Agreement in Restraint of Trade is Void

Synopsis

Introduction

Section 27 of the Indian Contract Act, 1872, declares agreements in restraint of trade void, upholding the common law principle that every person has the right to pursue any lawful trade or profession, protecting individual freedom and promoting competition.

Section 27 of the Indian Contract Act, 1872

Every agreement by which any one 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 good-will 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 good-will 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.

This means that no person can lawfully enter into an agreement that restricts another from pursuing their occupation, trade, or profession. Such restraints are considered against public policy, as they limit an individual’s economic freedom and competition in society.

The section applies both to total restraint (complete restriction from carrying on trade) and partial restraint (restriction limited by area or time). In India, unlike English law, even partial restraint is generally void, unless it falls within a recognized statutory exception.

Thus, the principle behind Section 27 is to safeguard the freedom of trade and employment, ensuring that everyone has the right to earn a livelihood through any lawful means.

Object and Purpose of the Section

The main object of Section 27 is to preserve individual liberty and promote free trade. In a democratic and competitive economy, every person should have the right to engage in business or profession without unjust interference.

The purposes of this section include:

Therefore, Section 27 upholds the principle that no one should be forced to abandon their trade or profession because of contractual restrictions that benefit another.

Exception to Section 27

Although Section 27 declares all agreements in restraint of trade as void, the Act provides one statutory exception— relating to the sale of goodwill of a business.

The exception clause reads:

“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.”

This means that when a person sells the goodwill of his business, he may agree not to open or carry on a similar business within a certain area or time frame. This restraint is considered valid because it protects the buyer’s legitimate interest in the goodwill he has purchased, and it is reasonable in nature.

For instance, if a shopkeeper sells his bakery’s goodwill to another person, he may promise not to open another bakery within the same locality, as it would otherwise destroy the value of the goodwill sold.

Conditions for Validity of the Exception

For the exception under Section 27 to be legally valid and enforceable, certain conditions must be fulfilled. These conditions ensure that the restriction is reasonable and not misused.

The key conditions are:

  1. Sale of Goodwill: The restraint must be directly connected to the sale of goodwill of a business, not to ordinary employment or trade relations.
  2. Specified Local Limits: The area within which the seller is restricted must be clearly defined in the agreement.
  3. Reasonableness: The restriction must be reasonable with respect to time, area, and nature of the business. Courts will assess whether the limits are fair considering the business context.
  4. Duration of Restriction: The restriction should operate only so long as the buyer, or any person deriving title to the goodwill, continues to carry on that business.
  5. Not Against Public Policy: Even if all other conditions are met, the restriction should not harm public interest or create a monopoly.

If these conditions are met, the restraint will be considered valid under the exception to Section 27.

Examples

Example 1 – Void Agreement: A and B are cloth merchants. A agrees with B that he will not carry on business anywhere in India. This agreement is void under Section 27 because it is an unreasonable restraint on trade.

Example 2 – Valid Exception (Sale of Goodwill): A sells the goodwill of his bakery to B and promises not to open another bakery within 5 kilometres for three years. This agreement is valid because it protects the buyer’s goodwill and is reasonable in scope and duration.

Example 3 – During Employment (Valid): X agrees not to work for another company during his employment with Y Ltd. This is valid, as it protects the employer’s business interests during employment.

Example 4 – Post-Employment Restriction (Void): An employee bond prohibiting an employee from joining a competitor after resignation. This is void, as it restrains trade beyond the employment period and violates Section 27.

Import Case Law

1. Madhub Chander v. Raj Coomar

Facts:

Issue:

Whether the plaintiff could recover or enforce payment of money under an agreement that restrained the defendant from carrying on a lawful business.

Analysis:

Judgment:

The Calcutta High Court held that:

2. Superintendence Company of India (P) Ltd. v. Krishan Murgai

Facts:
The respondent, an employee of the appellant company, had signed a contract agreeing not to engage in similar business for two years after leaving the company. After resignation, he started a competing business. The company sued for breach of contract.

Issues:
Whether an agreement restraining an employee from carrying on a competing business after the termination of employment is valid under Section 27.

Analysis:
The Supreme Court observed that post-employment restraint affects the fundamental right of a person to earn a livelihood and is against public policy. Such a restriction is considered void under Section 27, as it prevents a person from exercising a lawful profession.

Judgment:
The Court held that the clause restraining the employee after termination of employment was void and unenforceable under Section 27 of the Indian Contract Act, 1872.

3. Gujarat Bottling Co. Ltd. v. Coca Cola Co.

Facts:
Gujarat Bottling Co. had a franchise agreement with Coca Cola to bottle and sell its beverages. The agreement stated that the company would not deal with rival brands during the contract. Later, Gujarat Bottling tried to collaborate with Pepsi, and Coca Cola objected, claiming breach of contract.

Issue:
Whether the clause restricting Gujarat Bottling from dealing with competitors during the agreement period was void under Section 27 of the Indian Contract Act, 1872.

Analysis:
The Court held that a restriction which operates only during the period of the contract is not a restraint of trade. It ensures fair performance and protects business interests. However, a restraint after termination of the contract would be void.

Judgment:
The Supreme Court ruled that the negative covenant was valid, as it applied only during the contract’s term and was reasonable.

Principle:
A restraint on trade during the subsistence of a contract is valid; restraint after its termination is void under Section 27.

Conclusion

Section 27 of the Indian Contract Act, 1872 establishes a clear rule that agreements restraining trade are void, ensuring freedom of profession and protection of public interest.

However, the exception for sale of goodwill allows reasonable restraint to protect the legitimate business interests of a buyer.

Thus, the law strikes a careful balance between individual liberty and commercial fairness, promoting both free competition and good faith business practices in India.