This article has been written by Janika Dave, pursuing the Paralegal Associate Diploma Course from LawSikho, and edited by Koushik Chittella. It provides a detailed analysis of Section 27 and its implications, judicial interpretations, and exceptions.

Introduction

The Indian Contract Act, 1872 (ICA), forms the bedrock of contractual law in India. Within its extensive framework, Section 27 occupies a critical space, addressing agreements in restraint of trade. This is a pivotal aspect of the Act because it underscores the balance between individual contractual freedom and the broader public interest in promoting trade and commerce.

Section 27: an analysis

The origins of Section 27 can be traced back to the common law principle against restraints of trade, which was developed in England. Historically, English courts were wary of any agreement that could restrict trade, fearing monopolies and the suppression of competition. This philosophy was adopted into Indian law through the Indian Contract Act, 1872, reflecting a colonial import of legal principles aimed at ensuring economic freedom and preventing anti-competitive practices.

Provision and meaning

The exact wording of Section 27 of the Indian Contract Act, 1872, is as follows: “Every agreement by which anyone is restrained from exercising a lawful profession, trade, or business of any kind, is to that extent void.”

This provision categorically invalidates agreements that impose restrictions on an individual’s ability to engage in any lawful profession, trade, or business. The section enshrines a fundamental principle that has significant implications for employment contracts, business partnerships, and commercial agreements.

Scope and application

• General Rule of Invalidity: The general rule established by Section 27 is that any agreement that restrains a person from carrying out a lawful profession, trade, or business is void to the extent of such restraint. This rule is absolute and does not consider whether the restraint is reasonable or not. The core idea is to prevent any contractual term that could limit an individual’s right to engage in economic activities.
• Total vs. partial restraints: Unlike English common law, which distinguishes between total and partial restraints (with the latter sometimes being enforceable if reasonable), Section 27 does not make this distinction. It marks all agreements imposing any form of restraint, total or partial, as void, unless they fall within the statutory exceptions.

Judicial interpretations

Indian courts have consistently interpreted Section 27 to uphold its stringent stance against restraints of trade. Several landmark judgements illustrate the judiciary’s approach to this provision:

1. Madhub Chander v. Rajcoomar Doss (1874):

In this case, the Privy Council, through Sir Richard Couch, held that Section 27 makes no distinction between reasonable and unreasonable restraints and invalidates any agreement restraining trade outright. 

2. Niranjan Shankar Golikari v. Century Spinning & Manufacturing Co. Ltd. (1967):

In this case, the Supreme Court of India recognised the enforceability of negative covenants in employment contracts, provided they are operative during the period of employment. The Apex Court held that a clause preventing an employee from joining a competitor during the term of employment does not amount to a restraint of trade under Section 27. 

3. Superintendence Company of India (P) Ltd. v. Krishan Murgai (1980):

In this case, the Supreme Court reaffirmed the principle that post-employment restraints are void. The Apex Court struck down a clause that restricted an employee from engaging in a similar business for a certain period after leaving employment, emphasising the absolute nature of Section 27.

4. Gujarat Bottling Co. Ltd. v. Coca-Cola Co. (1995):

This case involved a franchise agreement, and the Supreme Court ruled that non-compete clauses preventing the franchisee from engaging in similar business during the term of the agreement do not violate Section 27. However, any post-termination restraints were held void.

5. Nordenfelt v. Maxim Nordenfelt Guns and Ammunition Co. (1874):

This case involved a restrictive covenant that, for 25 years, the defendant would not engage in a similar business with no limit as to territorial extent and that he would not engage in any business with the competitors of the plaintiff. This is a covenant restraining trade. Here, the House of Lords held that any trade restaurants that are against public policy are void unless there is a specific ground recognised by law and that the restraint must be fair and in the best interest of the public.

Exceptions to Section 27

While Section 27 is rigorous in its invalidation of restraint agreements, there are specific statutory exceptions where restraints are permissible: 

1. Sale of Goodwill: The exception provided in the proviso to Section 27 allows for restraints in agreements for the sale of goodwill. It permits the seller of a business’s goodwill to agree with the buyer not to carry on a similar business within specified local limits, provided these limits are reasonable and necessary for protecting the buyer’s interests. 

The rationale behind this exception is that the buyer of the goodwill should be able to enjoy the benefits without undue competition from the seller. This is a common practice in business acquisitions where the goodwill’s value is intrinsic to the business’s success. 

2. Provisions of Partnership Act: The Indian Partnership Act, 1932, also provides specific instances where restraints may be enforceable:

• Section 11 of the Act speaks about the determination of rights and duties of the partners in a partnership by a contract between them, and it permits partners to agree on non-compete clauses during the partnership. It explicitly mentions that the partners can make a contract stating that they would not carry on any business other than that of the firm while the partnership stands and that agreements in restraints of trade would be valid in such a case. 
• Section 36 allows restraints on a partner after leaving the firm, provided they are reasonable in duration and geographical scope. It mentions that the partners can make an agreement with each other that, upon ceasing to be partners with the firm, within a specified period or local limits, they will not carry on any business that is similar in nature to the business of the firm, and such agreements that restrain trade are valid and reasonable.
• Section 54 endorses agreements that restrict partners upon dissolution or retirement from the partnership within reasonable limits. Partners may make an agreement that, upon dissolution of the firm, they will not carry on a business that is similar to the firm’s business within a specified period of time or specified limits. Such an agreement that restrains trade would be valid if the restrictions imposed were reasonable.

3. Service Contracts: If, in case of an employer-employee relationship, any reasonable restraints are placed on the employee for the advantage of the company’s freedom of trade in a service agreement, the agreement shall not be void under Section 27 of the Indian Contract Act, 1872. The key point to note here is that such restriction applies throughout his employment period, but it expires the minute such employment ceases to exist. 

Analysis with other jurisdictions

1. English law: In contrast to Section 27, English law, under the common law doctrine, allows for reasonable restraints. Such restraints must protect legitimate business interests, and their reasonableness is judged in terms of duration, geographical area, and scope.
2. American law: In the United States, the approach is somewhat similar to English law. The enforceability of non-compete clauses depends on their reasonableness concerning the interests of the employer, the employee, and the public. 
3. Australian law: Australian courts also uphold reasonable restraints, provided they are designed to protect legitimate business interests without being overly restrictive.

The strict stance of Section 27 differentiates Indian law significantly, aligning more with a policy of economic liberalism and individual freedom.

Policy considerations and criticism 

1. Protection of Individual Freedom: Section 27 protects individuals from unfair contractual obligations that could hinder their professional growth and economic freedom. It ensures that every individual has the opportunity to engage in trade or business without undue restrictions.
2. Economic Implications: By preventing anti-competitive practices, Section 27 fosters a competitive market environment, which is crucial for economic growth and consumer welfare. It discourages monopolistic practices and promotes innovation and efficiency.
3. Criticisms: Some critics argue that the absolute nature of Section 27 may be too rigid, preventing legitimate business practices aimed at protecting trade secrets and business interests. In a globalised economy, where businesses often operate across multiple jurisdictions, the lack of flexibility in Indian law can be a disadvantage.

For instance, businesses may struggle to protect their proprietary information and investments in employee training if they cannot enforce reasonable non-compete clauses. Critics suggest that a more nuanced approach, considering the reasonableness of restraints, could better serve modern business needs without compromising individual freedoms.

Conclusion

Section 27 of the Indian Contract Act, 1872, is a cornerstone of Indian commercial law, reflecting a commitment to individual economic freedom and anti-monopoly principles. While its absolute prohibition against trade restraints serves to protect individual and public interests, it also poses challenges for businesses seeking to safeguard their legitimate interests. The judicial interpretations of this section reinforce its strict stance, though they recognise certain permissible restraints under specific conditions, such as in the sale of goodwill and partnership agreements. As the Indian economy continues to evolve, there may be ongoing debates about whether Section 27 should be amended to allow reasonable restraints, align with international practices, or whether its current form best serves the country’s economic and social policies.

References

1. www.lawbhoomi.com
2. www.manupatra.com
3. https://blog.ipleaders.in/section-27-of-indian-contract-act-1872/#Principles_laid_down
4. https://www.egyankosh.ac.in/bitstream/123456789/13381/1/Unit-6.pdf
5. https://www.mondaq.com/india/employee-rights-labour-relations/486496/employment-contracts–enforcement-of-restr