Free Judiciary Notes · Contract Act Notes
ICA: - Sec.27
22 min read
AGREEMENT IN RESTRAINT OF TRADE
(SEC. 27)
According to section 27,
"every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void."
An agreement which unnecessarily curtails the freedom of a person to trade is against public policy. Restraining a person from carrying on a trade generally aims at avoiding competition and has monopolistic tendency and this is both against an individual's interest as well as the interest of the society and on that ground such restraints are discouraged by law.
Section 27, which declares an agreement in restraint of trade as void, does not allow any distinction between a total restraint or f partial restraint.
Thus, whether the agreement imposes a total restraint, e.g., it says that A shall not carry on a trade any where in the country during his lifetime, or it imposes only a partial restraint requiring A not to trade within a certain area or for a certain duration, the agreement is void.
In MadhubChander v. Rajcoomar Dass, "[(1874) 14 B.L.R. 76.]
Facts of the case:
1. A and B carried on the same kind of business in the same locality in Calcutta.
2. B agreed to pay some amount to A if A closed the business in that locality.
3. A closed his business and then brought an action against B promised amount. to recover the
It was held that even though the restriction was merely a partial one restraining A from carrying on a particular business only in a certain locality, it was still void being in restraint of trade, and, therefore, A was not entitled to recover the amount.
Similarly, an agreement not to carry on some business for a period of three years, [Nur Ali Dubashv. Abdul Ali, (1892) 19 Cal. 765.] or to close down a mill for 3 months in a year, [Khemchand Manekchandv. Dayaldas, A.I.R. 1942 Sind 114.] is void.
In England also an agreement in restraint of trade is void.
The modern English law on the point was laid down by the House of Lords in Nordenfelt v. Maxim Nordenfelt Guns and Ammunition Co. Ltd. [(1894) A.C. 535.]
Facts of the case:
In this case the appellant, Nordenfelt, was the manufacturer of guns and ammunition. He sold his business to the respondent company for a consideration of £ 2,87,500. He agreed that for 25 years, he would not engage, either directly or indirectly,
(1) In the trade or business of manufacture of guns, gunmounting or carriage, gunpowder, explosives or ammunition, or
(2) In any business competing or liable to compete in any way with that for the time being carried on by the company.
It was held that
the first part of the agreement provided a reasonable protection to the interest of the buyer of the business for such a large sum, and it was valid,
whereas the second part requiring him not to compete "in any business" was unreasonable and, therefore, void.
The importance of the case lies in the fact that it laid down that both the general as well as the partial restraint of trade are prima facie void, except when the restraint is reasonable in reference to the interest of parties concerned and also to the interests of the public.
The following statement of Lord Macnaughten may be noted [Ibid., at 565.]:
"All interferences with individual liberty of action in trading, and all restraints of trade of themselves, if there is nothing more, are contrary to public policy and therefore void. That is the general rule. But there are exceptions. Restraints of trade and interference with individual liberty of action may be justified by the special circumstances of a particular case. It is a sufficient justification, and indeed, it is the only justification, if the restriction is reasonable, that is, in to the interest of the parties concerned and reasonable in reference to the interests of the public, so framed and so guarded as to afford adequate protection to the party in whose favour it is imposed, while at the same time, it is in no way injurious to the public."
In Gujarat Bottling Co. Ltd. v. Coca Cola Company [AL.R. 1995 S.C. 2372.]
Facts of the case:
1. On April 30, 1994 Coca Cola Co. entered into an agreement with Gujarat Bottling Co.
2. (GBC) whereby the former granted to GBC a non-exclusive license to use the trade marks mentioned in the schedule to the agreement, viz.. Gold Spot, Limca, Thums up, Maaza, Citra, etc.
3. in relation to goods prepared by or for the licensee (GBC) from concentrates and/or syrups supplied by the Coca Cola Co. and packaged or dispensed in accordance with standards, specifications, formulae, process and instructions furnished or approved by the licensor, i.e., Coca Cola Company.
4. The said agreement could be terminated by 90 days' notice from either side.
The agreement was subject to an obvious condition that the franchisee (GBC) shall not deal with competing goods.
It was held that such a condition requiring the franchisee not to deal with the competing goods is meant to facilitate distribution of the goods of the franchiser, and it cannot be regarded as in restraint of trade. Moreover, since the negative restriction is operative only during the period of franchise, it is not hit by sec. 27 of the Contract Act, so as to be termed as in restraint of trade.
In England, all agreements in restraint of trade are void, unless there is some justification for the restraint making it reasonable. If the restriction is reasonable in the interest of the contracting parties and also in the interest of public, the agreement is valid. Thus, any restraint which is justified as being reasonable is valid in England. Indian law is stricter. It recognizes only certain exceptions through statutes and judicial decisions. Any agreement which is not covered by any one of the recognized exceptions is void.
Exceptions to an agreement in restraint of trade
(1) Sale of Goodwill
When there is sale of business by a person along with its goodwill, the seller of the business may make an agreement with the buyer not to carry on the business in competition with the buyer. Such an agreement, if imposes a reasonable restriction on the seller's right to carry on the business, is valid, both in India and England.
Exceptions 1 to sec. 27, Indian Contract Act, which permits such an agreement on the sale of goodwill, reads as under:
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 longas the buyer, or
any person deriving title to the good will from him,
carried on a like business therein, provided that
such limits appear to the Court reasonable, regard being had to the nature of the business. 10
Exceptions 2 and 3 to this section have been repealed by the Indian Partnership Act, 1932.
Thus, an agreement by a person, who sells the goodwill of his business not to carry on a similar business within specified local limits, so long as the buyer carries on a similar business, is valid, provided that the restrictions are reasonable.
When a person purchases the goodwill of the business, he pays for the right to carry on a certain type of business, in exchange for an express or an implied promise by the seller not to carry on that type of business. It will be contrary to the spirit of the contract of sale of goodwill, if the seller of the goodwill, who has received money for the same, starts that business in competition with the buyer again. If the object of the agreement is to protect the right of the buyer of the goodwill, the restraint is valid. If, on the other hand, the restraint merely aims at avoiding competition, the covenant would be invalid.
Thus, in Nordenfelt v. Maxim Nordenfelt Guns and Ammunition Co. Ltd.,"[(1894) A.C. 535.]
Facts of the case:
1. an agreement by a person, who sold his business of manufacturing guns and ammunition for a huge sum of £ 2,87,500,
2. not to engage in the business of manufacturing guns and explosives, etc.elther directly or indirectly, for a period of 25 years was valid.
In this case looking to the nature of the business and also the fact that the Government of that and other countries was customers, a covenant unrestricted as regards space was necessary for the protection of the company purchasing the business. The covenant was not considered to be against the public interest and the same could be enforced through an injunction.
However, another part of the agreement in this case whereby the vendor covenanted not to engage in any business which might compete in any way with that for the time being carried on by the vendee company, was considered to be unreasonable, and void. The restriction was considered to be wider than what was necessary for the protection of the interest of the person purchasing the business.
If the agreement in essence is a covenant against competition rather than that of sale of goodwill it would be void.
In Vancouver Malt and Sake Brewing Co.v. Vancouver Breweries Ltd., (1934)A.C. 181,
Facts of the case:
1. The appellants had a brewer's license in respect of their premises In Vancouver City, under which they could manufacture and sell beer:
2. They never manufactured or sold beer.
3. The only liquor they were manufacturing was sake, Japanese liquor made from rice.
4. The appellants made an agreement with the respondents under which they purported to sell and assign to the respondents for $15,000 all the goodwill of their brewer's license and agreed that they would not engage.
5. In the trade or business of manufacturing or selling beer for a period of 15 years.
6. The covenant, however, provided that the appellants were free to continue manufacturing and selling sake.
The Privy Council held that agreement void for two reasons:
1. The agreement purported to sell the business of manufacturing beer, which the appellants had never carried on. There could be no goodwill of a business which had never been carried on. This only meant an agreement not to make any competition in future in manufacturing beer.
2. The restraint was very wide, restraining the appellants from manufacturing beer anywhere in the world, and therefore, unreasonable and void on that ground also.
(2) Exceptions under the Indian Partnership Act
Notwithstanding the rule contained in section 27, Indian Contract Act, that an agreement in restraint of trade is void, such an agreement can be validly made by the partners in four situations mentioned in sections 11(2), 36(2), 54 and 55(3) of the Indian Partnership Act, 1932.
(i) Section 11(2), Indian Partnership Act:
permits the partners of a partnership firm to make a contract which provides that
a partner shall not carry on any business other than that of the firm while he is a partner.
The purpose of such an agreement is that the partners will not carry on their own business ignoring the partnership business.
Such an agreement is valid and is not hit by the rule contained in section 27, Indian Contract Act.
(ii) Another exception is contained in section 36(2), Indian Partnership Act:
According to this provision, such an agreement may be made between the outgoing partner and the remaining partners who continue the business of the firm.
Generally, an outgoing partner is paid his share of the goodwill of the firm, and
it is reasonable that he agrees that he will not carry on a business similar to that of the firm.
Such an agreement is valid if the restrictions as regards time for which, and the area within which, a similar business is not to be carried on, are reasonable.
(iii)Section 36(2) of the Partnership Act reads as under:
"A partner may make an agreement with his partners, that on ceasing to be a partner,
he will not carryon any business similar to that of the firm within a specified period or within specified local limits; and
notwithstanding any thing contained in section 27 of the Indian Contract Act, 1872,
such agreement shall be valid if the restrictions imposed are reasonable."
(iii) Section 54, Indian Partnership Act, contains another exception to the rule and permits such an agreement to be made upon or in anticipation of the dissolution of the firm.
The provision is as follows:
"Partners may, upon or in anticipation of the dissolution of the firm, make an agreement that some or all of them will not carry on a business similar to that of the firm within a specified period or within specified local limits; and notwithstanding anything contained in section 27 of the Indian Contract Act, 1872, such agreement shall be valid if the restrictions imposed are reasonable."
When a firm is dissolved, either some of the partners or some third party may purchase the business as well as goodwill of the firm. Those partners who get such payment for the sale of goodwill may then agree that they will not carry on a similar business within a specified period, or within specified local limits. If the restrictions imposed are reasonable, the agreement is valid.
(iv)Section 55(3), Indian Partnership Act, contains still another exception to the rule. The section reads as under:
"Any partner may, upon the sale of the goodwill of a firm, make an agreement with the buyer that such partner will not carry on any business similar to that of the firm within a specified period or within specified local limits, and notwithstanding anything contained in section 27 of the Indian Contract Act, 1872, such agreement shall be valid if the restrictions imposed are reasonable."
We have already noted that when a person purchases the goodwill of a business, his interest may be protected by a covenant by the seller of goodwill that the latter will not carry on a business similar to the one which has been sold.
Similar is the position when, on the dissolution of the firm, firm's goodwill has been sold. Thus, there may be an agreement by any partner, who has received consideration on the sale of goodwill of the firm, in favour of the buyer of the goodwill, that such partner shall not carry on a similar business for a certain duration of time or within specified local limits, such an agreement is valid, if the restrictions imposed are reasonable.
(3) Restraint by a contract of service
An agreement of service under which an employee agrees that he will serve a particular employer for certain duration, and that he will not serve anybody else during that period, is a valid agreement. During the period of employment, the employer has an exclusive right to avail the services of his employee and, therefore, a restraint on the employee to serve somebody else at the same time is reasonable Such an agreement is not hit by the doctrine of restraint of trade. Although, according to Specific Relief Act, 1963, a contract to serve a particular person is not capable of being specifically enforced, See Sections 14(1)(b), 38 and 41 (e), Specific Relief Act, 1963.] Yet the negative covenant saying that the employee will not serve anybody else is valid and enforceable."[See section 42, Specific Relief Act, 1963.]
For example: Therefore, if B contracts with A to serve him faithfully for twelve months as a clerk, and also agrees not to serve anybody else during that period, A is not entitled to a decree for specific performance of the contract by B to serve A. He is, however, entitled to an injunction restraining B from serving a rival business house as clerk. [This is illustration (d) to section 57, Specific Relief Act, 1877. The present section 42, Specific Relief Act, 1%3 contains a similar provision to sec. 57 of the earlier Act, but Specific Relief Act. 1963 contains no illustrations. Also see Moganlalv. Ambica Mills Ltd., A.I.R. 1964 Guj. 215.]
In Charlesworth v. Mac Donald, [I.L.R. (1898) 23 Born. 103.]
Facts of the case:
the defendant agreed to serve as an assistant to the plaintiff, a physician and a surgeon at Zanzibar, for a period of three years and
not to practice himself during that period.
After one year, he left the plaintiffs service and started his own practice in Zanzibar.
It was held that the plaintiff was entitled to restrain the defendant from practicing during the period of agreement in Zanzibar.
In Niranjan Shankar v. Century Spinning and Manufacturing Co, Ltd.,"[A.I.R. 1967 S.C. 1098.J
Facts of the case:
1. the respondent Century Spinning Company, who manufactured tyre cord yarn at its plant at Kalyan received foreign know-how from certain concerns on the condition that the respondent company should keep all technical information, know-how, knowledge, experience, data and documents, etc. secret.
2. The respondent company undertook that they would make necessary secrecy agreement with all their employees.
3. The appellant, Niranjan Shankar, who was appointed as a Shift Supervisor in the Century Spinning Company for a period of five years,
4. was made to sign an agreement in the following terms: "In the event of the employee leaving, abandoning or resigning the service of the company in breach of the terms of agreement before the expiry of the said period of five years, he shall not directly or indirectly engage in or carry on of his own accord or in partnership with others the business at present being carried on by the company and he shall not serve in any capacity, whatsoever or be associated with any person, firm or company, carrying on such business for the remainder of the said period."
5. Niranjan Shankar served Century Spinning Company for about one year and during that period acquired certain knowledge which he had undertaken to keep secret, and
6. then he got a job at a higher salary with Rajasthan Rayon Company at Kotah, who were also engaged in manufacturing tyre cord yarn.
7. Century Spinning Company brought an action to restrain Niranjan Shankar from serving the other concern in breach of the agreement, for the duration of the remaining period.
The agreement restraining Niranjan Shankar from taking another job was held to be valid and he was restrained, by an injunction, from taking up the other employment.
If an agreement between a company and the person appointed as its advisory stipulates that he would not carry on business activities similar to those carried on by the company, the restraint is not void under section 27 of the Contract Act. However, the restraint will be effective only during the period of appointment of advisory.[M/s Sociedade de Fomenlo Industrial Ltd. Ravindra nath Subraya kamat, A.I.R. 1999, Bom. 158.].
Employee's freedom to work can be restrained even after the employment is over, provided the restraint is reasonable
For example: an agreement by a solicitor's clerk not to practice within 7 miles of that place after leaving his employment, was held to be valid even though the restraint was unlimited in point of time."[Fitch v. Dewes, (1921) 2 A.C. 158.]
Similarly, an agreement by a Works Manager of a glass manufacturing concern, having market throughout the country, not to engage in a similar business throughout the country, was held to be valid because looking to the employer's business, the agreement was reasonable. [Foster & Sons Ltd. v. Suggett, (1918) 35 T.L.R. 87.]
If the employee occupies an insignificant position in the employer's concern,
for example, he is a mere salesman with a firm of drapers, a covenant restraining him from canvassing his employer's customers for five years after leaving the employment, will be considered unreasonable, as the period of restraint is longer than is necessary for the protection of the employer's Interest."[M. & Drapers v. Reynolds, (1955) 1 W.L.R. 9.]
Similar considerations apply in other contracts as those in contracts of service, where for the protection of genuine interest of a party to the contract, a restraint on the other party regarding the business to be carried on by the other may be valid
In Vidya Wati v. Hans Raj,"[A.I.R. 1993 Delhi 187.]
Facts of the case:
1. the owner of a shop in Sunder Nagar Market, New Delhi,
2. who was running a sophisticated Cosmetic Hair Dressing shop there under the name and style of M/s. Andre Hair Dresser and Cosmetic Stores,
3. gave on contract the said shop and with the said business all tools and machinery, fans, air-conditioners, telephone and other equipment to a tenant,
4. restricting the tenant to do a particular type of business only under a particular name and style.
It was held that the dominant purpose of the agreement was to give a business on lease, rather than the shop, and therefore, the agreement that the tenant should conduct a particular kind of business only in that shop was not in restraint of trade, and was not hit by section 27 of the Contract Act.
(4) Trade Combinations
Sometimes, the traders or manufacturers combine together to eliminate competition as between themselves and make agreements fixing minimum price, regulating the supply of goods and putting profits in a common pool and the dividing the same amongst themselves. Such agreements are neither void on the ground of being opposed to public policy, nor are they deemed to be in restraint of trade [fraser& Co. v. Bombay Ice Manufacturing Co., (1904) 29 Bom. 107; Bhola Nath v. Lakshmi Narain, A.I.R. 1931 All. 83.]
In England, such combinations are valid if they impose excessive restraint on the freedom of trade, but are valid if the restraint imposed is reasonable in the interest of the parties as well as the public interest
In English Hop Growers v. Dering,[(1928) 2 Κ.Β. 174.]
Facts of the case:
1. the plaintiff was an association of hop growers, who had combined with a view to avoiding competition between themselves by marketing the produce of all the members through regulated sales.
2. The defendant was the member of this association and he agreed to deliver all his crop for a particular year to the association to be sold by the association.
It was held that the restriction on the defendant's power to himself dispose of his own crop was not unreasonable.
In Fraser & Co. v. The Bombay Ice Manufacturing Co., [I.L.R. (1904) 29 Bom. 107.]
Facts of the case:
1. there was an agreement between various ice manufacturers fixing minimum price at which the ice manufactured by them was to be sold.
2. The agreement further provided that the profits of these various manufacturers will be pooled together and then distributed in a certain agreed proportion.
It was held that the agreement was valid.
Similarly, an agreement between several firms to charge uniform rates for ginning and bailing cotton, and also pool their income together and then distribute the same amongst themselves, is not in restraint of trade. [Ruber Nath v. Mahali Ram, I.L.R. (1912) 34 All. 587; Haribhaiv. Sharafali, I.L.R. (1898) 22 Bom. 861.]
(5) Solus agreement
Sometimes the seller or the manufacturer of a certain product may agree that he will supply the whole of his product to a particular single buyer only, or, similarly, a buyer may agree that he will purchase all his requirements of a certain commodity from a particular seller or manufacturer only and none else Such agreements are called 'solus agreements".
In such a case, one party agrees to deal only with the other party and none else. They are also known as 'exclusive dealing agreement'. So long as the object of the agreement is the benefit of the parties to the contract rather than monopolizing the trade, there is nothing unreasonable in it and the agreement is not considered to be in restraint of trade.
Thus, if the seller agrees to supply all the goods produced by him to a certain buyer and to nobody else, and the buyer also in turn undertakes to accept the whole of the quantity produced by the seller, the agreement is valid." [Mackenzie v. Striramiah, L.A.R. (1892) 15 Mad. 79.]
Thus, an agreement to sell, all the salt produced during a certain period to a particular buyer only, [Mackenzie v. Striramiah, I.L.R. (1890) 13 Mad. 472; confirmed on appeal in l'adotopaRamanjiahv. Mackenzie, I.L.R. (1892) 15 Mad. 79.] or to sell a certain variety of duties manufactured by the defendant to the plaintiff only and no other person," [Carlisle., Nephews & Co. v. Ricknauth, I.L.R. (1882) 8 Cal. 809.] is not in restraint of trade.
In the following exceptional cases solus agreements are not valid:
(1) When the buyer does not agree to purchase the whole quantity, he cannot restrain the seller from selling his surplus to others
For example: an agreement to sell a certain quantity of silica sand to the plaintiff every month, and not to sell any sand to four specified factories, was in restraint of trade so far as it related to restriction on sale of sand to other factories. [Har Bilas v. Mahadeo Pd, A.I.R. 1931 All. 539.]
(2) When the object of the agreement is to corner goods or to monopolize trade, or the restraint is for an unduly long time,
for example: binding a party with such agreement from generation to generation, the agreement cannot be considered to be lawful.
In Sheikh Kalu v. Ram Saran Bhagat,"[(1908) 13 Cal. W.N. 388.]
Facts of the case:
1. The respondent, Ram Saran Bhagat, took an agreement from 29 out of 30 manufacturers of combs in Patna, according to which all these manufacturers during their lifetime were to supply all the combs manufactured by them to the respondent and his heirs.
2. They undertook not to supply combs to any body else.
3. It was also stipulated that the respondent was not bound to accept the combs if he found that there was no market for the same.
It was held that the agreement was void as the restraint was for unreasonably long time and also because the agreement aimed at suppressing competition and monopolizing the market through contracts under which the manufacturers undertook to supply their entire production to the respondent.
Agreement void only to the extent of restraint
An agreement in restraint of trade is void only to the extent it imposes restraint [See sec. 27.] If a part of the agreement does not impose restraint and the other part does so, the agreement may be void as regards the second part of it
In Har Bilas v. Mahadeo Prasad, [A.I.R. 1931 All. 539.]
Facts of the case:
the defendant agreed to supply a certain quantity of silica sand to the plaintiff every month.
He also agreed not to sell silica sand to four specified factories.
It was held that the whole of the agreement was not void, it was void only to the extent it restrained the defendant from selling his surplus silica sand to four specified factories.