Restraint of Trade and its Exceptions

Protection under the Constitution of India

Part XIII of the Constitution of India contains provisions relating to the freedom of trade, commerce and intercourse within the territory of India. The provisions are laid down in articles 301-307. Just as the Legislature cannot take away individual freedom of trade, wise versa the individual cannot barter it away by agreement. 'The Principle of law is this: 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.'  So plain meaning of Section 27 is every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is, to that extent, void.

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.

Section 27 of Indian Contract Act, 1872: Agreement in restraint of trade, void Every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.

Exception 1 : Saving of agreement not to carry on business of which good will 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.

Madhub Chander vs. Raj Coomar is the first case in which scope of the section came up for consideration before the Calcutta High Court. Here in this case restraint was only partial as he was restrained from exercising his profession only in one locality and that such restraints had been upheld in English law.

The Supreme Court of United States, in the leading decision in Standard Oil Company vs. United States (6) that as a 'rule of reason' that the term "restraint of trade" means that it meant at common law and in the law of the United States when the Sherman Act was passed and it covered only those acts or contracts or agreements or combinations which prejudice public interest by unduly restricting competition or unduly obstructing the due course of trade or which injuriously restrain trade either because of their inherent nature of effect or because of their evident purpose.

Section 27 of the Indian Contract Act, 1872 states that an agreement, which restrains anyone from carrying on a lawful profession, trade or business, is void to that extent. The main reason behind this section is that agreements of restraint are unfair, injustice as they impose an undue restriction on the personal freedom of a contracting party. However, as an exception, if a party sells his goodwill to another he can agree with the buyer that he will not carry on a similar business within the specified local limits.

Restriction for long period

The doctrine of restraint of trade has been reconsidered by the House of Lords in Esso Petroleum Co Ltd. vs. Harper's Garage Ltd. In this case, their Lordships struck down an exclusive dealing agreement because it extended to a period of 21 years, which was unreasonable. A five year period would have been held to be reasonable. They said that the doctrine applied only if a man contracted to give up some existing freedom which he had.

Zaheer Khan vs. Percept D'mark India (P) Ltd, AIR 2004 Bom 362, a contract restricting the party's future freedom to carry on his affairs in a manner he likes and with persons of his choice, held, unreasonable restraint of trade.

Coca Cola Company, (AIR 1995 SC 2372), where the defendant and the plaintiff used to carry on the business of ferrying boats and arrived at a business settlement whereby the defendant promised to pay a certain amount to the plaintiff in order that the plaintiff abstain from carrying on his boat business for a period of three (3) years, the court held that the agreement was void as the restraining covenant was a vital part of the agreement and did not fall under the 'goodwill exception' to section 27 of the Indian Contract Act, 1872.

In Petrofina (Great Britain) Ltd. vs. Martin (5), Diplock L.J., a  contract in restraint of trade is one in which a party (the covenanter) agrees with any other party (the covenantee) to restrict his liberty in the future to carry on trade with other persons not parties to the contract in such manner as he chooses."

In the same case, Lord Denning M.R. has expressed that: "Every member of the community is entitled to carry on any trade or business he chooses and in such manner as he thinks most desirable in his own interests, so long as he does nothing unlawful: with the consequence that any contract which interferes with the free exercise of his trade or business, by restricting him in the work he may do for others, or the arrangements which he may make with others, is a contract in restraint of trade. It is invalid unless it is reasonable as between the parties and not injurious to the public interests."

Statutory Exceptions

Sale of Goodwill

The only exception mentioned in Section 27 of the Contract Act is related to 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.

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.

Partnership Act

According to Section 11 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. Section 36 the Partnership Act,1932 is related to restrain an outgoing partner from carrying on a similar business within the specified period and specified local limits,

  • The agreement should specify the local limits or the period of restraint, and
  • The restriction imposed must be reasonable.

Firm Daulat Ram vs. Firm Dharm Chand, AIR 1934 Lah 110, where two ice factory owners constituting a partnership agreed that only one factory will be worked at a time and its profits distributed among them. The restraint was held to be justified.

Restraint upon employees

Restraint during Employment

Agreement of service contain negative covenants is for preventing the employee from working anywhere during period covered by the agreement. Nowadays trade secrets is main contention for negative covenants. Employer's wants to protect his trade secrets because of that employment agreement with negative covenants are generally used. Agreements for protection of confidentiality and trade secrets are not one sided or unfair or unreasonable. Any breach of such clauses on the part of employee can be treated as a misconduct.

Restraint during the employment and post-employment this issue was first time discussed by Supreme Court in  Niranjan Shankar Golikar vs. Century Spg & Mfg Co. Ltd. a  company manufacturing tyre cord yarn was offered collaboration by a foreign producer on the condition that the company shall maintain secrecy of all the technical information from its employees. The Defendant was appointed for a period of five years, the condition being that during this period he shall not serve anywhere else even if he left the service earlier. Shelat J held the agreement to be valid. The defendant was accordingly restrained from serving anywhere else during the currency of the agreement.

Post-Employment Covenant

According to Indian laws any agreement which is related to restraint of trade and profession shall not be binding on the parties and the same shall be null and void. By using the term void ab initio, for such type of agreements it has shown that it has kept such non-compete clause in the agreements beyond consideration. Indian courts have also consistently refused to enforce post termination non-compete clauses in employment contracts as 'restraint of trade' is impermissible under Section 27 of the Indian Contract Act 1872, and have held them as void and against the public policy because of their potential to deprive an individual of his or her fundamental right to earn a living.

Covenants that prohibit employees from engaging in a business similar to or competitive with that of the employer beyond the term of employment or post-employment are invalid.

A non-compete clause is well known under the Contractual Laws as the clause being made out into any agreement between two parties where one party is the employer and the other party is the employee. According to this non-compete clause, the employee undertakes and gives his acceptance as per the condition of the employer that during the course of the employment or even after post-employment, he will not be the competitor of the employer in the form and nature of the employment of the employer. The Non-compete clause finds place under the agreements and contracts throughout the world. According to Indian Contract Act, 1872 the non-compete clause, it is prohibited.

Pepsi Foods Ltd. & ors. vs. Bharat Coca-cola Holdings Pvt. Ltd. (19), post-employment restrictions were held to be invalid and violative of Article 19 (1)(g) of the Indian Constitution. Negative covenant in contract restraining employee from engaging or undertaking employment for twelve months after leaving the services of plaintiff was held to be contrary and in violation of Section of the Indian Contract Act, 1872 and injunction was declined

Conclusion

Article 21 of the Constitution of India guarantees the right to livelihood and this is the fundamental right. Nobody can take away fundamental right because of this to enforce non-compete clauses in India even more difficult. But if we consider the global market and new upcoming conditions with new opportunities we need to adopt few legal changes. Therefore, the need to find equilibrium between rights of the employer and the employee.

It is believed that the factor of "reasonableness" would be the right covenant between employer and employee interests.

 

Omkar Wangikar 
on 12 September 2017
Published in Corporate Law
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