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Introduction
Any term of a contract of employment, which operates in restraint
of trade, is, prima facie, contrary to public policy and therefore
unenforceable. Such a term may, however, be justified if:-
a) it is designed to protect a legitimate business interest, and;
b) the restriction is no greater than is reasonably required to
protect the relevant interest.
As what constitutes restraint of trade is summarized in
Halsbury’s
Laws of England (1), where it is opined that it is a general
principle of the Common Law that a man is entitled to exercise any
lawful trade or calling as and when he wills and the law has
always regarded jealously any interference with trade, even at the
risk of interference with freedom of contract, as
it is public
policy to oppose all restraints upon liberty of individual action
which are injurious to the interests of the State. The principle
is not confined to restraint of trade in the ordinary meaning of
the word "trade". Moreover, it extends to contracts restricting
the way in which a tradesman carries on his business on a piece of
land, and to restraints imposed by the rules or practices of
professional or other bodies controlling particular activities.
In deciding whether a contractual term amounts to a restraint of
trade, the Court looks not at the form of the term but its effect.
In Marshall vs. N M Financial Management Ltd
(2), in which it was
held that the doctrine can therefore apply to indirect
restrictions, such as a financial incentive not to compete with
the employer. A clause stipulating that a self-employed agent
would only be entitled to commission accruing after the
termination of the relationship if he did not compete with the
company was an unreasonable restraint of trade.
Agreements in restraint of trade are extremely common and it would
be intolerable hindrance to business if they were not allowed. (3)
Section 4 of the Competition Act of 1891 provides a provision for
the limitation of business through such non-competition
agreements.
Chitty on Contracts
(4) states the law qua restraints of trade-
"All covenants in restraint of trade are prima-facie
unenforceable at Common law and are enforceable only when
they are reasonable with reference to the interests of the parties
concerned and the public. Unless the unreasonable part can be
severed by the removal of either part or whole of the covenant in
question, its inclusion renders the covenant or the entire
contract unenforceable."
In Petrofina (Great Britain) Ltd. vs. Martin (5), Diplock L.J., in
the Court of Appeal, had observed that:
"A contract in restraint of trade is one in which a party (the covenantor) agrees with any other party (the covenantee) to
restrict his liberty in the future to carry on trade with other
persons not parties to the contract in such manner as he chooses."
In the same case,
Lord Denning M.R. has expressed that:
"Every member of the community is entitled to carry on any trade
or business he chooses and in such manner as he thinks most
desirable in his own interests, so long as he does nothing
unlawful: with the consequence that any contract which interferes
with the free exercise of his trade or business, by restricting
him in the work he may do for others, or the arrangements which he
may make with others, is a contract in restraint of trade.
It is invalid unless it is reasonable as
between the parties and not injurious to the public interests."
The Supreme Court of United States, in the leading decision in
Standard Oil Company vs. United States (6) that as a 'rule of
reason' that the term "restraint of trade" means that it meant at
common law and in the law of the United States when the
Sherman
Act was passed and it covered only those acts or contracts or
agreements or combinations which prejudice public interest by
unduly restricting competition or unduly obstructing the due
course of trade or which injuriously restrain trade either because
of their inherent nature of effect or because of their evident
purpose.
Restraint of Trade in India
The Law
In India Agreements in Restraint of Trade are governed by
Sec. 27
of the Indian Contract Act, 1872, which is enunciated as follows:
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."
Exception 1- 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 long as the buyer, or any person
deriving title to the goodwill from him, carries on a like
business therein: Provided that such limits appear to the Court
reasonable, regard being had to the nature of the business.
The law provided in the Contract Act was modified by the Indian
Partnership Act, 1932, which makes specific stipulations regarding
agreements in restraint of trade, which finds mention in four
sections i.e. Sec.11 (2), 36 (2), 54 and 55 (3). Further, Sec. 19
of the Trade Unions Act, 1926 AND Section 57 of the Specific
Relief Act, 1963 provides for provision similar to Contract Act.
There is an ongoing debate to introduce the aforesaid provision in
the Intellectual Property Law (7).
The Acts envisages such contract at various stages of the
partnership i.e. while it is commenced, while it is continuing,
upon anticipation of the dissolution or at the time of
dissolution. Therefore all agreements in restraint of trade will
be valid provided, they are reasonable in the interests of the
parties and in the public interest.
The Precedents
The doctrine of restraint of trade was introduced in Indian Courts
by the celebrated decision of Sir Richard Couch, C.J. in
Madhub
Chunder vs. Rajcoomar Doss (8) where the scope of section 27 of
the Contract Act, 1872 was extensively discussed. Let us discuss
more recent and pertinent judgments:
1. M/s. Gujarat Bottling Co. Ltd. & ors. vs. Coca Cola Company &
ors. (9)
The Hon’ble Supreme Court of India discussed the scope of section
27 of the Contract Act and opined that:
"A covenant in restraint of trade must be reasonable with
reference to the public policy and it must also be reasonably
necessary for the protection of the interest of the covenantee and
regard must be had to the interests of the covenantor. Contracts
in restraint of trade are prima facie void and the onus of proof
is on the party supporting the contract to show that the restraint
goes no further than is reasonably necessary to protect the
interest of the covenantee and if this onus is discharged the onus
of showing that the restraint is nevertheless injurious to the
public is on the party attacking the contract.
The court has to decide, as a matter of law,
(i) whether a contract is or is not in restraint of trade, and
(ii) whether, if in restraint of trade, it is reasonable.
(10)"
2. Superintendence Company of India (P) Ltd. vs. Sh. Krishan
Murgai (11)
The Hon’ble Apex Court observed that "the
doctrine of restraint of trade does not apply during the
continuance of the contract for employment and it applied only
when the contract comes to an end. While during the period
of employment, the Courts undoubtedly would not grant any specific
performance of a contract of personal service, nevertheless;
Section 57 of the Specific Relief Act clearly provides for the
grant of an injunction to restrain the breach of such a covenant,
as it is not in restraint of, but in furtherance of trade. (12)"
3. Percept D'Markr (India) Pvt. Ltd. vs. Zaheer Khan and Anr. (13)
The view taken in Superintendence Company Case (14) is relied in
catena of cases (15) and the Hon’ble Supreme Court upheld it. The
Court observed and held:
"The
doctrine of restraint of trade does not apply during the
continuance of a contract of employment and it applies only when
the contract comes to an end. Accordingly, a restrictive
covenant will apply during the period of the contract but will be
hit by Section 27 of the Indian Contract Act and be void, after
the contract is ended. (16)"
4. Niranjan Shankar Golikari vs. The Century Spinning and Mfg. Co.
Ltd. (17)
The Court drew a distinction between a restriction in a contract
of employment, which is operative during the period of employment,
and one, which is to operate after the termination of employment.
After referring to certain English cases where such distinction
had been drawn, the Court observed:
"A similar distinction has
also been drawn by the Courts in India and a restraint by which a
person binds himself during the term of his agreement directly or
indirectly not to take service with any other employer or be
engaged by a third party has been held not to be void and not
against Section 27 of the Contract Act. (18)"
Post-Employment Covenant
1. Pepsi Foods Ltd. & ors. vs. Bharat Coca-cola Holdings Pvt. Ltd.
& ors. (19)
"Post employment restrictions were held to be invalid and violative of Article 19 (1)(g) of the Constitution....
Negative covenant in contract restraining employee from engaging
or undertaking employment for twelve months after leaving the
services of plaintiff was held to be contrary and in violation of
Section of the Indian Contract Act, 1872 and injunction was
declined. (20)"
2. American Express Bank Ltd. vs. Ms. Priya Puri.
(21)
"Enforcement of post employment contract restrains restricting the
freedom of an employee to obtain different job opportunities was
held to be unenforceable and void."
3. Wipro Limited vs. Beckman Coulter International S.A. (22)
"Agreements of service, containing a negative covenant preventing
the employee from working elsewhere during the term covered by the
agreement, are not void under Section 27 of the Contract Act, on
the ground that they are in restraint of trade. Such agreements
are enforceable. The reason is obvious. The doctrine of restraint
of trade never applies during the continuance of a contract of
employment; it applies only when the contract comes to an end.
While during the period of employment, the courts undoubtedly
would not grant any specific performance of a contract of personal
service...(23)"
4. The question of negative covenants was considered by the
Supreme Court in the case of Niranjan Golikari's Case (24) and
Superintendence Co. Ltd. Case (25), Wherein the Courts held that
"negative covenants operative during the period of employment when
the employee is bound to serve his employer exclusively are not to
be regarded as restraint of trade and therefore do not fall under
Section 27 of the Contract Act."
Conclusion
There is no better way to conclude this topic then quoting the
observations of Sir Richard Couch, C.J., in Madhub Chunder v. Raj
Coomar Doss (26) which has become the ‘locus classicus’ on this
subject. The observations were:
"The
words 'restraint from exercising a lawful profession, trade or
business' do not mean an absolute restriction, and are intended to
apply to a partial restriction, a restriction limited to some
particular place, otherwise the first exception would have been
unnecessary.' Moreover, 'in the following Section
(Section28) the legislative authority when it intends to speak of
an absolute restraint and not a partial one, has introduced the
word 'absolutely'.... The use of this word in Section 28 supports
the view that in Section 27 it was intended to prevent not merely
a total restraint from carrying on trade or business, but a
partial one. We have nothing to do with the policy of such a law.
All we have to do is to take the words of the Contract Act, and
put upon them the meaning which they appear plainly to bear."
References
1. 4th Edition, Butterworths Publications, London, Vol. 47, pg. 19
onwards.
2. [1997] IRLR 449
3. Lord McNaughen in Nordenfelt vs Masim Nordenfelt Guns and
Ammunitions Co, (1894) AC 535.
4. 20th Edition, Sweet and Maxwell, London, Vol. 1, pg. 874.
5. (1966) 1 Ch. 146.
6. 221 U.S. 106; 55 L. ed. 609.
7.
http://www.competition-commission-india.nic.in/competition_forum/IPRs_by_Dr.Chakravarthy_22July2005.pdf
8. [1874] 14 Beng. L.R. 76
9. (1995) 5 SCC 545
10. Para 21, (1995) 5 SCC 545.
11. (1981) 2 SCC 246, (1980) 3 SCR 1278
12. Para 17, (1981) 2 SCC 246
13. (2006) 4 SCC 227
14. Supra Note 9.
15. Mr. Diljeet Titus, Advocate vs. Mr. Alfred A. Adebare and Ors.
130 (2006) DLT 330; See Also- Yanala Malleshwari and Ors. vs.
Ananthula Sayamma and Ors. 2006 (6) ALD 623; Pepsi Foods Ltd and
Ors. vs. Bharat Coca-Cola Holdings Pvt Ltd and Ors. 1999 (50) DRJ
656; R. Babu and Anr. v. TTK LIG Ltd. 2005 (124) Comp Cases 109
(Madras).
16. Para 41, (2006) 4 SCC 227
17. AIR 1967 SC 1098
18. Para 16, AIR 1967 SC 1098
19. 81 (1999) DLT 122, 1999 (50) DRJ 656; See Also- Y.G.
Ramamurthy vs. Chairman Central Board Excise & Customs; [1983(2)
S.L.J. 59]; Iqbal Ahmad vs. Chief Justice of High Court of
Judicature at Allahabad AIR 1962 All 391; Indra Bahadur Singh vs.
Bar Council of U.P. AIR 1986 All 56.
20. Para 77, 81 (1999) DLT 122
21. (2006) III LLJ 540 (Del) (Para 42)
22. 131 (2006) DLT 681
23. Para 28, 131 (2006) DLT 681
24. Supra Note. 17.
25. Supra Note. 11.
26. Op. Cit. Note 8.
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Restraint
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