This article is written by Michael Shriney from the Sathyabama Institute of Science and Technology. This article discusses Section 27 of Indian Contract Act of 1872, including its history, statutory exceptions, nature, scope, and case laws. This article focuses on the restraint of trade as mentioned under Section 27.
This article has been published by Sneha Mahawar.
An agreement that prevents two or more parties from engaging in a lawful trade or business profession is declared void by the court. The court rules that preventing one or more people from engaging in certain lawful business is unfair and violates a person’s fundamental right and freedom to select the type of profession in which he wishes to engage. It is restricting one’s interest in business, hence the court decided that the restraint of trade agreement is unreasonable and void.
For example, suppose ‘Shankar’ runs a lawful business in the middle of a town. Shankar was the first person in his community to open a Chinese restaurant. ‘Mani’ opened another Chinese restaurant directly across the street from Shankar’s. If Shankar stops Mani from operating his restaurant because Shankar started it first, this is known as a restraint of trade, which the court considers unlawful since it is unreasonable and unfair to the other business. Under Section 27 of the Indian Contract Act of 1872, this trade constraint is addressed.
Background of Section 27 of the Indian Contract Act, 1872
The Section on restraint of trade was derived from David D. Field’s Draft Code for New York, which was based on the ancient English concept of restraint of trade. While interpreting Section 27, the Indian High Courts decided that both the criteria of ‘reasonable’ and the “principle of restraint” were not relevant to the case covered by this Section, unless they come under particular exceptions. The law commission’s first draft of legislation did not include any trade restraints.
However, during the enactments, only Section 27 of the Indian Contract Act of 1872 was introduced. The primary goal of this Section is to safeguard Indian trade. Though the Law Commission’s original draft ignored the subject of trade restraint, it has inserted it in the Indian Contract Act through Section 27 after considering the complexities between market freedom and contract freedom.
The objective of destroying legally these trade restraint agreements is to improve market competition since the dominance of contract freedom adds to discouraging competitive agreements that restrict competition from utilising unique deals within the contract limitations. In its thirteenth report, the law commission suggested that the statute be amended to enable limits and so all contracts in restraint of trade, whether general or partial, that were appropriate in the interests of the parties and the public. However, no action was made in response to the above-mentioned suggestions.
What is the purpose of Section 27 of the Indian Contract Act, 1872
The aim of Section 27 of the Indian Contract Act, 1872 is that any agreement that restricts commerce or business is unlawful. An agreement that prevents or restricts one person from engaging in trade, business, or lawful profession of any type is void, according to the clause. As a result, a void agreement is one in which a person refrains from engaging in a certain business of his interest that is unfavourable to the other parties. Every law must be structured in accordance with the dependence of the Indian Constitution, and trade restraint is also allowed under Part XIII of the Indian Constitution. The freedom of trade, business, and exchange is recognised under Articles 301 to 307 of the Constitution. It ensures that every Indian citizen has the ability to choose any legal profession, business, or trade.
Under Section 27 of the Indian Contract Act, 1872, there are exceptions that are considered valid contracts. However, Act 9 of 1932 repeals exceptions 2 and 3 but exception 1 is regarded as a valid contract, that is as follows:
Exception 1 : Saving of agreement not to carry on the business of which goodwill is sold
When one party (seller) sells the goodwill of a business to another party (buyer), the buyer agrees to refrain from carrying on the same business within specified local limits as long as the buyer purchases the title of goodwill from the seller, who is giving an offer not to carry on a similar business within certain limits. This criteria makes the court appear reasonable owing to the nature of the company.
Public Policy underlying Section 27 of Indian Contract Act, 1872
Every person should be free to engage in his or her profession, i.e., occupation, and to conduct his or her business (i.e., buying and selling products and services) and trade in any specified area of activity, according to public policy. This liberty is important for society’s economic development. It encourages both competition and industry. Agreements that restrict this liberty are against public policy and are thus null and void. This is also an exception to the rule in this case. If ‘A’ sells his business to ‘B,’ for example, ‘B’ may tell ‘A’ that he would not engage in the same business in the same town as ‘B.’ Such a contract limits his business independence, which is fair. Public policy is implemented by Section 27 and it gives effect to the exception.
Exceptions 2,3 have been repealed, but Sections 11(2) and 55 of the Partnership Act of 1932 have been added to replace them. The Indian Constitution guarantees freedom of trade, profession, and business under Article 19 (1)(g). An agreement that deals with trade freedom is found unlawful since it is a trade restriction agreement that is also contradictory to public policy. Under Article 19 (6) of the Indian Constitution, reasonable restrictions on freedom of trade are enforced. The goal of public policy is to promote trade while avoiding monopolies.
Scope of Section 27 of the Indian Contract Act, 1872
The Section is broad in scope, declaring all contracts in restraint of trade unlawful, pro tanto (to that extent or for so much) unless the exception is met. The Section establishes a very strong rule that disproves restraints, both general and partial, and prevents the exception of specific local limits. Agreements in restraint of trade, in broad terms, are those in which one or both parties limit their ability to work or carry on their profession or company in some way. Such agreements are frequently criticised since they are in contradiction with the public interest and are unjust in that they limit human freedom unnecessarily. Every commitment connected to commercial activities, in certain ways, acts as a trade restraint since it limits the promisor’s future responsibility. The restraint is “unreasonably destructive to a genuinely competing private economy.” Lord Birkenhead has set up two criteria for determining whether an agreement is a trade restraint. They are as follows:
- Whether it is reasonable in the view of the parties.
- Whether it is consistent with the public’s intention.
Case laws with respect to Section 27 of the Indian Contract Act, 1872
Superintendence Company of India Private Limited v. Krishan Murgai (1979)
Facts of the case
This article presents a case study of trade restraint. A contract of employment stated that the employee would not work for any of his employer’s opponents in Delhi or start a nearly equivalent business in Delhi for two years after the respondent’s employment ended. On the terms and conditions of the contract, the respondent worked for the appellant’s firm as the branch manager of the New Delhi office. After seven years, the respondent’s employment came to an end. In Delhi, the respondent started his own firm, which is identical to the former appellant’s business. Now, the appellant has sued in this matter, demanding damages of Rs. 55,000 for violating the employment contract.
Issues involved in the case
Whether the agreement was valid and enforceable against the respondent?
Judgement of the Court
Restraint on trade after an employment contract has ended was found to be void and unenforceable in this case. The agreement was declared invalid and unenforceable against the respondent.
Madhub Chunder Poramanik v. Rajcoomar Doss and Others (1874)
Facts of the case
The plaintiff and defendant, in this case, were both running the same business in Calucatta’s same locality. Since the defendant had experienced a loss, he suggested the plaintiff close his firm in exchange for a particular sum of money. The plaintiff filed a lawsuit against the defendant after the defendant failed to pay the agreed-upon sum.
Issues involved in the case
Whether the agreement here is in the form of trade restraint?
Judgement of the Court
The plaintiff’s claim was rejected by the High Court of Calcutta because the agreement is in the form of trade restraint. This lawsuit is a turning point for fair competition protection. The concept of trade restraint was established in India as a result of this decision. It clarified all doubts and ambiguity around this concept.
Nordenfelt v. Maxim Nordenfelt Guns and Ammunition Co. (1874)
Facts of the case
Nordenfelt, the defendant, was a Swedish national at the time of the lawsuit. The defendant’s business is dealing with quick-firing guns. He sold his firm to the plaintiff for Euros 2,87,500. He enters into a restrictive covenant as follows:
- For the next 25 years, the defendant would not engage in any similar activity within an unlimited geographical region, such as the manufacture of quick-firing firearms, unless it was for the company’s benefit. In other words, he is prohibited from engaging in any identical activity for the next 25 years unless it is on behalf of an organisation.
- He should not engage in any business that is in any way competitive with the plaintiff’s company.
Later, Nordenfelt reached a deal with another gun manufacturer. The appellants stated that trade restraint is maintained and that it is reasonable to be held.
Issues involved in the case
- Whether the defendant was obliged by the above trade constraint requirements?
- Whether such restraints were void or valid?
Judgement of the Court
The House of Lords was convened to hear the case. The Court found the first clause of the covenant to be reasonable because the defendant sold the company for a large sum of money and the order was issued. However, the second condition preventing the defendant from engaging in any other rival company is unjust and unreasonable.
Principles laid down
The principles established in this case are:
- Any trade restraints that are against public policy are void unless there are specific grounds that are recognized by law.
- Restraints on trade may only be excused if they are fair: in the interest of the contracting parties; and in the interest of the general public.
- Restraints on trade can be declared valid if they are proven to be reasonable to the contracting parties and the general public.
Statutory exceptions to Section 27 of the Indian Contract Act, 1872
Restraint of commerce is generally invalid, although it is allowed under certain statutory exceptions. They are:
- Sale of goodwill
- The Partnership Act, 1932
- Trade combinations
- Service contracts
Sale of goodwill
A company’s goodwill is a non-tangible asset. It’s a company’s name and reputation. This exemption allows a buyer of a company’s goodwill to show that the seller of the goodwill is subject to certain restrictions. When a person sells the goodwill of his business to another party on the condition that the person will not enter another identical business, this is a restraint of trade on the seller’s part that is valid for the buyer’s interest in buying the goodwill for which he has paid a particular sum. When a firm does not sell its goodwill but instead enters into a deal that violates public policy, the agreement is null and void. The scope of the law is limited to the meaning of Section 27.
As a result, the goodwill will:
- The only function for as long as the buyer obtains the title from him and runs a business for the rest of his life, or
- It will work until the term expires, it does not prevail under these circumstances, and the agreement becomes void if restraint of trade is present in it.
The Partnership Act, 1932
Sustainability of company or organisation
Section 11(2) of the Partnership Act of 1932, when partners agree to share joint rights and responsibilities with mutual consent. When the agreement prevents the partners from starting their own firm, the agreement remains in effect valid as long as they remain business partners.
The partnership has come to an end
To safeguard the interests of other partners, Section 36 of the Act states that when a partner leaves a firm after his accounts are paid, he must agree not to carry on a similar business for a given amount of time or within specific territorial limits.
Dissolution of the firm
Section 56 of the Act deals with the agreement to be valid when, at the time of dissolution, some of the partners begin an agreement with the other partners not to do the same business for a certain length of time or within specific territorial limitations.
Sale of goodwill
The Act’s Section 55(3) deals with validating trade restraints on the sale of goodwill. Any partner could sell a firm’s goodwill to make a deal with the buyer that such partner will not undertake any similar business to that of the firm for a fixed time or within specified jurisdiction, despite that at all contained in Section 27 of the Indian Contract Act, 1872. Such a contract is enforceable if the limitations enforced are reasonable.
A valid restraint of trade agreement is formed when dealers or manufacturers in almost the same company join an organisation to regulate business or fix pricing. The main purpose of such an agreement is to prohibit them from competing by creating a minimum procedure, managing product and service supply, aggregating firm profits, and distributing them according to the traders’ agreement. It is considered in the public interest when two or more people make a formal agreement to control their own trade. It is a legally binding contract.
If there are any reasonable restraints on the employee for the advantage of the company’s freedom of trade in a service agreement, in the context of the employer and employee relationship. In this case, the agreement between the employee and the employer is not null and void. Such limits are imposed on the employee throughout the employment time and not after the job period has expired.
Protection of trade secrets and confidential information
The employer maintains trade secrets and business contacts that should be protected under an employment contract. In the event of restraints in employment contracts, it is required to prove that the employee has made a contract with a customer or has knowledge of the employer’s trade secrets. After deciding his employment, an employer may lawfully suspend his employee from choosing any job where the employee is likely to use the information or trade secrets acquired by him.
There will be agreements in place where one party will only deal with the products of a specific manufacturer or producer and will not deal with anybody else. Such contracts are known as solus or exclusive dealing agreements. For example, a buyer of a certain commodity may decide to buy all of his necessities from a single producer, or vice versa. The goal of the parties determines the legality of such agreements. Such an agreement is lawful if it is reasonable for the advantage of the parties to the agreement; however, such an agreement is void if it tries to force unfair restrictions on the other party in order to monopoly trade.
Thus, the article concludes that an agreement with the restraint of trade or business-related matters is generally void. If there is a trade restraint, the court will formally declare the agreement void. As the court sees it, the agreement is unreasonable, unfair, and violates the individual’s right to choose any profession, trade, or business. This trade limitation is designed to promote healthy competition among individuals. But there are some exceptions, such as those related to the sale of goodwill or public policy interest, or for the sake of partnership restrictions on trade for their benefit, employer and employee restrictions are considered to be valid agreements. The court declares that if any of the above exceptional circumstances occur, the agreement is lawfully regarded as valid, reasonable, and fair.
- Lectures on Contracts -I by Dr. Rega Surya Rao.
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