legal contours of restrain of trade agreements

INTRODUCTION-

Section 27 of the Act makes agreements in restraint of commerce unenforceable. That is, any agreement prohibiting one individual from establishing or maintaining a trade or profession in exchange for a monetary reward is null and void. As a result, any arrangement that prevents a person from dealing in the manner or location of his choice, based on an agreement with another party, in which the other party benefits from him ceasing his trade or profession, is referred to as a trade constraint agreement. Except for two exceptions, which we will detail below, all trade restraint agreements are null and void. The Sale of Goodwill and Partnership Act contain two exclusions.

COMMON LAW

The history of tension between free markets and contract freedom provides the backdrop for delegitimizing a trade restraint pact. To ensure contract freedom, it would be necessary to legitimise agreements in restraint of trade, which would lead to parties agreeing to limit competition. Under the common law, the current position is derived from the case of –

Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd

Thorsten Nordenfelt was a gun manufacturer in Sweden and England in this case. Thorsten sold his company to a corporation, which ultimately passed it on to Maxim Nordenfelt. Thorsten agreed with Maxim at the time to refrain from manufacturing weapons for the next 25 years, with the exception of what he does on behalf of the company. Thorsten later abandoned his promise, alleging that the arrangement was unenforceable since it was a trade restraint. Thorsten won the case, and the court ruled in his favour.

A test of reasonableness is used in common law. If the following conditions are met, a trade restraint agreement is valid:

The party applying the restraint is attempting to defend a legitimate interest.

The restraint is limited to what is required to defend this interest.

Restraint is not inimical to the general good.

POSITION IN INDIA

With the exception of the Sale of Goodwill, all agreements under restraint of commerce are void pro tanto under Section 27 of the Indian Contract Act. It’s crucial to note, however, that these agreements are null and invalid, not criminal. This means that these agreements are not illegal to create; they are only unenforceable in a court of law if one of the parties fails to fulfil his or her obligations. Even partial agreements in restraint of commerce or reasonable restraint are not legal under the Contract Act, unlike the common law.

In a Bareilly neighbourhood, Shalini manages an office supply and book business. Zahida is planning to open a similar commodities business in the same area. Shalini, terrified of market rivalry, agrees to stop operating her business in the area for 15 years in exchange for a monthly payment from Zahida. Shalini then refuses to pay the agreed-upon sum. Zahida makes an attempt to take the matter to court. Because the agreement is null and void, Zahida has no case.

CASES

Madhub Chunder v. Rajcoomar

The parties in this case were Calcutta merchants. The defendant, Rajcoomar, sustained a loss as a result of the plaintiff’s competition and agreed to refund the plaintiff all of the advances he had made to his workers if he terminated his business there. When the defendant failed to pay, the plaintiff attempted to reclaim the money but was unsuccessful because the contract was a restraint of trade agreement that was not enforceable in a court of law. In this case it was held that partial restraint on trade or business is also restraint of trade.

Superintendence Co. of India Pvt. Ltd. v. Krishan Murgai

In this case, the Supreme Court came to the conclusion that Section 27 expressly declares all agreements (apart from one exception) to be void and the section cannot be attributed two meanings. The test of reasonability as applicable in England cannot be applied in India.

Bholanath Shankar Dar vs. Lachmi Narain  “it is unfortunate that Section 27…seriously trenches upon the liberty of the individual in contractual matters affecting trade”. In the 1967 case of Niranjan S. Golikari v. Century Spinning Co., the Supreme Court decided on the legality of Section 27 of the Act for the first time. The Supreme Court determined that the condition imposed in this instance was limiting in character since it relates to the duration of employment and work that is comparable or substantially similar to that which the appellant performed while employed by the respondent corporation. This restriction was deemed reasonable and necessary for the protection of the company’s competitive interest. The Court acknowledged the right of the aggrieved party to enforce Section 27 of the Act and concluded by stating that the restrictive condition contained in the employment agreement did not amount to a restraint of trade and hence would not fall under the purview of Section 27.

In 1980, a 3 judge bench of the Supreme Court in Superintendence Co. of India Pvt. Ltd. v. Krishan Murgai followed a different path in determining the interpretational boundaries of Section 27. After a thorough review of Section 27, the Supreme Court came to the conclusion that the aim of this particular provision of the Act could only be met by applying a direct and literal reading to it. The Supreme Court ruled that the contours of Section 27 could not be tailored to fit the needs of each case. The Supreme Court determined that any and all restrictions on a contracting party’s freedom to engage in any trade, profession, or business of their choice are void and contrary to public policy. Furthermore, the principle of reasonableness of restraint so imposed would not be applicable to agreements under the Act because of the manner in which Section 27 had been drafted.

Other decisions that followed this case backed up this reasoning. The fact that diverse interpretations were presented for the same statutory provision, however, indicated that the meaning of Section 27 was in flux. This was especially true when it came to contractual agreements in which one party had more bargaining power than the other. Employment contracts, for example, where the employee is at the mercy of the employer and has little bargaining power in the negotiation. In light of this, the case of Percept D’Markr (India) Pvt. Ltd. v Zaheer Khan (the “Zaheer Khan case”), decided in 2003, was a watershed moment in tipping the scales in favour of the party that was wronged by the restrictive covenant’s execution.

Thus, the Act invalidates all restraints of trade, whether general or partial restraint unless it falls within the exception of this section. However, there are two exceptions to this provision (i) provided by the statute, and (ii) arising from judicial interpretation of Section 27 of the Act.

  1. Statutory Exceptions:

As per the statutory exceptions, an agreement for one who sells the goodwill of the Company has to specify the local limits of the restraints. The seller can be restrained within certain territorial or geographical limits and the limits must be reasonable.

In Affle Holdings Pte Limited v. Saurabh Singh After spending a considerable sum of money, the petitioner purchased the full controlling interest in the company from the promoters in order to acquire the promoter’s business as well as its goodwill. Because the petitioner had paid substantial consideration to the promoter under the Share Purchase Agreement, the Delhi Court held that the case would fall within the scope of Exception 1 to Section 27 of the Act, and that non-compete restrictions on the promoter not to engage in a competing business for a period of 36 months were not void.

  1. Judicial Interpretation:

In the case of Gujarat Bottling Co Ltd v. Coco Cola Co, during the term of the agreement, Coca-Cola Co. agreed to provide Gujarat Bottling Co. a franchise not to manufacture, sell, deal, or otherwise be involved with the product, beverages of any other brands, or trademarks/tradenames. The negative stipulation was deemed to be meant to promote commerce, and the requirement was limited to the duration of the agreement, not after its termination. As a result, the stipulation could not be considered a trade constraint. Then, unless the contract is completely one-sided, the law of restraint of commerce would not be drawn.

In a recent judgement, the Karnataka High Court in the case of MU Sigma Business Solutions Pvt.Ltd v. Sagar Balan and others, The Karnataka High Court considered whether or not to grant an injunction against the plaintiff’s former employees. The plaintiffs claimed that the cause of action is based on a non-compete and secrecy clause, alleging that the defendants have used the plaintiffs’ sensitive information, specific methods, and trade secrets in violation of their employment agreement. The plaintiff’s allegation was found to be insufficiently elucidating a justification for an injunction.

CONCLUSION

The validity of trade and employment restraints in India is governed by Indian law. An agreement that prohibits anybody from engaging in a lawful profession, trade, or business is void under Indian contract law. Agreements that restrict commerce or business are unjust, according to Section 27 of the Indian Contract Act of 1872, since they impose an unreasonable constraint on the contracting party’s personal freedom. As a result, unless it comes within the exceptions of this provision, the Act invalidates all trade barriers, whether general or partial prohibitions. There are two exceptions to this rule: I those given by statute, and (ii) those resulting from judicial interpretation of Section 27 of the Act.

BIBLIOGRAPHY

  1. https://www.mondaq.com/india/contract-of-employment/941370/indian-law-on-the-validity-of-trade-and-employment-restraints
  2. https://www.latestlaws.com/bare-acts/central-acts-rules/section-27-agreement-in-restraint-of-trade-void/
  3. https://gamechangerlaw.com/obstructing-the-field-restraint-of-trade-clauses-in-contracts/

Aishwarya Says:

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