The Indian Constitution safeguards an individual’s freedom of trade and commerce and makes sure that any Legislature does not take away the said freedom and so also the individual cannot take it away by any agreement, where Section 27 ensures that every individual has the freedom to work for themselves and prohibits them from entering into agreements that deprive themselves or society of labour, skill, or talent. It emphasizes that everyone should have unrestricted liberty to use their abilities for their own benefit and that of the community. Consequently, Section 27 explicitly states that any agreement restraining a person from pursuing a lawful profession, trade, or business is void to that extent.
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Emergence of Section 27 Indian Contract Act in India
The first instance where the scope of section 27 was examined by the Calcutta High Court is Madhub Chander v Raj Coomar [1874], where the plaintiff and defendant were rival shopkeepers in a locality in calcutta.
The defendant agreed to pay a sum of money to the plaintiff if the plaintiff closed his business in that locality.
The plaintiff complied and the defendant refused to pay. Consequently, the plaintiff sued for the money.
The defendant argued that the restraint was only partial as it applied to a locality and claimed that such restraint was valid under English law.
However, Couch J held the agreement to be void and said, “the words restrained from exercising a lawful profession, trade or business” do not imply an absolute restriction but are meant to apply to a partial or location specific restriction, this view was also observed in Shaikh Kalu v Ram Saran Bhagat [1909].
The judge relied on the use of the word absolutely in section 28, which addresses the restrictions on legal proceedings.
Since this word is absent in section 27, it is concluded that this section aims to prohibit not only total restraint, but also partial restraint. This interpretation of section 27 has been widely accepted.
Consequently, agreement, in cases like Khemchand Manekchand v Dayaldas Bassarmal [1942] and Mohammad v Ona Mohd Ebrahim [1922], Where in the former one the closing of a mill for three months, a year was held void, similarly in the latter case the division of the sale of beef between two parties, one selling for 14 days, and the other for the remaining days have been deemed void.
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General principle in Indian Law and English law
Indian law is far stricter than English law regarding agreements in following manner:
General Approach
Indian Law: Section 27 of the Indian Contract Act, 1872 imposes a strict prohibition on agreements in restraint of trade. Such agreements, whether total or partial, are considered void unless they fall under specific exceptions provided in the Act, such as the sale of goodwill.
English Law: English law adopts a more flexible approach. Agreements in restraint of trade are valid if they are reasonable in terms of scope, geography, and time, and are not contrary to public policy. This principle was established in the case of Nordenfelt v. Maxim Nordenfelt Guns & Ammunition Co. [1894].
Test of Reasonableness
Indian Law: Section 27 of the Indian Contract Act, 1872 does not explicitly recognize the doctrine of reasonableness. Even reasonable restraints may be declared void unless they fall within the defined exceptions. Partial restraints are also void unless covered under recognized exceptions, as noted in Nur Ali Dubash v. Abdul Ali [1892].
English Law: English courts actively apply the doctrine of reasonableness. A restraint is enforceable if it reasonably protects legitimate business interests and does not harm public interest.
Statutory Basis
Indian Law: Section 27 of the Indian Contract Act, 1872 provides a rigid statutory framework, leaving little room for judicial discretion outside its provisions.
English Law: English law relies on judicial precedents and common law principles, allowing for greater flexibility to adapt to individual cases.
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Statutory exceptions under Section 27 of Indian Contract Act
Under Section 27 of the Indian Contract Act, 1872, generally agreements in restraint of trade are void. However, there are some statutory exceptions which allows such reasonable restraints:
1. Sale of goodwill
This is the only exception given in Section 27 ICA, 1872. The term “goodwill” refers to the reputation or established customer base of a business that enhances its value. When selling goodwill, the seller can agree to specific restrictions to safeguard the buyer’s interest. This includes a commitment not to establish a competing business, which could diminish the value of the transferred goodwill. The restriction is only valid if it is reasonable.
The agreement must define clear geographic boundaries where the restriction applies. The local limits should be reasonable based on the nature and scope of the business.
The restriction is valid only as long as the buyer or deriving title from the buyer continues to carry on the business. The court evaluates whether the restrictions in terms of geographic area and time are reasonable and do not unnecessarily harm public interest.
According to Lord Macnagthen in Ann Trego v George Stratford Hunt [1896], goodwill encompasses much more than what is commonly understood. In his view, Goodwill often represents the essence and vitality of a business without which the enterprise would generate little to no profit. It includes all the advantages derived from the reputation and connections of a firm, which may have been established through years of sincere effort or significant financial investment
This interpretation was later upheld by the judicial committee in an appeal from a Calcutta High Court decision in Parasullah Mullik v Chandra Kanta Das [1917], the plaintiff and defendant top rated businesses as passenger carriers by boat. The plaintiff sold his business to the defendant for a specified amount and agreed to refrain from engaging in a similar boat business in that area for three years.
When the defendant failed to pay the agreed on the plain filed a suit to recover it. The court ruled in favour of the plaintiff, stating unequivocally that the transaction constituted a sale of goodwill, as defined by the established interpretation of the term.
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2. Provisions of the Partnership Act, 1932
The partnership act contains four provisions that validate agreements imposing restrictions on trade. The provisions are as follows -
Section 11: Where partners, during the operation of the partnership may mutually agree to limit their freedom by ensuring that none of them engaged in any business other than that of the firm.
Section 36: This section allows partners to restrict an outgoing partner from engaging in a similar business with a specified timeframe or geographic area. Such restrictions are considered valid if they are reasonable in nature.
Dissolution agreements: Section 54 states that partners may also agree, either at the time of or in anticipation of the firm's dissolution to mutually refrain from conducting any business similar to that of the firm.
Retiring partner’s land: In Hukumi Chand v Jaipur Ice and Oil Mills [1980], the Court said that a retiring partner can agree not to engage in a similar business on land owned by them. If they sell the land, this restriction is Infosec Upul against the buyer provided the agreement is reasonable.
These provisions ensure that reasonable limitations on trade within the context of partnerships are legally binding.
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Exceptions laid by Judicial Interpretation
There are basically three types of exceptions interpreted by Indian Judiciary which are as follows -
1. Restraints upon employees
The judiciary introduced the principle of reasonable restraint upon employees to ensure that while individual freedom to engage in lawful businesses, protected, employers, legitimate business interests such as safeguarding trade secrets, client relationships, and confidential information can also be held.
However, for such restraint to be valid, they must be reasonable in nature, both in terms of geographical scope and duration so as not to unduly restrict the employees free freedom to earn a livelihood.
The landmark case regarding this principle is of Niranjan Shankar Golikari v The Century Spinning Mfg. Co. Ltd. [1967 AIR 1908] where the court in this case acknowledge that while section 27 of the Indian contract act, generally prohibits any agreement that restraints a person from carrying on a lawful business, it carved out an exception for reasonable restrictions imposed on employees in order to protect the legitimate interest of the employer.
The court held that an agreement restraining an employee from working for a competitor or starting a company business would be enforceable if it was reasonable in scope, time, and geographical limits. However, an agreement that prevents an employee from competing with their employer after the termination of employment may not be upheld by the courts.
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2. Trade Combinations
A trade combination refers to an agreement or association between individual businesses or organisations within the same industry or trade to regulate competition, control, production or distribution, set prices or achieve other collective business objectives. These combinations are often formed to protect mutual interest, improve operational efficiency, or established standards within the trade.
Trade combinations are considered an exception under section 27 of the Indian contract act which generally void agreements that restrain trade.
The judiciary recognizes that certain trade combinations aimed at regulating competition or promoting fair business practices may be valid if they are reasonable in scope and do not harm the market or public interest.
Such combinations which might include setting standards or fixing prices within an industry are allowed as long as they are not overly restrictive or monopolistic.
The first case in India to introduce this principle was Karumuthu Thiagaraja Chettiar v. E. Rajeshwara [AIR 1919 Mad 391] where the Madras High Court upheld a trade combination regulating the cotton supply and pricing. The court found that not all restraints on trade are unlawful if they serve legitimate business purposes and are reasonable. The reasonable trade combinations can be permissible under section 27.
3. Solus or exclusive dealing agreements
A common business practice involves a producer or manufacturer choosing to sell their goods through a sole agent or distributor who in turn agrees not to deal with the products from any other manufacturer.
For example, a producer might agree to sell all their output to a single consumer, who then agrees not to purchase similar goods from any other source. As long as this negative condition is only a secondary or incidental part of a primary agreement, it typically does not violate section 27 of the Indian Contract Act.
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Conclusion
Section 27 of the Indian Contract Act 1872, protects individuals freedom to trade by declaring any agreement that restricts a person from engaging in a lawful business as void. It ensures that individuals can freely use their skills and abilities for personal and social benefit. However, there are exceptions such as the sale of goodwill and partnership agreements. In India, the law is stricter than English law, which allows reasonable restraint if they are justifiable in scope and.
Judicial exceptions include restraint on employees, trade, combinations, and exclusive dealing agreements. Such exceptions are permitted only when deemed reasonable, ensuring they do not unfairly limit an individual's freedom while safeguarding legitimate business interests. Influential cases like the Niranjan Shankar Golikari case and the Karumuthu case have significantly contributed to defining these exceptions. While section 27 generally void trade restraint, it permits reasonable limitations to foster fair business and practice competition.
FAQs on Section 27 of Indian Contract Act 1872
Q1. Are all agreements in restraint of trade void under Indian law?
Yes, unless they fall within the exceptions outlined in the Act, such as agreements relating to the sale of goodwill or certain partnership agreements.
Q2. What is the only statutory exception under Section 27 of Indian Contract Act?
The sale of Goodwill is the only statutory exception, allowing reasonable restriction to protect the buyers interest.
Q3. What are judicially recognised exceptions to Section 27 of Indian Contract Act?
Indian courts have allowed exceptions for restraint upon employees, trade, combinations, and exclusive dealing agreements if the restrictions are reasonable.
Q4. What is the significance of the Madhub Chander v Raj Coomar case?
This case established that even partial restraint on trade is void under Indian law, reinforcing the strict interpretation of section 27 of Indian Contract Act 1872.
Q5. Are agreements with geographic or time specific restrictions valid in India?
No, such restrictions are void unless they fall with an exception like sale of goodwill or partnership agreement.
