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Agreements In Restraint Of Trade

Written by: Arushi Gupta




INTRODUCTION


“Section 27 of Indian Contract Act, 1872: Every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.”[1]


“In Electrosteel Castings Ltd vs Saw Pipes Ltd, (2005) 1 CHN 612, the words ‘lawful profession’ in Section 27 include both an independent professional and salaried professional. Self-employment and all modes of economic survival or of earning one’s livelihood are covered.”[2]


“The principle of this law is: Public policy requires that every man shall be at liberty to work for himself, and shall not be at liberty to deprive himself, skill or talent, by any contract that he enters into.”[3]


The main objective of devising this law was that every person should have complete freedom to enter into any profession and work freely without boundations or restraint being enforced from contracts.


“The Section is general in its terms and unequivocally declares all agreements in restraint of trade void pro tanto, except in the case specified in the exception. This Section lays down a very rigid rule invalidating restraints and also restricts the exception to narrow limits but it can still be enforced by parties if they wish to do so without acting illegally.”[4]


The section is very rigid in its wordings and enforcement leaving little room for restraints to be valid. The sole purpose of this strictness is to protect people’s right to work, which is as important as the right to live. However, parties may enter into contracts with restraint clauses on them will, for some specific scenarios without acting illegally. “Law Commission of India recommended that this Section be amended to permit reasonable restraint on the right to carry on trade, which unfortunately was never implemented by the legislature.” [5]


Even the law commission of India has suggested making improvements to the clause to enlarge the room for restraints but it hasn’t been implemented.


“Even the Allahabad High Court has observed that it is unfortunate that Section 27 seriously trenches upon the liberty of the individual in contractual matters affecting trade”.[6]


Allahabad high court has remarked that the section encroaches upon freedom of individuals to form business contracts in their interests as they might want restraints for Bonafede reasons like regulating the market, protecting trade secrets and confidential information.


“But a 3 Judge Bench of the Supreme Court of India in Superintendence Co. of India Pvt. Ltd. v. Krishan Murgai, while interpreting the contours of Section 27, concluded that ‘the Section will have to be interpreted literally and no two meanings can be attributed to it. All restraints on an individual’s liberty to practice any trade, profession or business of one’s choice are void and against public policy and the concept of reasonableness & fairness will not apply to agreements in India as compared to the United Kingdom.”[7]


In Superintendence Co. of India Pvt. Ltd. v. Krishan Murgai, the apex court while demystifying the profile of section 27 closed that no amendments be made to the section as it is in the interest of the general public at large to protect them from any contract that forces them to stay employed. People have to be allowed at all times, to work where ever they want and no contract can restrict this right. The stringen of the section is accurate as no relaxations or defences can be given in this matter.


Agreements that support restraint of trade are as follows:


Sale Of Goodwill


“The only exception mentioned in Section 27 of the Contract Act is the sale of goodwill. 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.


The meaning of Goodwill: - There should be real goodwill to be sold. The Goodwill which has been the subject of sale is nothing more than the probability that the old customer will resort to old place” [8]


Section 27 of the Indian contract act specifies only one exception to its otherwise uncompromising rule i.e., the sale of goodwill. It implies that whenever the goodwill of a business I sold, the buyer may impose on the seller to not start another business along the same line. However, it is only permissible for a reasonable and specified time period. The reason behind it is that goodwill is the most valuable asset of the business and the selling of goodwill must be accompanied by reasonable restrictions on the owner of the said goodwill as “old customers resort to the old place.


Partnership Act


According to Section 11 of the Partnership Act,1932 “partners during the continuance of the firm to restrict none of them shall carry on any other business than that of the firm.


According to Section 36 of the Partnership Act,1932 is related to restraining an outgoing partner from carrying on a similar business within the specified period and specified local limits, a. The agreement should specify the local limits or the period of restraint, and b. The restriction imposed must be reasonable.” [9]


Section 11 of the act explains that two or more partners while carrying on a firm can restrict one another to solely carry on that firm and no other business besides it.


Section 36 of the act permits restraint on any retiring partner by current partners of a business or firm to not start a like business. However, 2 conditions must be fulfilled: The agreement should compulsorily specify the geographic and time limits of such restraints.


The restraints must be found to be just and reasonable


CASE LAW


In Firm Daulat Ram vs. Firm Dharm Chand, AIR 1934 Lah 110, two ice factory owners formed a partnership and agreed that only one plant would be run at a time and that the earnings would be shared equally. The constraint was found to be justified by the courts.


Restraint during Employment


Negative clauses in a service agreement restrain the employee from working anyplace else during the period agreed upon in the contract. The purpose of such negative covenants is to protect trade secrets as an employer might sell precious information about the company or business to an opponent putting them at a disadvantage. Therefore, to keep the confidentiality of secret formulas and methods of product designs and distributions and constituents, these agreements are held justified and not unreasonable or one-sided.


CASE LAW


In Niranjan Shankar Golikar vs. Century Spg & Mfg Co. Ltd. In SC, A producer offered to a tyre cord yarn making small company dealership on the constraint that technical information about the making of the product had to be kept a confidential secret from the workers/labourers. Another condition was that the company owner couldn’t entertain anyplace else’s contracts for 5 years even if his service with the producer ends earlier. The agreement was held reasonable and just by the judge.


Trade Combinations


Trade combinations formed to control business or fix prices are not void, but trade combinations that aim to create monopolies and are detrimental to the public interest are For example, a contract between two people to only do business with members of their caste is void. But if for instance, the supply of a product in the market increases rapidly dropping its price, then the traders of that commodity may agree to withhold production for a short time to regulate the market.


Exclusive Selling Agreements


Manufacturers frequently grant rights to only one agent or distributor to sell their products in a specific geographic area as long as the buyer or his representatives carry on the company. This technique is legal, but the restriction must be fair in the court's opinion.


CONCLUSION


Delhi High Court has, after extensively analysing the contours of section 27 of the contract act and the judgements of the supreme court and different high courts in the matter, has narrowed down the principles to the following:

  • Negative covenants along with positive ones during the upkeep of any contract be it of employment, partnership, business or the like would not be considered as a restraint in trade unless the clauses are found to be wholly one-sided or with malicious intentions .

  • Any negative clause in any employer-employee contract that dictates the employee to not work anywhere else after the termination of his employment is void and non- enforceable. Is it the same as forcing someone to idleness which is not permissible? All post-employment restraint covenants are void.

  • Courts have said to be taking a stricter view in employer-employee contracts than in other partnership or business contracts as in the former the employees are often in a disadvantaged situation wherein; they have to sign a contract or not work at all. Therefore, more rigorous measures are taken to protect the rights of this class of people.

  • The concept of reasonableness need not be considered at all that whether a restraint is only partial or complete.


FOOTNOTES


  1. The Indian Contract Act, 1872, No. 9, Acts of Parliament.

  2. Electrosteel Castings Ltd vs Saw Pipes Ltd, (2005) 1 CHN 612.

  3. Omkar Wangikar, Restraint of Trade and its Exceptions, TAXGURU CONSULTANCY & ONLINE PUBLICATION LLP, (Sept 11 2017), https://taxguru.in/corporatelaw/restraint-trade-exceptions-2.html

  4. Boddington vs. Lawton (1994) ICR 478

  5. Law Commission of India, 13 report, 1959, para 55

  6. Bholanath Shankar Dar vs. Lachmi Narain, AIR 1931 All 83

  7. AIR 1980 SC 1717

  8. Omkar Wangikar, Restraint of Trade and its Exceptions, TAXGURU CONSULTANCY & ONLINE PUBLICATION LLP, (Sept 11 2017), https://taxguru.in/corporatelaw/restraint-trade-exceptions-2.html

  9. The Indian Partnership Act, 1932, No.9 of 1932, Acts of Parliament.

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