This article has been written by Manisha Tripathi pursuing the Certificate Course in Introduction to Legal Drafting: Contracts, Petitions, Opinions & Articles from LawSikho. This article has been edited by Zigishu Singh (Associate, Lawsikho) and Ruchika Mohapatra (Associate, Lawsikho).

Introduction 

Whenever a party restricts another party to carry certain business or trade as per  a contract, it falls under the Section 27 of Indian Contract Act, 1872. It has been an issue of discussion for a long time in the field of Commercial law; especially in the case of employment agreement. There is a clause which affects a person’s liberty by restricting them from carrying on the same business, profession or trade for a certain time period. That law is made to protect the interest of businessmen and their business. Hence, this clause is applicable with “reasonable” grounds of the agreement. Debate over this clause is a long fighting battle in which one side says that this is a pivotal clause of the employment agreement and on the other hand, the other proponents say that; an individual should be free to carry the profession, trade or business of his/her choice without obstructions of such legal terms. Such contracts are highly criticized and conflicted in terms of public interest. Under Indian Contract Act its provision Section 27 states that agreement in restraint of trade is void. Every single agreement or contract which restrains a person from practicing any lawful profession, trade or business is null and void. There are few exceptions mentioned regarding this provision in the statute.  Whenever the issue of restraint of trade arises in the Indian context, the first aspect highlighted is that the Indian position is different from the common law of England, by precluding a reasonableness inquiry. 

Aim of restraint of trade agreement

The general principle behind this law is almost the same in India and England. The principle is that all the restraint on lawful business whether partial or full are void. Only difference is; in England the restraint will be valid only if it is reasonable. In India it is valid only if it falls under any statutory or judicial exception. The English law is a little flexible with the word ‘reasonable’ which enables the court to adapt its dynamic conditions. The aim behind this law is to restrain an employee from joining a business or profession which is in direct competition to the employer as per the legal terms of the contract.  

Stipulation of restraint of trade is imposed upon the employee to prevent him/her from benefiting from the skills acquired during the term of an employment from the employer. Particularly, the employer protects his interest and business to a certain extent. Whereas, when certain restrictions are imposed upon an individual during the term of his/her employment, the motive behind it is to ensure performance of employees and fulfillment of contract terms of the employment contract. 

For instance, after signing and entering into an employment contract of a company ,an employee cannot join another company or business of it is forbidden to establish its own business of the same nature as well, during the employment or prior the termination and; in some cases even after the termination for a reasonable time period. For example, in franchise agreement, this provision of restraint prohibits the franchisee from dealing with competitors during the existence of the contract. Thus, this way the franchiser may promote and protect their own goods by reducing the chances of competition in their field of business. An employment contract generally includes this clause into its contract for safeguarding the interest of the employer and business, organization or firm. These are the few clauses that put a restraint over trade.

• Non-compete clause which specifically forbids former employees to carry the same profession, business or trade after the termination of the contract within a reasonable time period.
• Non-solicit clause is the serving clause which prevents the employee from consulting or soliciting the employer’s client for a reasonable time period.
• Non-recruitment clauses prevent the employee from hiring the employer’s former employees.
• Confidential information clauses forbid the employee to disclose employer’s confidential information.

Statutory exceptions

1. Sale of Goodwill-  Goodwill is an intangible asset and the only exception that is referred to in Section 27 of the statute. It means the restrictions imposed on the seller should be reasonable. Seller is restrained from practising such business or trade for a certain time period for which this business is sold, either by buyer or by any person obtaining title to the goodwill from him/her.  

• Whenever a person holds reputation or status of a business or brand value, morale, employee, customers and advantages and decides to sell off the goodwill of his/her business, he is obliged to give an undertaking to the buyer of the goodwill that in future, he will not practice any kind of business related, which the goodwill is being sold. These agreements will be considered valid for the reason that its sole purpose is to preserve the interest of the buyer, for which buyer has paid the consideration. Without sale of goodwill of business, such terms of restraining someone from carrying  such business would be against public policy and therefore held void. Here the scope of this rule of exception to this section is narrow. Further, the restrictive covenant would stand extinguished when the goodwill comes to an end.

• This theory of restraint of trade is a common law related to the enforcing contractual restrictions on liberty to conduct specific business. It became the forerunner of modern competition law. 

• The Indian Contract Act, which helps to govern the formation and performance of a contract in force inside India, except few parts; deals with the legality of such non-competition covenants. This regulation clearly states that an agreement, whichever puts restriction upon someone from carrying a business, trade, occupation of their choice is void and unenforceable. 

2. Indian Partnership Act, 1932- Under the statute of Indian Partnership, Section 36 defines that those business partners who are stepping out of agreement, shall not carry the similar business or trade for a specific time duration within specified geographical local limits; in these circumstances this kind of agreements will be held valid, except mentioned few reasonable restrictions upon that. Section 11 given under this Act states that the partners cannot involve themselves into competing business during the continuance of the partnership. 

3. Solus and Franchise Agreement- 

1. Solus agreement is an english concept which deals with the provisions where a manufacturer markets his goods through a single distributor in the market or by an agent. In such conditions agreements may take place, where one party is completely dealing with the product of particular good or the manufacturer is not dealing with another person. For instance: a buyer of a certain goods may agree that he/she will purchase all the requirements from a particular manufacturer of goods only. The rationality of these agreements depends upon the parties. This kind of agreement would be valid if there is an element of reasonableness for the parties to the agreement. If such agreement focuses on making restrictions by one party on the other with an objective to controlling trade, then such agreements are void/invalid.

2. Franchise agreement gives you the authority and right to use someone else’s name and brand with their permission to run your business under their name and brand. It gives you the right to use the trademark of the franchisor that is the most important element of this agreement. Hence it is legally binding that you need to fulfil certain requirements for receiving the approval for a franchise example: site, branding, advertising, training, support, intellectual property and trademark etc.  

Judicial interpretations 

These agreements are made to put a negative obligation and forbid employees to work for another person during the term of employment. These clauses tend to prevent leakage of trade secrets and confidential information.

• Those agreements which put restraint after the term of employment on their employees are not allowed by the courts.

In the case of Brahmaputra Tea Co v E. Scarth here an attempt was made to restrain an employee as per employment agreement he was not allowed to compete for five (05) years after termination of service. Court observed in this case that restraining someone from competing, even after the termination of the employment agreement without reasonable grounds, especially the former employees; may be applicable within reasonable limits.This law is derived from english law, and the omission to make such an exception to the general prohibition contained in the provision given under its section 27 which specify that it was not intended to give them legal effect in this country.

In the case of Niranjan Shankar Golikari v Century Spg. & Mfg. Co. Ltd., the respondent’s company is the manufacturer of products like tyre cord yarn and many other essential products. The respondent invited applications for appointments in said plaint. Here, the appellant was employed for the position of shift supervisor in the tyre cord company and entered into a contract for a term of five (05) years. After the completion of training for 9 months, the appellant started being absent from the job and afterward he informed the company that he had resigned without giving prior written notice. Company rejected his resignation and ordered him to rejoin but he had already obtained another employment during that course of time. The respondent company suffered damages due to appellant because he had learned the company’s trade secrets during his training period. Therefore respondent wanted an injunctive relief to restrain him from obtaining employment from any rival company. Whereas appellant said that this agreement and this clause of restraint on trade is against public policy interest at large. The trial court and the High Court found that the negative covenant in the said case was reasonable and it was necessary to protect the company’s interest from huge loss.  

In the case of  M/S.Blb Institute Of Financial Markets vs Mr.Ramakar Jha, the petitioner company is one of the leading educational institutions in the field of financial services. During the course of the business, the petitioner appointed the respondent as one of their faculty members. Due to the work performance, respondents received many promotions and hikes in salary multiple times too. One day the respondent sent his resignation via email and stopped working for the petitioner. The petitioner returned the resignation and asked the respondent to resume his work. As per the said terms and conditions of the employment agreement, the respondent is not authorised to resign before the period of 3 years of the employment or in case willing to resign have to serve 6 months prior notice to the company. Apart from that, respondents cannot join any rival business of the same course of nature. The same thing was observed by the court, that the respondent made a breach of the contract. In this case the petitioner had only asked for interim measures and the final decision was to be rendered by the arbitrators appointed as per the contract.

In “Blue Dart Aviation Limited, Regd Office at Blue Dart Centre, Chennai v/s Capt.Puneet Shankta Chennai”, Here in this case the defendant was a certified pilot. It was agreed to make him a Senior First Officer for an aircraft. Therefore he was liable to serve the plaintiff. Apart from that, the defendant abandoned the services of the plaintiff without giving the company a prior three (03) months written notice. In consequence a suit was filed against him by the plaintiff and prayed for an injunctive relief against him to restrain the defendant from taking employment as a pilot in any other company. As a result of breach of contract, the defendant became liable to pay an amount of Rs. 10,00,000  with 15% outgoing interest from the date of filing the suit. The plaintiff also prayed to the Hon’ble court to grant permanent injunction against the defendant to restrain him from taking up employment in any other company or airline, for three (03) years as per the term of the contract. Injunction is based upon court’s discretion, however court granted injunction for a reasonable time period, as it became difficult for company to arrange another pilot, due to being unable to arrange another pilot within such a short time duration; company had to minimise the flying operation, which directly leads plaintiff to suffer loss. Therefore, in the above stated situation here court desists from directing restoration of status quo ante and for plaintiff to claim any compensation by amending the plaintiff at any stage. 

In the case of Superintendence Company Of India vs Krishan Murgai, the Supreme Court has noticed that any negative covenant beyond and to the extent of termination of the service is void and not enforceable. The Court said:

According to clause 10 of the agreement, the negative covenant not to serve anywhere or enter in any competitive business, during or after the termination of employment of an employee; even if the employee withdraws himself from service despite wrongful dismissal is contradictory to the contract of service. which relieves the employee from prohibitive covenant.

The Delhi High Court in Modicare Limited vs Gautam Bali & Ors, has explained the validity of 27 of Indian Contract Act as:

• According to this section, every agreement through which anyone is restrained from practicing any lawful profession, trade or business of any nature is void and unenforceable.
• Under their agreement where the plaintiff has undertaken that he will not involve or carry on any other business in his capacity, which is competing in nature with the defendant, even after termination of employment of the said agreement. According to said section, it would be void and unenforceable to restrain someone from carrying out the profession or business of their choice.
• Court observed that such terms in the agreement are purely inappropriate, on the other hand the plaintiff was forced to agree upon such terms voluntarily to not to do something competing in nature or to the extent, which was declared void.

3. Conflict of Laws- According to the Constitution of India, Article 19(1)(g) guarantees freedom of trade,occupation and business anywhere in India, with a few reasonable restrictions given under Article 19(6) it shall affect the operation of any existing law or prevent the state from making any law imposing or in the interest of the general public. These restrictions are reasonable and can only be imposed by the law. This is in conflict with the negative covenants in contracts that restrict the fundamental right of freedom of occupation.

Conclusion

Debate over non-compete and non-solicit is also a tough battle and is definitely an important issue of discussion. Law needs to amend and transform as per the time, we are the citizens of a free country and have our fundamental rights too. For the sake of protecting someone’s interest, ceasing someone’s liberty over their choice of profession, trade and business sounds cruel in itself. Section 27 needs to be amended, it also permits and mandates a ‘reasonableness’ inquiry. Whenever the issue of restraint of trade arises in the Indian context, the first aspect highlighted is that the Indian position is differ from the common law of England, by precluding a reasonableness inquiry. 

Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skills.

LawSikho has created a telegram group for exchanging legal knowledge, referrals, and various opportunities. You can click on this link and join:https://t.me/joinchat/J_0YrBa4IBSHdpuTfQO_sA

Follow us on Instagram and subscribe to our YouTube channel for more amazing legal content.