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DRAWING A LINE- PROTECTING BUSINESS SECRETS

Updated: Sep 25

Author: Nisha Singh, III year of B.A.,LL.B.(Hons.) from Amity Law School, Noida, Uttar Pradesh

Co-author: Simran Bajaj, III year of B.A.,LL.B.(Hons.) from Amity Law School, Noida, Uttar Pradesh


ABSTRACT

This paper brings to light the importance for a business to protect key information from being copied or used by its competitors that give a company a competitive edge over its competitors. Employees leaving an organization typically carry with them a lot of insights about the organization, including commercially sensitive and significant information. There have been many instances where former employees of a company freely make use of such trade secrets to start a competing business. To protect confidential information the businesses can either incorporate a confidentiality clause in the employment contract or by making an employee sign a stand-alone non-disclosure agreement The confidentiality clause/agreement has a broad application in real life, and it’s used in almost every commercial dealing.


Keywords- Confidentialiy, Trade Secrets, Non-Disclosure Agreements


INTRODUCTION

Every business has certain systems, processes, know-how or other proprietary information that help them stand out in the market and that they would like to keep to themselves. When business owners hire employees, they feel hesitant to share such confidential information with them, unless they can be sure that the employee will not disclose the information. To ensure that your exclusive information remains a secret, the employers get their employees to agree to confidentiality.


More than ever before, almost all businesses are driven by information and for the continued success of a business, it is of prime importance that the business is able to protect key information from being copied or used by its manipulators. Such information may include matters related to internal processes, techniques, technical know-how, training methods, Business & Marketing Plans etc and even include a unique way of handling and processing information which gives a company a competitive edge over the others in the market.


While it is difficult to define what type of information is “confidential”, it is without a doubt vital that organizations protect such information, especially when, in the course of routine business, the information is shared with employees, business partners and others. Some trade secrets have great economic value and they are kept confidential for long periods of time. For instance, the compositions of soft drinks or the ingredients that go into making a popular brand of fried chicken have been kept confidential and secret for many decades and those businesses retain their competitive advantage mainly based on those retained trade secrets. [1]


This can be done in two ways:

1) By incorporating a confidentiality clause in the employment contract

2) By making an employee to sign a stand-alone non-disclosure agreement



NEED FOR MAINTAINING CONFIDENTIALITY

When a person becomes an employee of a company or any of the workplaces, the first rule of etiquette is to maintain confidentiality. By maintaining confidentiality at a workplace, the employer not only shows his respect and loyalty towards the company but also abides by the law and prevents sensitive information from being leaked. In an era, where everything is stored in an online form, the need for maintaining confidentiality has drastically increased. The coming of computers and technologies has made the work easier for people, however has also increased the risk by making accessibility easier for outsiders.


It is instilled in people’s minds that one should not share sensitive information with any third person, however, the employee tends to make an honest mistake and do so unintentionally which may result in grave consequences for the employee and the company. For example, sending a confidential email to the wrong email address. The smallest of mistakes can lead to the disruption of the company’s reputation. As a result of an anticipated breach of confidentiality, the companies make a confidentiality agreement which is to be signed by the employee. The agreement mentions that the employee will be fired from the company, and the monetary compensation to be provided in case of a breach of confidentiality.


However, losing their job and paying monetary compensation are not the only consequences that an employee will have to face in case he breaches the non-disclosure agreement. If the reputation of the company is hampered severely, then criminal charges can also be imposed on the employee who has leaked sensitive information about the company in the first place. The breach may be seen as theft in the case of intellectual property. In this case, the company would not be responsible to file a suit against the employee, rather the state will file charges against the employee.


Thus, maintaining confidentiality by the employee becomes a vital part of their work life. Things can go wrong in different ways if an employee fails to maintain confidentiality. Losing trust in the eyes of people you work with is just one of the consequences of the breach. As a consequence of the breach of a confidentiality agreement, the future of the employee may also be jeopardized. Also, things tend to go completely out of hand when the reputation of the company is hampered and the employee faces legal consequences.


CONFIDENTIALITY CLAUSE

A ‘confidentiality clause’ is a clause often included in employment contracts that imposes an obligation on employees not to disclose proprietary and other specified pieces of information made available to them. In essence, it legally binds the employee not to disclose information of a specified kind that they can expect to be exposed to in the course of their employment or after the termination of employment. This obligation often is expressly stated to continue in effect even if the employment agreement comes to an end.[2]


The concept of the trade secret as defined by the court in the case of Ambiance India Pvt Ltd. v Shri Naveen Jain, where it was upheld that “a trade secret is some protected and confidential information which the employee has acquired in the course of his employment and which should not reach others in the interest of the employer. However, routine day-to-day affairs of employers which are in the knowledge of many and are commonly known to others cannot be called trade secrets. A trade secret can be a formula, technical know-how or a peculiar mode or method of business adopted by an employer which is unknown to others.”[3]


Simply put, a confidentiality clause in a contract legally binds the parties to the specified confidential information. The confidentiality clause serves as an important mechanism, not only in protecting sensitive information, especially that related to a business, giving it an edge over its competitors and also preventing the employees from stealing such crucial information.


For instance, international food chains such as Domino’s, Pizza Hut, McDonald’s etc.. would want to keep their recipes a secret so as to maintain the competitive edge that they hold over the others.


NON-DISCLOSURE AGREEMENT

A non-disclosure agreement (“NDA”), also known as a confidentiality agreement, in the employment context, is a contract between an employer and employee, where the employee promises not to disclose, process or use confidential information belonging to the employer.[4]


There are three types of NDAs: Mutual NDAs, Unilateral NDAs and Multilateral NDAs. They differ with respect to which parties are required to maintain confidentiality. A Mutual NDA imposes a reciprocal obligation of confidentiality on the parties who provide and receive information. A Unilateral NDA imposes a one-sided obligation of confidentiality on the party who receives information which in this case is the employee. No obligation is imposed on the party which provides information. A Multilateral NDA is the one where there are three or more parties are involved, out of which one of the parties reveals a piece of confidential information and the other parties promise to keep that information protected.[5]


In an employment relationship, the employer is the only party who shares confidential information. The employer is the only party disclosing confidential information ,thus, employers generally request employees to sign unilateral Non-Disclosure Agreements. The employees are on the receiving end of the confidential information have an obligation to maintain confidentiality.


At first sight, it seems that employees also share confidential information worthy of confidentiality as well. So, should this not mean that an employer and employee should sign a mutual NDA where both should be bound to confidentiality? The answer is, no. Generally, such confidential information like the employee’s addresses, bank details, phone numbers etc. cannot be protected by an NDA with the employer. Instead, the disclosure, processing and general handling of these personal details are regulated by privacy regulations. These regulations differ based on jurisdiction and include the General Data Protection Regulation (GDPR) in the European Union and the Privacy Ordinance in Hong Kong.[6]





IS A NON-DISCLOSURE AGREEMENT IN RESTRAINT OF TRADE?

Section 27 of the Indian Contract Act, 1872 states that “Every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.” This provision is put to use by the employees to argue that non-disclosure agreements included in the non-compete clause act as a restraint of trade. However, there is an exception provided in this section in the case of goodwill which states that “One who sells the goodwill of a business may agree with the buyer to refrain from carrying on a similar business, within specified local limits, so long as the buyer, or any person deriving title to the goodwill from him, carries on a like business therein, provided that such limits appear to the Court reasoned, regard being had to the nature of the business.” Thus, Section 27 of the Indian Contract Act is ‘restrictive’ in nature and does not specifically mention an NDA.


In a 2016 case of Stellar Information Technology Private Ltd. vs. Rakesh Kumar and Ors, the employee was restricted from working for a competition business post his employment in this company and it was mentioned that if the employee successfully proves that during the course of his employment in the competitive business, he didn’t breach the confidentiality clause as mentioned in the contract.


It was observed by the court that the information that was claimed confidential by the plaintiff was already out in the public domain. And the court held that “Once it is held that in the guise of a confidentiality clause, the plaintiff is attempting to enforce a covenant in restraint of trade, the same must be held to be void.”[8]


POSITION IN USA

In the United States of America, after the enactment of the Economic Espionage Act, 1966, the unauthorized use of trade secrets became a federal criminal offence. The Act also defines ‘trade secret’ as information that is associated with finance, business, economy, engineering, science and technology despite how they are stored, accumulated or memorialised. If the owner has taken reasonable steps to keep the information a secret; if it is not discoverable by the public even through proper means; and causes potential or actual economical benefit, only then it is believed to be a trade secret.


Furthermore, section 757 of the Restatement of Torts defines trade secrets and also widens the scope by stating that the exact definition of a trade secret is not possible. However, certain factors were to be taken into consideration to ascertain the existence or non-existence of trade secrets. These factors include the value of the information, the expense incorporated to develop the same, the extent of information known to the people outside the people working for the business, etc.


Furthermore, the scope of obligation is determined by a test via ‘limited purpose test’ to decide if the breach of duty of confidence has taken place. This test indicates that if the information so provided was for a limited or specific purpose, then it must not be used for any other purpose and would lead to any obligation of confidence.


DOES INDIA NEED TO MAKE A CHANGE FOR THE SAME?

In India, there is a need to enact an explicit and comprehensive law to protect confidential information and trade secrets. The United States of America has already enacted the Uniform Trade Secrets Act for protecting their confidential information. It has now become a federal criminal offence in the USA. Similarly, in India, there is a need to enact a structured act for ensuring the non-disclosure of sensitive information, which also lays down strict punishment in case of a breach of the non-disclosing agreement.


Similarly, there is a concept of a non-compete clause, also known as the restrictive covenant clause under Section 27 of the Indian Contract Act in which one of the parties to the contract agrees to not enter into a profession that is similar in nature or with a trade-in competition against another party. This clause can also impose restrictions on the employee even after the cessation of the contract. Thus, despite what is mentioned in the act, there is a need to consider these clauses as a concept of equity to provide the employee with proper compensation so that the employee does not face any loss whatsoever.


Lastly, there is a need to interpret Section 27 of the Indian Contract Act and to balance the interest of the employer and the employee, as it becomes difficult to ensure non-disclosure post-employment cessation. The employer can claim copyright for some of the information that is used by the employee, however, the information on which the copyright cannot be claimed can be easily and freely used by the employee.[9]


BREACH OF CONFIDENTIALITY Breach of confidentiality occurs when a person intentionally or unintentionally, discloses the information given to him in confidence. When someone agrees to keep something private, they will be responsible for its violation even if there was no mens rea i.e. no intention of giving out the confidential information.


A classic example of breach of confidentiality is the Coca-Cola case, wherein 3 employees offered the company's "Coke" trade secrets to PepsiCo. They were charged with stealing secrets, including a specimen of a new drink being developed from Coca-Cola. PepsiCo received a letter saying that it carried "detailed and confidential" information about Coca-Cola. On investigation by the FBI, the employees were found guilty. The executive administrative assistant of Coke was sentenced eight years and other employees for five years, along with a fine of $40,000 for restitution.[10]


Today, virtually all business operations take place online. As a result, there are higher confidential risks with storing sensitive material online or in a company database, especially if a company's greatest asset is its Intellectual Property. Intellectual Property along with other confidential matters because it is an asset worth protecting as it includes proprietary software, marketing strategies, exclusive products, and processes for manufacturing products, etc. The employees and freelancers have access to a lot of confidential information during work which can be used or disclosed by them.


Unfortunately, employees pose the biggest threat to a company's confidential information by revealing ideas, digital records and other private information. Thus, there are some ways in which an employer can preserve the company's integrity and reputation by proactively reducing privacy risks in the workplace.


Exceptions To Breach Of Confidentiality

There are a few exceptions to the breach of a confidentiality agreement. However, the most common exceptions include[11]:

1. A piece of information that was already known to the public or public domain before the information was ever disclosed.

2. If the information was already in the possession of the recipient without any confidentiality restrictions.

3. If the information disclosed by the recipient party was received by a third disclosing party which was under no obligation to keep the information confidential.

4. If the information so disclosed by the recipient party was independently developed, and the disclosing party’s confidential information was not used whatsoever.

5. If the information, after the disclosure, becomes publicly known and available through the idleness of the recipient party.

6. If the information disclosed by the recipient party was because of a legal process, for example, a court order.[12]


CASE STUDY- HOMAG INDIA PVT. LTD. V ULFATH ALI KHAN

Introduction and Background

The plaintiff, Homag India Private Ltd, a private limited company registered under the Companies Act, 1956, is an Indian subsidiary belonging to Homag Group, originated in Germany having various subsidiaries across the world. The plaintiff company dealt with the supplies of machines, cells and factory installations for the panel processing furniture, structural element and timber frame house construction industries. The plaintiff had entered into trading and service activities. Their product range focuses on machines, cells and factory installations designed for efficient, versatile processing of wood-based panel materials. The plaintiff's company had a separate department for research and development, where huge amounts of funds were spent for the purpose of developing new processes for the manufacture of lightweight panels, like honeycomb structures, high-speed machines for the manufacture of flooring etc.


The first defendant, Mr Ulfath Ali Khan joined the services of the plaintiff as a Senior Service Engineer in October 2006. In the course of employment, he had access to confidential information about the plaintiff's business.


Facts

After joining the services of the plaintiff company, the first defendant was given two promotions. In March 2009, the first defendant submitted his resignation. At that time, he was holding the post of "Product Manager-Sawing" which was a highly responsible post where he had access to highly confidential and commercially sensitive information pertaining to the plaintiff's business, products and operations. He also had access to the plaintiff's entire customer database in India, details of contracts entered into with customers, details of methodologies and processes in relation to the products supplied to various customers The first defendant was fully aware that if the data was made publicly available, it would act as a springboard for any other company to launch itself in the Indian market.


Officials of the plaintiff company found that the first defendant had sent several emails from the official e-mail address containing confidential information to the second defendant, IMA AG Asia Pacific PTE. Ltd., which was a Company incorporated under the laws of Singapore. These emails included customer details including added updated commissioned reports, the status of pending offers and other technical details of the plaintiff's products. Upon enquiry with the first defendant, he confessed to having taken aforestated data.


On perusal of the appointment letter of the defendant, the plaintiff realized that the first defendant had been hired by the second defendant for the purpose of working on its behalf in the Indian market. The agreement clearly stated that the first defendant approached the second defendant and offered to provide services in the field of market entry as well as services in India. As per the terms of the contract between the first and second defendant, the former promised to assist the latter in sales in direct competition with the plaintiff's business and the first defendant would be appointed as Director of the Indian subsidiary of the defendant’s company. The plaintiff also realized that the first defendant had taken employment with the second defendant before he submitted his resignation to them.


The second defendant had enticed the first defendant with a profitable offer to appoint him as the Director of its Indian subsidiary to get confidential information relating to the plaintiff's business. The first defendant was in contract with the second defendant from August 2008. The II-defendant wants to use confidential information so far furnished by I-defendant as a springboard to set up its operations in India.


Issues[13] 1) Whether the plaintiff has made out a prima-facie case for grant of a temporary injunction against defendants No.1 and 2 pending disposal of the suit?

2) Whether or not the balance of convenience lies in favour of the plaintiff?

3) Whether the plaintiff would suffer irreparable loss or injury if an order of temporary injunction is not granted?


Arguments

The following reliefs were sought by the plaintiff:


I. A judgment and decree of permanent injunction restraining the defendants, their agents, servants, contractors or anybody claiming under them from carrying on business in India or carrying on business with, dealing or in any manner transacting with any of the customers of the plaintiff by utilizing confidential information[14] whether it is in the form of technical data, correspondence and information pertaining to the manufacturing process, marketing plans, offers, pricing, customer list, etc.


II. A judgment and decree of permanent injunction restraining the defendants from utilizing and disclosing confidential information whether it is in the form of technical data, correspondence and information pertaining to, manufacturing process, etc.


III. A judgment and decree of permanent injunction restraining the first defendant from working, dealing with or functioning in any manner or capacity, or carry on business, either with the 2nd defendant or anybody else or independently, in any area or field competing with the plaintiff's business and restraining the second defendant, its subsidiaries or associated companies from employing or dealing with or being associated with the first defendant in any way.[15]


The first defendant admitted that he joined the services of the plaintiff as a Senior Service Engineer in October 2006 and was later promoted to higher positions where he had access to confidential information. As per the terms of the letter of appointment, the first defendant was expected to maintain confidentiality of the information of the plaintiff's business, both during the course of employment and also thereafter and he was not expected to take up employment with any competitor of the plaintiff or to start on his own accord, anything in competition with the plaintiff's business for a period of one year after termination of his employment.


The first defendant denied that he had transferred the confidential information of the plaintiff's business from companies Email ID to his personal Email ID with an intention to help the second defendant for the purpose of working with the second defendant and enable the second defendant to establish its subsidiary in India as a competitor to the plaintiff.


He denied that he had entered into a contract of employment with the second defendant. The first defendant has contended that a letter dated 24.04.2009 said to have been executed by him was under threat and coercion. The first defendant also contended that there is no cause of action against him and the plaintiff did not make out a prima-facie case to grant an order of temporary injunction against the first defendant.


The second defendant also denied the correspondence of defendants No.1 and 2 interse and Emails exchanged between defendants 1 and 2 interse. The second defendant has denied that first defendant for and on behalf of the second defendant had tried to establish contacts with several customers of the plaintiff.


The second defendant has denied that the first defendant has breached confidentiality by revealing confidential information of plaintiff's business to the second defendant. The second defendant has denied that he was fully aware of the first defendant being in possession of highly sensitive confidential information pertaining to the plaintiffs business and the second defendant had induced the first defendant to leave services with the plaintiff, employed the first defendant and obtained confidential information relating to the plaintiff's business from the first defendant. The second defendant has contended that the plaintiff has no right to sue against the second defendant. The plaintiff is not entitled to an order of temporary injunction against the second defendant.


Judgment

The appeals of the plaintiff were accepted. The first and second defendants were restrained by an order of temporary injunction from carrying on business in India or carrying on business with, dealing or in any manner transacting with any of customers of the plaintiff by utilizing confidential information whether in the form of technical data, correspondence and information pertaining to, manufacturing process, marketing plans, offers, etc.


In a decision reported in the case of Niranjan Shankar Golikari Vs. Century Spinning and Manufacturing Co. Ltd., the Supreme Court held that negative covenant in maintaining the confidentiality of the information and negative covenant during the subsistence of contract is essential to the fulfilment of the contract.


Under Exception I to Section 27 of the Contract Act, post-service restraint in maintaining the confidentiality and also carrying on any other business for a limited period is permissible.

In the case of John Richard Brady and Others Vs. Chemical Process Equipments P. Ltd. and another, it was held that ‘..in general rules of equity, there can be restraint of breach of confidence.’


The Delhi High Court relying on a judgment reported in 1948 held, "Secrecy The maintenance of secrecy which plays such an important part in securing to the owner of an invention the uninterrupted proprietorship of marketable know-how, which thus remains at least a form of property, is enforceable at law. That statement may now be examined in the light of established rules making up the law of trade secrets. These rules may, according to the circumstances in any given case, either rest on the principles of equity, that is to say, the application by the Court of the need for conscientiousness in the course of conduct, or by the common-law action for breach of confidence which is in effect a breach of contract.”[16]


CONCLUSION

Confidentiality agreements have a widespread application in real life and are used in almost every commercial dealing. They are involved where major trade secrets, know-how or other information crucial to a business needs to be protected. Currently, Indian laws do not adequately protect confidential information that constitutes “trade secrets”. Trade Secrets that are shared in confidence with employees and business partners, may have immense economic value to the owner and need to be protected so that the employer/business does not lose its competitive edge over the others. Employees leaving an organization naturally carry with them insights about the organization, including commercially sensitive and crucial information. There are various instances where former employees of a company freely make use of trade secrets to start a competing business or aiding existing competitors in boosting their business.


It is of prime importance that the business is able to protect key information from being copied or used by its manipulators. Such information may include matters related to internal processes, techniques, technical know-how, training methods, Business & Marketing Plans etc and even include a unique way of handling and processing information that gives a company a competitive edge over its competitors.


This can be done in two ways:

1) By incorporating a confidentiality clause in the employment contract

2) By making an employee sign a stand-alone non-disclosure agreement


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