Agreement in Restraint of Trade – Section 27 of Indian Contract Act

Introduction

The agreement in restraint of trade has avowed as the agreements made to impede a person from exercising his liberty to carry out a specific profession or business with any other people without seeking prior permission from the contracting party of the agreement. In a slew of cases, Indian courts have expressly held that suspending someone from proceeding or commencing a particular lawful profession, trade or business, through the implications of an agreement is void.

Section 27 of the Indian Contract Act broached the subject and 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. Thus, the agreement, which debars a person from doing any occupation as per his wish, withal, which aids the other party to reap the benefit, is void, pursuant to the scheme of Section 27.

In general, every legislation that has been created is ought to be in line with the Indian constitution, substantially, the underlying bedrock of this provision has been laid in part XIII of the Indian Constitution.

Articles 301 to 307 of the Constitution guarantee the freedom of trade, commerce, and exchange. Thus, the same ensures the capability of every Indian citizen to grab the opportunity of participating in any legal profession or business or trade. Hence, reiteratively, a person cannot be limited from practicing any sort of legal exchanges.

Background

This provision on the agreement in restraint of trade has been brought from the D. Field’s Draft Code for New York, which had its roots in the old England doctrine of restraint of trade. Though the original draft of the law commission had overlooked this subject, it has introduced in Indian Contract Act through Section 27, after emphasizing its significance by considering the longstanding conflict between the notions of freedom of market and freedom of contracts.

The rationale for the de-legitimization of these covenants in restraint of trade is to facilitate the market competition since the supremacy of freedom of contracts contributes to the anti-competitive agreements that distort competition using an exclusive dealing within the contract requirements.

Common law

It is pertinent to note that the enactment of statutes in nexus with the restraint of trade has not nullified the essence of common law upon the subject worldwide. Indeed, in the case of Standard Oil Company v. the United States,[1] the Supreme Court of the United States decided that the term “restraint of trade” in an Act (The Sherman Act) should be construed as the declaratory of the common law on the subject.

Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd[2] is a notable case since its rationale is the nemine contradicete common law source. Here, a restrictive covenant of employment was made to curb the petitioner from engaging in a particular manufacturing profession with people other than the respondent for 25 years. As far as common law is concerned, the limitations are substantial if it is sensible. Likewise, the court prescribed the ‘test of reasonability’ after encapsulating the fact as,

Sensu lato, the agreement in restraint of trade is void, but it can be exalted to be valid, if

  • It is sensible i.e. with the best interest of the involved parties.
  • It seeks to protect a legitimate interest.
  • It is not against the public interest.

Statutory Exceptions

Section 27 of Indian Contract Act declares all the agreements in restraint of trade void since it has been drafted in a manner to fortify the competition, disregarding the reasonableness of such restraint.[3] In Gujarat Bottling Co. Ltd. and Ors v. Coca Cola Company and Ors,[4] after analyzing the facts, the Hon’ble Supreme Court of India held that as like in England, Indian courts are not purposed to enquire into the reasonableness of the restraint since it is not envisaged by Section 27. However, the only question that is required to be considered is whether the contract is or is not in restraint of trade. At the same time, it is noteworthy that these agreements are void, pro tanto, but not illegal i.e. the agreement by which any person is limited from exercising the lawful profession of any kind is unenforceable.

The rigidity of the language in Section 27 of the Indian Contract Act has not left much room for exceptions but mentions only one exception as follows,

Exception 1.― saving of agreement not to carry on business of which goodwill is sold–

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 reasonable, regard being had to the nature of the business. Therefore, the only exception that validates the restraint of trade agreement is the sale of goodwill, pursuant to Section 27.

Sale of goodwill

Goodwill is a business asset that can be sold and brought just like other assets of a business. In common parlance, the goodwill of a company is the reputation and the solid customer base associated with its brand name. Thereby, it holds multiple values. When a company owner chooses to sell the company, it will be sold along with its goodwill. Since the transfer of the ownership transfers with a contract, the seller is allowed to compete with the business unless a non-compete clause has been included in that contract of sale.

As per Section 27, the person who sells the goodwill concurs to shun carrying out a similar business within the specified local limits is valid qua reasonable.

In the case of Chandra Kanta Das v. Parasullah Mullick,[5] the plaintiff and the defendant were engaged in a similar business at the same place. To avoid competition, the plaintiff had bought the defendant’s business along with the goodwill under a contract that limits the defendant to set up a similar business in that local area for the following three years. Since the defendant fails to comply with the terms of the implemented contract, the Bombay High Court settled the dispute by upholding its validity.

Partnership Contracts

An additional exception to Section 27 of Indian Contract Act has been incorporated in Partnership Act, 1932, to reinforce the joint venture partnership businesses. Such exceptions are avowed in sections 11, 36, 54, and 55 of the Act.

1. Continuance of business: Section 11 of the Act authorizes the partners to determine their common duties and rights through a mutual agreement. Withal, if the covenant that debars the partners from engaging in their own business as long as they continue the partnership in a business, is valid. (Under Section 11(2))

2. Cessation of the partnership: Section 36 of the Act provides that when a partner ceases to be a partner in a firm, even after getting his accounts settled, he is required to concur not to carry out a similar business for a specified period or within specified local limits, to protect the interest of other partners.

3. Dissolution of the firm: At the time of firm’s dissolution, some of the partners may procure an agreement from other partners agreeing not to conduct a similar business for a specified period or within specified territorial limits. As per Section 54, such agreements are valid.

4. Sale of goodwill: In addition, Section 55 of the Act validates the restraint of trade on the sale of goodwill.

Firm Daulat Ram v. Firm Dharm Chand,[6] wherein a partnership agreement between two ice factory owners was held valid by the court, though it expressly provides that only one factory will be working at a time and the profit obtained will be shared.

Restrictive Covenants of Employment,

The restrictive covenant is a clause that presumably clashes with the scheme of Section 27 of Indian Contract Act; that is why it is considered to be the most contentious issue of all. Usually, these negative covenants are included in an agreement of service to limits an employee from disclosing the confidential information of a company, which he was privy to during the tenure of his employment. At times, these covenants are used to prevent an employee from seeking employment till a predetermined time after leaving the organization.

Thus, restrictive covenants that are used by the employer for the protection of trade secrecy and confidentiality are reasonable in the eyes of the law. Niranjan Shankar Golikari v. Century Spg & Mfg Co. Ltd[7] is the case where the apex court has discussed the restrictive covenant vis-à-vis Section 27 of Indian Contract Act and affirmed its validity by concluding that ‘a negative covenant operating in restraint of trade during the term of employment of the employee is enforceable’.

Therefore, judicial pronouncements of the catena of cases provide that it is an irrefutable fact that the protection of ‘rights of an employee seeking employment’ ranks above the protection of ‘interests of the employer from the competition.’

But, if once the restrictive covenant comes to an end either naturally or through abrogation, such covenant is not enforceable, and the party seeking for its enforcement shall not be entitled to injunctive relief.[8]

Conclusion:

Wipro Ltd. v. Beckman Coulter International SA[9] is the case where the Delhi High Court elucidates the crux of Section 27 of the Indian Contract Act as,

1. Negative covenants pertaining to confidentiality, non-disclosure, and non-solicitation will not be considered as an agreement in restraint of trade unless it ends up being unreasonable, or one-sided, or unfair.

2. After the termination of a restrictive covenant in employment, the employee is free to exercise his right to seek placement and cannot be forced to work for the former employer.

3. The court shall give special importance to the employer-employee contract over other contracts like partnership or collaboration contracts while determining whether the contract is in restraint of trade or not. The rationale is that in such contracts employer is always being authorized over the employee.

Howbeit, Article 19 (1) (g) of the constitution confer a right on Indian citizens to practice any profession, trade, or business. Withal, Article 21 of the Indian constitution guarantees the right to livelihood followed by Section 27 of Indian Contract Act, which de-legitimizes all the agreements in restraint of the trade. But, on the other end of the spectrum, both Article 19 (g) and Section 27 of Indian Contract Act are subjected to exceptions and reasonable restrictions, which leads to ambiguities and uncertainty while endeavoring to categorize what types of restraints are allowed pursuant to the scheme of Section 27 of Indian Contract Act. Thus, the judiciary plays a pivotal role in settling the disputes arising out of the agreement in relation to restraint of trade by analyzing the pertinency of exceptions.

Reference:

[1] 221 U.S. 1 (1910)

[2] [1894] AC 535

[3] Superintendence Co. of India Pvt. Ltd. v. Krishan Murgai, 1980 SCR (3)1278

[4]  [1995] SC, 5 (SC)

[5] (1922) 24 BOMLR 602

[6] AIR 1934 Lah 110

[7] 1967 AIR 1098

[8] Percept Talent Management Pvt. Ltd. v. Yuvraj Singh & Globosport India, 2008 (2) BomCR 654

[9] 131 (2006) DLT 681

Note - The information contained in this post is for general information purposes only. We try our level best to avoid any misinformation or abusive content. If you found any of such content on this website, please report us at [email protected]

Interested to publish an article at Law Corner? Click Here to submit your article.

About Snegapriya V S

A second-year student of law at Vellore Institute of Technology (VIT School of Law), budding first-generation lawyer cum legal researcher with multiple publications in various web journals and portals on different subject matters of law in issue. Being a zealous-natured person with thoughts enrooted in epistemophilia has boosted my passion for research writings by interpreting diversified legal facets. As a perceptive observer and reader, I pay greater attention to the overlooked legal fields where divergent challenges might arise, that include cyber law, environmental law, consumer law, and several constitutional provisions. Besides, I prioritize construing legal problems with social psychology. My dream and vision are to catch myself as a skilled legal adroit.

Whats app group joining
Lex Research Hub