Acquisition Of Company: May Fell Into Thug Trap
Non-compete clause as central theme and luring clause to cheat the buyer company
The Non-Compete clause in acquisition of high stake business forms a central and most important clause in which buyers insist that Sellers enter into an obligation not to compete with the Buyer, the acquired entity and its business for a given period. This type of a restrictive clause is termed “covenant not to compete”, “promise not to compete”, or “contract not to compete”.
A non-compete covenant may be aimed at preventing various events, which can occur after the entity is sold, e.g. a Seller may start operating a competing business or set up a new company that will compete with the acquired entity or any of its activities; solicit employees or contact former clients; take away the data base, confidential records, know-how, IPR’s or otherwise interfere with the business sold. All the above actions could impair the entity’s goodwill. A non-compete provision is often supplemented by a penalty clause. The aim of such a provision is to protect and preserve the value of the acquired entity and to obtain some sort of certainty that the Seller does not re-enter the market soon after the sale has been completed. Without the non-compete clause the sale of business agreements would be meaning less and the companies won’t spend billion of dollars for acquiring the entity for operational convenience, increased profitability, if they have to again face the stiff competition.
What if one lures a established business house to sell an entity with a covenant in the Purchase Agreement that bars the seller to take on competing business for a period of say 5 years and induces the established business house to enter into a contract and gets purchase consideration and later on through their proxies opens up a competing company with a similar line of business with the database, technical know-how, IPR they sold to the buyer along with the entity. Is it mere violation of the terms of contract when they from the very beginning at the time, when they induced the buyer to enter into contract, have malafide intention to set up a competing parallel business with poaching of key employees along with database, technical know how, trade secrets & IPR’s and the inclusion of non-compete clause was mere a farce to induce the buyer to cough up millions of dollars in acquiring the business set-up under the belief & false representation by the seller that he would not re-enter the market for a specified period of time after the sale has been completed. It is a well crafted design to cheat the innocent corporate house in the garb of commercial contract.
One such case of cheating came to notice recently where the directors of lesser known logistics company approached a renowned logistics company having its offices all over India to sell their entity. The management of renowned logistics company was led to believe that after the take over of the company, the promoters directors of the vendor company won’t re-enter the market scene & compete with the buyer company for a period of five years and the buyer company would have an competitive edge with the competitive state of art software developed by the vendor company through its IT department for inventory management solutions and databases comprising of business strategies, methodologies, client profile containing specific client profile, client inventory details, inventory cost data etc. The buyer logistics company with offices all over India induced by the vendor, seen it as a golden opportunity to acquire the company to get competitive edge in the market, expand its market share and attain near monopoly. The buyer company and the vendor company entered into a Share Purchase Agreement (SPA) for the purchase of 100 % shareholding from the existing shareholders/directors of the vendor company. There was one Non-Compete Clause of the SPA which barred the erstwhile directors (sellers) to take on competing business involving providing logistic services in relation to warehousing and transportation to third parties for a period of 5 years from the execution of the agreement. It seemed to be a smooth business takeover where the buyers spend around Rs. 60 Crores to take over the entity from the vendor. However, it was not the case; the crooked vendor directors have something else in mind. They have devised a meticulously planned well crafted strategy to cheat the well known logistics company and make them poorer by Rs. 60 Crores.
Facts of the case
- The Vendor Company lets say ABC company is a well known logistics company having its offices all over India engaged in the business of cargo handling including freight forwarding, custom clearance, transportation and material handling, warehousing and warehouse management. The company basically provides domestic logistics management services to leading telecom segment players like Bharti Airtel, Tata Teleservices, Reliance Telecom, Ericsson India, Motorola, Siemens, etc.
- The directors of lesser known vendor company say XYZ Ltd. approached the management of ABC Company and induced them to buy/takeover the XYZ Ltd. They represented that they have a pool of talented employees who are developing a state of art software which is basically inventory management software and provides complete warehousing solution applications for Telecom Industry. Further, the XYZ Ltd. in order to cater to the requirements of its esteemed clients maintained the huge database on its server containing inter-alia specific client profile, client inventory details, inventory cost data, business strategies and methodologies etc. The software was very crucial and important to provide effective warehouse support and other value added services to the clients and along with the valuable data base it can give the buyer company ABC Ltd. a competitive edge over other competitors, if it acquires, XYZ Ltd.
- The management of the ABC Ltd. entered into a Share Purchase Agreement (SPA) for the purchase of 100 % shareholding from the existing shareholders/directors of the XYZ Ltd. There was one Non-Compete Clause of the SPA which bars the erstwhile directors (sellers) to take on competing business involving providing logistic services in relation to warehousing and transportation to third parties for a period of 5 years from the execution of this agreement. The management of the ABC Ltd. were under belief that they were acquiring the XYZ Ltd. with its assets, human resources, IPRs consisting of copyrighted software and huge data bases.
- The Management of ABC Ltd after take-over of the XYZ Ltd. noticed that one recently launched logistics company hereinafter referred to as rival company (incorporated about 5 months after the take over of XYZ Ltd.) approached some of esteemed clients of the ABC Ltd. and made bids at slightly lower prices than the ABC Ltd. The Rival Company surprisingly, used same methodologies, strategies as that of ABC Ltd.; as if they knew beforehand what the management of ABC Ltd. are upto which looked quite weird. The management of ABC Ltd. was helpless as they could not do anything as there is nothing illegal in approaching or soliciting other clients even if it means huge loss to ABC Ltd. on the well established legal maxim “Damnum Sine Injuria”[i].
- The management of ABC Ltd. kept it fingers crossed until one day an ex-employee of the ABC Ltd. working at the Rival company informed the management of ABC Ltd. that the management of rival company Rival company has been using software which is nothing but exact replica of the customized software the ownership of which now vests with the ABC Ltd.. The said employee also send an e-mail to Head IT Development Team of the ABC Ltd., attaching the executive file of the said software for further analysis to find out the copying/duplicity of the copyrighted work.
- On analysis of the copyrighted software with the software purportedly developed by the rival company, it was revealed that the literal elements of copyrighted software i.e. source code, as well as its non literal elements i.e. the structure, sequence and organization, that is to say overall organization of a program, the structure of a program’s command system, the program’s flow charts, the screen presentation, graphical user interface etc. has been literally copied into the software purportedly developed by the Rival company
- The conduct of the rival company in approaching its customers, submitting quotations/bidding to its customers just below price quoted by ABC Ltd., using methodologies, operations similar to ABC Ltd., using its copyrighted software for a new company which has just come into operation could not have been possible without unauthorized accessing the huge proprietary database maintained in its server which was acquired by ABC Ltd. along with take over of XYZ Ltd.. Further, the developing such methodologies, operational procedures and development of such software can only be possible by spending resources, manpower, collection of data over a long period of time and the startling fact was that the rival company has just came into operation merely 5 months after the take over of XYZ Ltd. and it was highly improbable that it managed the impossible with its limited resources within such a short span of time.
- Later on it was revealed that one key employee of the development team who was having dominion and control over the database of the complainant and also part of the software development team has resigned in the suspicious circumstances and joined rival company along with few other key employees and shifted the acquired database of the ABC Ltd. to rival company. Later on it was revealed that the directors of rival companies are mere puppets whose strings are in the hand of erstwhile directors of XYZ Ltd. who have since resigned after the take over by the ABC Ltd.
The offence of Cheating
- It was now revealed that the intentions of the erstwhile directors from the very beginning of entering into contract with management of ABC Ltd. was malafide and the inclusion of non-compete clause was mere a farce to induce the management of ABC Ltd. to enter into Share Purchase Agreement and pay the huge purchase consideration of Rs. 60 crores. The erstwhile directors have dishonest intention from the very beginning to start a competing company with the misappropriated database and hacked software code with the help of their ex-employees whom they have induced to join the rival company after they sold XYZ Ltd. The Ex-employee acting under the instructions of accused erstwhile directors of XYZ Ltd. copied and took away databases consisting of specific client profile, client inventory details, inventory cost data, business strategies and methodologies etc. and other software containing the crucial clients information which has been used by rival company launched by erstwhile directors through their proxies with impunity to lure or solicit the clients of the ABC Ltd. to divert business from them causing major loss to them.
- The factual matrix of the case clearly discloses the offence of cheating which is defined under Section 415 IPC in following words:-
Whoever, by deceiving any person, fraudulently or dishonestly induces the person so deceived to deliver any property to any person, or to consent that any person shall retain any property, or intentionally induces the person so deceived to do or omit to do anything which he would not do or omit if he were not so deceived, and which act or omission causes or is likely to cause damage or harm to that person in body, mind, reputation or property, is said to “cheat”.
Explanation : A dishonest concealment of facts is a deception within the meaning of this section.”
- Clearly, the erstwhile directors of the XYZ Ltd. induced the management of the ABC Ltd. to enter into contract and pay huge purchase consideration on the false representation that they would not enter the market scene for the period of 5 years; the stipulation to this effect was also incorporated in the written agreement. Had they not incorporated this non-compete clause into written agreement, the deal of the take over of the company would not have materialized. But the intention of the erstwhile directors of the company was malafide from the very beginning. They hatched a criminal conspiracy with some of the key employees of XYZ Ltd. and sold the company XYZ Ltd. with the said non-compete clause and later on they through the ex-employees misappropriated the huge database and software source code and started new company with similar line of business with puppet directors on board. It’s a unique MO adopted by these corporate fraudsters, who again are establishing the company and will certainly look for other corporate prey and defraud them in same manner in the way, they defrauded the management of ABC Ltd.
Other penal provisions also attracted
- Section 66 IT Act, 2000: The illegal hacking of the computer source code from the computer resource of the ABC Ltd. by its Ex-employee and its misappropriation to make infringed software for rival company has diminished the value and utility of the information residing in the system of complainant company, as the same has fallen into the hands of rival who used the same along with other stolen secret trade information, computer database to lure the clients of complainant which caused it huge losses. Thus, the accused persons have committed the offence punishable under Section 66 of the Information Technology Act, 2000.
- Section 408/409 Indian Penal Code: Further, as the ex-employees and erstwhile directors were entrusted with the data of the XYZ Ltd. while they were in employment/directors of the company which they misappropriated for their illegal gain causing corresponding loss to the ABC Ltd., the offence u/s 408/409 Indian Penal Code is also attracted.
- Section 63/63 B Copyright Act: Further, the proprietary database along with source code of the software constitutes literary work within the meaning of Section 2 (o) of the Copyright Act, 1957 & therefore copyrightable work within the meaning of Section 13 of the Copyright Act, 1957. Therefore, any illegal copying, use of the misappropriated data attracts the offence U/s Section 63 of the Copyright Act. Further, as the copyrightable source code of the ownership of which now vests with ABC Ltd. has been copied to make the infringing software, it also attracts offence u/s 63 read with Section 63-B as there has been a knowing use of infringing software by the accused persons.
- A case has been registered by the Cyber Cell, CBI which constituted a team and conducted raid at the offices of the rival company situated at Delhi and NOIDA. During the raid, the CPU, hard disk, compact disk containing the infringed software/database and other incriminating documents were seized. Further, during the raid, the offices of the erstwhile directors of XYZ Ltd. was found at the corporate office of rival company. Further, the disclosure of few employees/officials of the rival company disclosed that the erstwhile directors were in the actual control of affairs of the rival company and directors of the said company are mere puppets in the hand of those erstwhile directors.
So, isn’t it a clear case of cheating. What do you think?
[i] The maxim means loss or injury to someone which does not give that person a right to sue the person causing the loss.