lawyers in India

Restraint of Trade and Post Employment Covenants

Written by: Divyam Agarwal - Final Year Law Student - Amity Law School, Delhi
Partnership laws in India
Legal Service India.com
  • 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. (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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