Section 27 of Indian Contract Act has its roots in the common law principle that emerged in England. Businesses which once regulated competition through their contracts were once threatened with imprisonment as they were regarded as invariably void. Since the reviewal of Restrain of trade was made in Mitchel vs Reynolds, the principle of common law changed in three respects.

1. Restraints are held prima facie void but can be justified if they are reasonable.
2. It is not required that the consideration should be adequate.
3. A rule that a restraint of trade must not be general is no longer applicable.

RESTRAINT OF TRADE AS PER COMMON LAW PRINCIPLE:

A covenant in restraint of trade is valid if the following three conditions are satisfied:

1. An existence of interest meriting protection
2. A reasonable restraint must be present
3. The restraint should be in contrast to the public interest.

In Nordenfelt case (1894) A.C. 535, the covenant restrained the seller from engaging not only in the manufacture of armaments but also “in any other business competing or liable to compete with that for the time being carried on by” the buyer. The latter part of the covenant was held invalid as its effect would be to restrain the seller from competing with the company if it started to make ploughshares and he had sold no business.

In Faccenda Chicken Ltd Vs Fowler [1987] Ch.117, it was held that “the covenant to restraint of trade can extend beyond the period of employment of an employee: eg. where, on leaving his job, the employee takes away, copies or memorises lists of the employer’s connections. He can then be restrained from using such information either for his own benefit or to the benefit of a third party which results in an unfair competitive advantage over his employer”.

In Frank Weisinger case, [1988] I.R.L.R. 60, it was held that a restraint is valid only if it goes no further than is reasonably necessary for the protection of the Covenantee’s interest. Reasonableness is determined by looking at the relationship between that interest and the covenant.

JUDICIAL INTERPRETATION BY INDIAN COURTS

 

It must be noted that, in India, agreements in restraint of trade were considered void and not illegal. Unlike the common law, in India, partial agreements in restraint of trade is itself not considered a valid contract. Following are the landmark judgments that support the said contentions.

In Madhub Chunder Poramanic V. Rajcoomar Doss reported in [Vol. XIV] Bengal Law Reports Page 76, for the first time, the Division Bench drew a distinction between the English law and Indian law and opined that any kind of restraint by which a person was prevented from exercising a lawful profession, trade or business was void. It did not matter whether that restraint was partial or appeared to be reasonable which was later approved and followed by the Supreme Court in the famous Zaheer Khan Case (2006) 4 SCC 277, where it was held that “The legal position clearly crystallised in our country is that while construing the provisions of Section 27 of the Contract Act, neither the test of reasonableness nor the principle of restraint being partial is applicable, unless it falls within the express exception engrafted in Section 27”.

In, Superintendence Co. of India v. Krishan Murgai, (1981) 2 SCC 246, it was stated that, “ The drafting of a negative covenant in a contract of employment is often a matter of great difficulty. In the employment cases so far discussed, the issue has been as to the validity of the covenant operating after the end of the period of service. Restrictions on competition during that period are normally valid, and indeed may be implied by law by virtue of the servant’s duty of fidelity. In such cases the restriction is generally reasonable, having regard to the interest of the employer, and does not cause any undue hardship to the employee, who will receive a wage or salary for the period in question. But if the covenant is to operate after the termination of services, or is too widely worded, the court may refuse to enforce it”.

While there are certain exceptions to it in Partnership Agreements and sale of good will, the interpretation of Section 27 of Indian Contract remains strict and limited in scope. As the Indian Law possesses an absolute ban on agreements that restrain trade, which can make it challenging especially for businesses that seeks to safeguard their interests