agreements

In cases where there is a business transaction that involves the sale of goodwill, non-compete clauses are valid and enforceable provided they pass the test of reasonableness. In the case of Arvind Singh and Another vs. Lal Pathlabs Private Limited and Others,³ the respondent while acquiring a diagnostic business and its goodwill, entered into a share purchase agreement which restricted the appellants from engaging in a competing business. While enforcing the restrictive covenant, the Delhi High Court held that the exception under section 27 of the Indian Contract Act, 1872 is limited to business and does not include profession and that the appellants were permitted to practice but were restricted to carry out any business of a pathological lab or a diagnostic centre in Udaipur for a period of 5 years.

In the case of Orchid Chemicals and Pharmaceuticals Ltd. and Hospira Healthcare India Pvt. Ltd.⁴, CCI approved the transfer of a pharmaceutical business and held that the reasonable restriction to not carry out certain business activities in the domestic market would be for a duration of 4 years. However, no restriction on research and development was permitted. In another case, CCI held that the non-compete clause in the sale and purchase agreement of a pharmaceutical company had to be restricted to 4 years and the scope was to be restricted to products manufactured and to pipeline products in development.⁵

Companies in the healthcare and life sciences sector should consider the following factors while drafting non-compete clauses in transactions:

(ii) Commercial Agreements

In commercial transactions, Courts have held that the doctrine of restraint of trade is attracted if such negative covenants extend beyond the term of the agreement.⁶ This principle was held in the case of Gujarat Bottling Co. Ltd. v. Coca-Cola, where the Apex Court drew a distinction between the laws in India and England in determining the validity of a clause in restraint of trade. The Court observed that with respect to commercial agreements, Indian law is restrictive in nature and neither the test of reasonableness nor the practice of permitting partial and reasonable restraint applies to a case governed by section 27 of the Indian Contract Act, 1872. However, under English Law, as the doctrine of restraint of trade is based on public policy, its application has been constantly evolving depending on what is desirable in the public interest. The courts in England therefore look at whether a covenant is in restraint of trade and whether such restraint is reasonable in nature.

(iii) Employment Agreements

Non-compete clauses in employment contracts that impose reasonable restrictions during the term of the agreement are valid and enforceable. However, courts have often taken a narrow interpretation of section 27 of the Indian Contract Act, 1872 and have held non-compete clauses operating post-termination of employment as void.⁷

UNITED STATES OF AMERICA (USA)

The Federal Trade Commission (FTC) has proposed to ban non-compete clauses across all industries except for commercial arrangements for the sale of the business or operating assets of a business or ownership interest in a business by an owner, member or partner holding more than 25% of the business.⁸The ban on non-compete clauses will negatively impact the life sciences industry as non-compete clauses are seen as an effective tool to protect the investment, resources and trade secrets of a company. The inability to have non-compete restrictions will discourage companies from investing in employee training and curtail research and development.

Presently, enforcement of non-compete clauses in the USA differs from state to state with a majority of states enforcing reasonably drafted non-compete clauses. In Massachusetts, a biotechnology company focussing on the development and sale of treatments for rare blood disorders had approached the court to prevent its former sales employee from working for a competitor. Despite having a non-compete clause restricting the employment of the former employee by a competitor, the court denied its enforcement as the employer failed to establish that the former employee had access to confidential information which could potentially harm the employer’s goodwill.⁹

Non-compete provisions restricting physicians and healthcare professionals are highly discouraged by the American Medical Association which issued an ethics opinion cautioning physicians not to enter into such agreements.¹⁰ The rationale is that non-compete clauses can restrict the healthcare professional’s ability to practice, which in turn affects access to healthcare for patients. Keeping this in mind, some states such as Rhode Island have prohibited the use of non-compete clauses for healthcare professionals whereas Connecticut has permitted non-compete clauses to a limited extent.¹¹

UNITED KINGDOM (UK)

Presently, due to the lack of any statutory provision on non-compete provisions, courts enforce non-compete clauses that are reasonable enough to protect the legitimate interest of an employer and are not contrary to the public interest. In a recent case – Boydell v NZP Ltd and Others,¹² the head of commercials of a pharmaceutical business ended his employment and sought to take up an opportunity in a competing business. When the employer approached the court for an injunction, the court observed that the non-compete clause, in this case, was detailed. The clause provided a list of activities and competitors that the employee should not engage in for 12 months post-termination. The court was of the opinion that the clause was wide but it could be severed and enforced without reconstructing the clause and therefore granted an injunction to the employer.

Life sciences companies should ensure that non-compete provisions reflect the intention of protecting their legitimate interest and that restrictions imposed are not wide or unreasonable. Additionally, the proactiveness of the aggrieved party to enforce the non-compete clause plays an important role in receiving a favourable verdict.

Similar to the position of FTC in the USA, the UK government in a policy paper published in May 2023, has announced its intention to limit the period of operation of non-compete clauses to a maximum of 3 months, prohibiting employees from either joining a competitor or setting up a competing business post termination of employment.¹³

CONCLUSION

Top life sciences law firms generally advise companies in their industry to be conscious and take proactive measures to protect their intellectual property and confidential information vis-à-vis companies in other industries as the competition between players in the life science industry is largely innovation-driven. A former employee or a party to a commercial agreement having access to sensitive information, expertise and technical ability will significantly undermine investments in a life sciences company, if not restricted.

The enforceability of non-compete clauses in agreements entered by life sciences companies largely depends on the facts and circumstances of each case and the test of reasonableness applied by courts. Life sciences companies should not adopt an approach of standard non-compete clauses in their agreements but should adopt tailor-made approaches for each employee, based on the information the employee or opposite party is privy to, its nature and turn-around time. It is a standard and accepted practice for life sciences companies to adopt a wider scope of restriction and duration for senior employees and founders as their expertise coupled with the industry and employer-specific knowledge can be used to the detriment of the employer.

In addition to non-compete provisions, life sciences companies should also ensure stringent confidentiality and non-solicitation provisions, which when read together with non-compete provisions would enable companies to protect their interests from an overall perspective.

If you would like to know more about navigating non-compete clauses in the life sciences sector, reach out to us at contact@spiceroutelegal.com. We are one of the top life sciences law firms in India.

[1] Niranjan Shankar Golikari v. Century Spinning and Manufacturing Company Ltd., 1967 AIR 1098.; Coppage v Safety Net Security Limited, [2013] EWCA (Civ) 1176; Letitia James, Non-Compete Agreements In New York State Frequently Asked Questions, New York State Attorney General, https://ag.ny.gov/sites/default/files/non-competes.pdf.
[2] Foreign Direct Policy of India, 2014.
[3] FAO (OS) 473/2014 and CM No. 20860/2014.
[4] Combination Registration No. C-2012/09/79 Orchid Chemicals and Pharmaceuticals Ltd. and Hospira Healthcare India Pvt. Ltd.
[5] Combination Registration No. C-2013/04/116.
[6] Gujarat Bottling Co. Ltd. v. Coca Cola, (1995) 5 SCC 545; Percept D’Mark (India) (P) Ltd. v. Zaheer Khan, (2006) 4 SCC 227.
[7] Tapas Kanti Mandal v. Cosmo Films Ltd., 2018 SCC OnLine Bom 2187; Superintendence Company of India (P) Ltd. v. Krishan Murgai, (1981) 2 SCC 246.
[8] Non-Compete Clause Rulemaking, Federal Trade Commission, United States of America.
[9] Genzyme Corp. v. Hanglin, SUCV19843502BLS2 (Mass. Super. Nov. 19, 2019).
[10] American Medical Association, Code of Medical Ethics Op. 11.2.3.1.
[11] David J. Clark, Connecticut and Rhode Island Enact Statutes Restricting Physician Non-Competes, Epstein Becker Green, https://www.tradesecretsandemployeemobility.com/2016/08/articles/non-compete-agreements/connecticut-and-rhode-island-enact-statutes-restricting-physician-non-competes/
[12] [2023] EWCA Civ 373.
[13] Smarter regulation to grow the economy, Department for Business and Trade, Government of United Kingdom.