CHANAKYA NATIONAL LAW

UNIVERSITY, PATNA

PROJECT OF LAW OF CONTRACTS-I

EXCEPTATIONS TO AGREEMENT IN
RESTRAINT OF TRADE

SUBMITTED TO: -
MRS. SUSHMITA SINGH
FACULTY OF LAW OF CONTRACTS

SUBMITTED BY: -
ABHINAV SWARAJ
ROLL NO. -1504
B.A. LL. B
2ND SEMESTER

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ACKNOWLEDGEMENT

Writing a project is one of the most significant academic challenges, I have ever
faced. Though this project has been presented by me but there are many people
who remained in veil, who gave their all support and helped me to complete this
project.

First of all, I am very grateful to my subject teacher MRS. SUSHMITA

SINGH without the kind support of whom and help the completion of the
project was a herculean task for me. He donated his valuable time from his busy
schedule to help me to complete this project and suggested me from where and
how to collect data.

I acknowledge my friends who gave their valuable and meticulous advice which
was very useful and could not be ignored in writing the project. I want to
convey most sincere thanks to my 3rd year senior Shri Ashutosh Kashyap, for
helping me throughout the project.

Last but not the least, I am very much thankful to my parents and family, who
always stand aside me and helped me a lot in accessing all sorts of resources.

I thank all of them!

Abhinav Swaraj

R.No.1504, Sem II
B.A.L.L.B. (H)

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 CONTENTS

ACKNOWLEDGEMENT ...................................................................................
1. INTRODUCTION ....................................................................................... 4
2. TYPICAL RESTRICTIVE CLAUSE ......................................................... 7
3. APPLICABLE LAWS................................................................................. 7
4. KINDS OF RESTRAINT ............................................................................ 9
5. RESTRAINT OF TRADE UNDER THE COMMON LAW ..................... 9
6. EMPLOYER MUST HAVE A VALID INTEREST ................................ 11
7. RESTRAINT MUST BE REASONABLE ............................................... 11
8. EXCEPTION ............................................................................................. 13
9. CONTRACTS OF EXCLUSIVE DEALING ........................................... 14
10.RESTRAINTS ON SONGWRITERS AND OTHER ENTERTAINERS . 15
11. IS RESTRAINT GOOD OR BAD FOR HEALTHY BUSINESS? ...... 16
12. CONCLUSION & SUGGESTION ........................................................ 22
BIBLIOGRAPHY ................................................................................................

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 a) INTRODUCTION

This research work deals with an area of law which under classical contract theory brought
two principles into direct conflict. On the one hand, classical theory endeavoured to promote
‘freedom of contract’ – it is the parties who determine their obligations, and the courts should
only intervene in exceptional circumstances. On the other, underlying classical theory was an
acceptance that the ‘free market’, in which competition takes place between those seeking to
make contracts, is the ideal economic framework for the operation of exchange transactions.
What happens when the freedom to contract is used to restrict competition? The answer of
the common law was limited. A range of contracts or contractual provisions which were
regarded as being ‘in restraint of trade’ were treated as being ‘illegal’, on grounds of public
policy, and therefore unenforceable. The main use of this approach, however, as will be seen
below, was in relation to restrictions contained in contracts of employment or in contracts for
the sale of a business, purporting to limit the economic activity which the employee or the
seller could engage in after leaving the employment or selling the business. The broader
problems of ‘anti-competitive’ practices, and in particular the problems arising from
situations of monopoly or near monopoly in a particular market, were never tackled by the
common law. There is now, however, extensive statutory intervention to control this area,
with much of the current law being shaped by the rules applicable in the European Economic
Community. The approach taken here is to deal only with the common law rules on ‘restraint
of trade’. Agreement in restraint of trade is defined as the one in which a party agrees with
any other party to restrict his liberty in the present or the future to carry on a specified trade
or profession with other persons not parties to the contract without the express permission of
the latter party in such a manner as he chooses. “Providing for restraint on employment in the
employment contracts of the employees in the form of confidentiality requirement or in the
form of restraint on employment with competitors has become a part of the corporate culture.
In other words “one in which a party agrees with any other party to restrict his liberty in the
future to carry on trade with other persons who are not parties to the contract in such a
manner as he chooses”.1 Contracts in restraint of trade are one of the most important
categories of unenforceable agreements at common law. In today’s world agreement in

1
Atiya law of contract,7th edition,2004,page no.207

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restraint of trade has a much wider scope and it is called ‘restrictive practice’, but the legal
and economic problem are same.in this type of agreement one or both the parties come under
a contract in which they limit their freedom to carry on their business or profession in a
particular way, by agreeing not to compete with each other in a particular area or place, by
agreeing not to disclose each other’s trade secret, by agreeing not to come under contract with
any other parties until the expiry of the current contract. Regulation on personal liberty are
regulated because it is thought that they may unduly restrict the freedom of the concerned
individuals. For e.g.- if a person A joins a company ABC, then the company in a contract can
restrict his freedom in order to protect the trade secret and safeguards of the company.
Agreements in restraint of trade are also widely thought to be problematic because of their
possible effect on the broader public interest. More specifically, restrictive agreement are
often attacked on the basis that they unduly restrict the free flow of labour and goods on
which a market economy depends.Essentialy the question is the extent to which the law
should interfere with the freedom of contracting parties to do business in such a way as to
limit or restrict competition, in earlier times, the traditional approach of the courts was to
leave the parties to use their own method of conducting business, even if this was likely to
lead to the creation of monopolies, unfair competition, or the enforcement of restrictive
practices of various kinds. According to section 27 “every agreement by which anyone is
restrained from exercising a lawful profession, trade or business of any kind, is to that extent
is void”.an agreement which unnecessarily curtails the freedom of a person to trade is against
public policy, restraining a person from carrying on a trade generally aims at avoiding
competition and has monopolistic tendency and this is both against an individual’s interest as
well as the interest of the society and on that ground such restraint are discouraged by law.in
today’s world everyone has right to do free trade practice anywhere in a country of which he
is resident and to restrain someone in doing so is illegal and also voidable by law.

AIMS AND OBJECTIVE

i. To discuss (in brief) the concept of agreement in restraint of trade
ii. To study the case law related to agreement in restraint of trade

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 REVIEW OF EXISTING LITERATURE
For the purpose of research the researcher visited cnlu library and review various sources
available both of primary and secondary nature. For

Primary Sources : -
a) Sec. 25 of Indian Contract Act,1872- Agreement without consideration, void, unless
it is in writing and registered or is a promise to compensate for something done or is
a promise to pay a debt barred by limitation law.—An agreement made without
consideration is void, unless— —An agreement made without consideration is void,
unless—"
(1) it is expressed in writing and registered under the law for the time being in force
for the registration of 1[documents], and is made on account of natural love and
affection between parties standing in a near relation to each other; or unless
(2) it is a promise to compensate, wholly or in part, a person who has already
voluntarily done something for the promisor, or something which the promisor was
legally compellable to do; or unless.
(3) It is a promise, made in writing and signed by the person to be charged
therewith, or by his agent generally or specially authorized in that behalf, to pay
wholly or in part a debt of which the creditor might have enforced payment but for
the law for the limitation of suits. In any of these cases, such an agreement is a
contract. Explanation 1.—Nothing in this section shall affect the validity, as between
the donor and donee, of any gift actually made. Explanation 2.—An Agreement to
which the consent of the promisor is freely given is not void merely because the
consideration is inadequate; but the inadequacy of the consideration may be taken
into account by the Court in determining the question whether the consent of the
promisor was freely given.
b) Sec. 27 of Indian Contract Act,1872- Agreement in restraint of trade, void. —
Every agreement by which any one is restrained from exercising a lawful
profession, trade or business of any kind, is to that extent void. —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. —Saving of
agreement not to carry on business of which goodwill is sold.—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.

Secondary Source: -

a)

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 RESEARCH METHODOLOGY
For the purpose of project research, Researcher will rely upon the Doctrinal Method of
Research.

b) TYPICAL RESTRICTIVE CLAUSE

1. Non-disclosure clauses
2. Non-compete clauses during employment
3. Non-compete post-employment clauses
4. Non- use post-employment clauses2

1. Non-disclosure clauses- It includes covering confidentially during employment as well

as after employment ceases such clauses typically prevents an employee from sharing
confidential information with outsiders.
2. A Non-compete clause during employment-these clauses prevents the employee from
engaging in activities that clash with his employment responsibilities.
3. Non-compete post–employment clauses-some employers do not want their employees
to join competitors even after the employee has quit the job. Restriction in this category
may also prevent an ex-employee from starting a competing business or even advising a
relative who is in a similar type of business.
4. Non-use post-employment clauses – such clauses are stricter than the previous one.
They not only prevent from using information gained during employment for competition
use. They go a step further and even stop an ex-employee from making a non-competitive
use of the information.

3. APPLICABLE LAWS
2
Sri rama rao,law of contracts,2002,3rd edition, page no.187

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 1. Indian Contract Act 1872 –section 27
2. Constitution of India Article 19(1)g
3. Competition Act 2002 section 3(1),(2),(4)section 4

1. Indian Contract act 1872- it makes void all contract that impose ‘restraint of trade’. The
provisions are as follows

A. every agreement by which anyone is restrained from exercising a lawful profession, trade
or business of any kind is to that extent is void.
B. the only exception that is permitted to the above is when goodwill of a business is sold.
The exception is not relevant to the discussion in this article

2. Constitution of India- Article 19 (1) g of the Indian constitution guarantees that all the
citizens shall have the right to practice any profession, or to carry on any occupation, trade or
business

However the right to carry on a profession trade or business is not unqualified.it can be
restricted and regulated by the authority of law. The restrictions have to be reasonable and
public interest.

Moreover, it is important to understand that fundamental right are available only against the
state or in other words government or government undertaking. Fundamental rights have
almost no scope when the relationship is between a private employer and individual
employee.

3. Competition Act 2002

a. According to section 3(1) of the competition act 2002, “no enterprise or association of
enterprises shall enter into any agreement in respect of
productivity,supply,distribution,storage,acquisition or contract of goods or provision of
services, which causes or is likely to cause an appreciable adverse effect on competition
within India

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b. According to section 3(2) of the competition act, 2002 any agreement entered into in
contravention of the provision.
c. Agreements which cause or are likely to cause appreciable adverse effect on competition
in market in India are anti-competitive and are voided.
d. According to the section 4 of the competition act,2002
e. No enterprise or group shall abuse its dominant position.
f. There shall be an abuse of dominant position under sub-section(1)

4. KINDS OF RESTRAINT
The law of restraint of trade was traditionally thought to be applicable solely to contractual
clauses that prohibit a person from working in a certain trade or profession, usually subject to
limitation of time and space.

1. They are found in contracts for the sale of the goodwill of a business or professional
practice or a sale of goodwill necessarily involves some degree of limitation on the
seller’s freedom to compete.
Example- the seller of a shop would like to be assured that the buyer will not immediately
set up a competing business next door and draw back most of his old customers. Hence
the seller will want the buyer to agree that he will not enter into competition with him.

2. this kind of clauses are often found in written contracts of employment, the employer
put a condition or agreement in front of his employer that he/she will not work for a
competing employer or set up a competing business of her own after he/she leaves her
present work. These kind of clauses are often found in analogous non-employment
relationship3

Example- A relationship between a singer and his music publisher, a professional sports
person.

5. RESTRAINT OF TRADE UNDER THE COMMON LAW4

Contractual provisions which attempt to restrict the ways in which one of the parties may do
business, or earn a living, have at different times been treated by the common law as being

3
Atiyah’s introduction to the law of contract, sixth edition,oxford,page no.216
4
Trebilcock, 1986

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prima facie void4, or prima facie valid.4 The current position derives from the House of
Lords’ decision in Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd.

Key Case

Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd (1894)5

Facts: Thorsten Nordenfelt had established a valuable business in the manufacture of

machine guns, operating in Sweden and England. His customers included most national
governments across the world. He sold the business to a company, which then transferred
it to Maxim Nordenfelt. At that time Thorsten Nordenfelt entered into an agreement with
Maxim that he (Thorsten) would not for a term of 25 years engage in the manufacture of
guns, explosives, etc, other than on behalf of the company. Thorsten broke this covenant,
alleging that it was unenforceable as being in restraint of trade.

Held

The House of Lords affirmed the decision of the Court of Appeal that the covenant,
though operating as a world-wide ban, was not wider than was necessary to protect the
interests of Maxim Nordenfelt.

Lord Macnaghten stated the House’s view of the correct approach to contracts of this type6
The public have an interest in every person’s carrying on his trade freely: so has the
individual. All interference with individual liberty of action in trading, and all restraints of
trade of themselves, if there is nothing more, are contrary to public policy, and therefore void.
That is the general rule. But there are exceptions: restraints of trade and interference with
individual liberty of action may be justified by the special circumstances of a particular case.
It is a sufficient justification, and indeed it is the only justification, if the restriction is
reasonable – reasonable, that is, in reference to the interests of the parties concerned and
reasonable in reference to the interests of the public.

5
[1894] AC 535
6
Ibid, p 565

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 6. EMPLOYER MUST HAVE A VALID INTEREST

Looking at the first of these requirements, an employer will have a legitimate interest in
restricting the activities of a departing employee, where that employee has either acquired
trade secrets, or has gained influence over the employer’s customers, either because they rely
on the employee’s skill and judgment, or because they have dealt exclusively with that
employee. As was made clear by the House of Lords in Herbert Morris Ltd v Saxelby,7 it is
not sufficient simply that the employee may compete with the former employer, or use ‘skill
and knowledge acquired by the employee in his employer’s business’.8
Examples from the cases where a restraint on an employee has been held to protect a
legitimate interest include a hairdresser,9 a sales representativ10 and a tailor.
In relation to the sale of a business, the interest which the buyer is trying to protect is likely to
be the ‘goodwill’ in the business, that is, the existing trade which has been built up by the
seller. The buyer will probably have paid a substantial sum as part of the purchase price for
the benefit of taking over the ‘goodwill’. In that context, the buyer has a legitimate interest in
preventing the seller from setting up a business which will attract all the old customers.
The courts have been prepared to recognise that the categories of legitimate interest are not
closed. For example, in Greig v Insole,11 which concerned restrictions placed on professional
cricketers by the cricketing authorities, Slade J recognised that there might be a public
interest that the game of cricket should be properly organised and administered. On the facts,
however, the restraint was in any case unreasonable. In Eastham v Newcastle United Football
Club Ltd,12 however, Wilberforce J was unable to find a legitimate interest in relation to
restrictions on freedom of transfer for professional footballers. It seems then that, although in
theory the categories of interest are open, the courts are likely to be very cautious in finding
new interests.

7. RESTRAINT MUST BE REASONABLE

The reasonableness or otherwise of the restraint must be looked at in the context of the
interest which is being protected. There are three main factors to consider: (1) the

7
[1916] 1 AC 688.
8
Ibid, p 710.
9
Marion White Ltd v Francis [1972] 1 WLR 1423
10
Lucas (T) & Co Ltd v Mitchell [1974] Ch 129; [1972] 3 All ER 689.
11
[1978] 3 All ER 449.
12
[1964] Ch 413; [1963] 3 All ER 139

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geographical area covered; (2) the length of time involved; and (3) the scope of the activities
covered.
For example, if a business is sold in one town, a restriction preventing the opening of a
similar business anywhere in the country would be unlikely to be regarded as reasonable.
In Mason v Provident Clothing Co,13 a canvasser who had been employed to sell clothes in
Islington was restrained from entering into similar business within 25 miles of London. This
was held to be too wide.
As regards time, this will again depend on the type of contract. In many employment cases, a
restraint of one or two years at most will be all that is reasonable. In Fitch v
Dewes,14however, a lifelong restraint on a solicitor’s managing clerk was upheld. The
justification was that the business was one to which clients were likely to return over a long
period. In Beckett Investment Management Group Ltd v Hall, for example, the Court of
Appeal held that a 12-month restraint on a financial adviser who had left the claimants’ firm
to set up his own business, was reasonable, though indicated that anything longer would
probably not have been. In Fitch v Dewes,15 however, a potentially lifelong restraint on a
solicitor’s managing clerk was upheld.

Key Case

Fitch v Dewes (1921)

Facts: The defendant was employed as a managing clerk of the plaintiff’s solicitors’ practice
in Taworth. His contract contained a clause that purported to restrict his work if he left the
practice. He was not to work in a solicitor’s office within seven miles of Tamworth for a
period that could be extended to the rest of his life. Following the termination of his
employment, the defendant intentionally committed a breach of the covenant to test its
validity.
Held: The House of Lords held that the clause did not exceed what was reasonably necessary
to protect the plaintiff’s business. The justification was that the business was one to which
clients were likely to return over a long period.

13
[1913] AC 724
14
[2007] EWC Civ 613: [2007] ICR 1539.
15
[1921] 2 AC 158.

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 8. EXCEPTION
One who sells goodwill of a business with a 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 business.

Although the section states that all agreements in restraint of any profession, trade or business
are void, the current trend as per various judicial pronouncements leads to the conclusion that
reasonable restraint is permitted and does not render the contract void ab initio.
Reasonableness of restraint depends upon various factors, and the restraint in order to prevent
divulgence of trade secrets or business connections has to be reasonable in the interest of the
parties to ensure adequate protection to the covenanted. The above section implies that to be
valid an agreement in restraint of trade must be reasonable as between the parties and
consistent with the interest of the public.

PUBLIC INTEREST

There is some controversy as to whether the public interest part of the rules concerning
enforceable restraint of trade does in fact exist. If it does, then it means that even if a restraint
satisfies the other conditions (that is, of legitimate interest and reasonableness), it may still be
struck down as being contrary to the public interest. This might be the case, for example, in
relation to a restraint on the work of a leading artist, playwright, doctor or scientist, whose
work might well be for the public benefit. The principle was stated in Wyatt v Kreglinger and
Fernau.16 The plaintiff’s pension was made contingent upon his not taking any part in the
wool trade. The Court of Appeal held that this stipulation was void, irrespective of whether it
was reasonable as between the parties, because it was contrary to the public interest. This was
followed in the similar case of Bull v Pitney Bowes.17 It seems difficult, however, to find later
authorities that have applied the principle, though Lord Denning supported it in relation to a
solicitor in Oswald Hickson Collier & Co v Carter Ruck.18 In subsequent cases, such as
Deacons v Bridge19 and Kerr v Morris,20 the courts have refused to apply the principle to the
circumstances before them, while not denying its existence.

16
[1933] 1 KB 793
17
[1966] 3 All ER 384
18
[1984] AC 720; [1984] 2 All ER 15
19
[1987] Ch 90; [1986] 3 All ER 217

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 9. CONTRACTS OF EXCLUSIVE DEALING

It was confirmed by the House of Lords in Esso Petroleum Co Ltd v Harpers Garage
(Stourport) Ltd21 that a contract in which one party agrees to take all supplies of a particular
product from one source (sometimes known as a ‘solus agreement’) could amount to an
unreasonable restraint on trade. Such arrangements are particularly common in relation to the
supply of petrol, and in relation to the supply of beer, etc, to public houses.22 The House of
Lords recognised in Esso v Harpers, as had been acknowledged in a report from the
Monopolies Commission published not long before its decision,23 that solus agreements are
not necessarily disadvantageous to the public. It is a question of whether the restraints
imposed by them are ‘reasonable’ overall. Such contractual arrangements may well also fall
foul of the restrictions on anti-competitive agreements contained in s 2 of the Competition
Act 1998, or Art 81 of the EC Treaty, but they may nevertheless be found to be unlawful at
common law.24

Key Case

Esso Petroleum v Harpers Garage (1968)

Facts: The case concerned two solus agreements in relation to two garages run by the
defendant. In respect of both, there was an agreement to take all supplies of petrol from Esso,
and to keep the garage open at all reasonable hours. In relation to garage A, the agreement
was to last for four years and five months. In relation to garage B, the agreement was to last
for 21 years, and was linked to a mortgage over the premises held by Esso, which was also
irredeemable for 21 years. The defendants started to sell cut price petrol of other brands. Esso
sought an injunction to prevent them doing this. The defence was based on ‘restraint of
trade’.
Held: The House of Lords held that contracts of this type could be regarded as being in
restraint of trade. As with the categories looked at above, the question was then whether the

20
[1984] AC 705; [1984] 2 All ER 19.
21
[1968] AC 269; [1967] 1 All ER 699
22
Byrne v Tibsco Ltd [1999] UKCLR 110; Inntrepreneur Estates (GL) Ltd v Boyes [1993] 2 CMLR 293
23
Report on the Supply of Petrol to Retailers in the United Kingdom, 1965 HC 265.
24
The statutory provisions have a minimum threshold based on the market share of the contracting parties;
the common law has no such restriction

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restraint was reasonable as between the parties, and reasonable in the public interest. In
relation to garage A, the five year restraint was reasonable. The 21 years in relation to garage
B, however, was unreasonable, particularly as it was linked to a mortgage.

10. RESTRAINTS ON SONGWRITERS AND OTHER

ENTERTAINERS

A particular area of difficulty has arisen in relation to contracts entered into by songwriters,
or pop musicians, with music publishers or recording companies. These often require the
artists to commit themselves to one company for a lengthy period of time, with no necessary
obligation on the company to promote, or even publish, the artists’ work. The validity of this
kind of ‘exclusive dealing’ agreement was considered in the following case.

Key Case

Schroeder Music Publishing Co Ltd v Macaulay (1974)25

Facts: The plaintiff was a young and unknown songwriter who entered into a standard form
agreement with music publishers (the defendants). The copyright in all the plaintiff’s
compositions for the next five years was assigned to the defendants, with an automatic
extension for a further five years if royalties exceeded £5,000. The defendants could
terminate the agreement on one month’s notice, but there was no similar power for the
plaintiff. The defendants were under no obligation to publish any of the plaintiff’s work. The
plaintiff sought a declaration that the agreement was in restraint of trade and void.
Held: The House of Lords held that, where there was unequal bargaining power, a standard
form agreement has to be looked at to see if, amongst other things, the restrictions it contains
only go so far as is reasonably necessary to protect legitimate interests. In this case, the
contract was in unreasonable restraint of trade because, whereas the plaintiff was totally
committed to the defendants, the defendants were not obliged to publish anything.

25
[1974] 3 All ER 616.

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The decision in Schroeder v Macaulay was applied in the similar case of Clifford Davis
Management Ltd v WEA Records Ltd.26In Panayiotou v Sony Music Entertainment (UK)
Ltd,27 on the other hand, a recording contract which was probably in restraint of trade when
entered into had been renegotiated after the performer concerned (George Michael) had
become famous. His subsequent attempt to challenge the renegotiated agreement failed
because, although it contained some unfavourable conditions, the performer had received full
legal advice. Moreover, the renegotiated agreement was part of a settlement of the dispute of
the original contract. In this context, public policy favoured giving effect to the settlement,
and therefore the revised contract. In any case, the recording company had a legitimate
interest to protect, in that it wished to sell as many records as possible, and the restrictions on
the performer were not unreasonable as a means of protecting that interest.

11. IS RESTRAINT GOOD OR BAD FOR HEALTHY

BUSINESS?
Somewhere restraint is good and somewhere it is bad. For example- if a person works in a
shop A which is famous for its biryani, this is because of a secret recipe which the shop
owner has been using for over 150 years, then they have the right to restrict their employer to
set up a competitive business in any other places or o work with any other employer.in order
to protect their trade secret from the other competitors. If they have the patent right for the
recipe.so in this case it can be consider as a healthy practice of restraint of trade.in other
example if a medicine company discovered a new formulae for the cure of cancer and applied
for the patient right, then they have right to restrict their employees to work with any other
firm in order to protect their secret or in order to protect the thing to get misused.

In other case if an employer restrain his employee to work in any other place after leaving the
job just for harassing the person then this can be said to have wrong practice of restraint of
trade, because this is the violation of article 21 each and every person has right to choose his
profession and place of his workplace.

26
[1975] 1 All ER 237
27
[1994] Ch 142; [1994] 1 All ER 755

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For example- if A works with a company B and he is in a contract that he will not join any
other company after he quits to his job and during his contract he is being unduly harassed, he
is not being paid his wages on time, he is being tortured at his workplace by superior
authorities, then he is free to leave his job and join any other company, if he proves this in the
court of law.

An agreement in restraint of trade lies between two different principles of public policy. A
person entering into a contract of his own free shall be bound by the same. At the same time it
is necessary that he should have liberty to exercise his powers and capacities for his own and
the community’s benefit. Public policy requires that every man, even though at liberty to
work for himself, is not at liberty to deprive himself or his labour, skill or talent by any
contract that he enters into.

A person may be restrained from carrying on his trade by reason of an agreement voluntarily
entered into by him with that object. In such a case the general principle of freedom of trade
must be applied with due regard to the principle that public policy requires the utmost
freedom to the competent parties to enter into a contract and that it is public policy to allow a
trader to dispose of his business and to afford to an employer an unrestricted choice of able
assistance and the opportunity to instruct them in his trade and its secrets without fear of their
becoming his competitors. Where an agreement is challenged on the ground of its being in
restraint of trade, the onus is upon the party supporting the contract to show that the restraint
is reasonably necessary to protect his interests. Once, this onus is discharged by him, the onus
of showing that the restrain is nevertheless injurious to the public is upon the party attacking
the contract. 28

A covenant in restraint of trade lies between two different principles of public policy. A
person entering into a contract of his own free shall be bound by the same. At the same time it
is necessary that he should have liberty to exercise his powers and capacities for his own and
the community’s benefit. Public policy requires that every man, even though at liberty to
work for himself, is not at liberty to deprive himself or his labour, skill or talent by any
contract that he enters into.

A negative covenant that the employee would not engage himself in a trade or business or
would not get himself employed by any other manner with whom he would perform similar
or substantially similar duties, is not therefore, a restraint of trade unless the contract as

28
Contract-1,r.k bangia,sixth edition,Allahabad law agency,page no.-240

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aforesaid is unconscionable or excessively harsh or unreasonable or one sided. A contract
which is in restraint of trade cannot be enforced unless (a) it is reasonable as between parties
and (b) it is consistent with the interest of the public.

The non-compete covenants used in agreements can be categorized into in term and post term
covenants. In an employment contract, the basic interests of the employer which are required
to be protected include trade secrets and business connections and other such confidential
information. In case of restraints in contracts of employment the nature of business and
employment is relevant in assessing the reasonableness of the abovementioned restraints. An
employee owes a duty to the employer to not disclose to others or use to his own advantage
the trade secrets or confidential information which he had access to during the course of
employment and he could be restrained from or sued for divulging or utilizing any such
information in his new employment. But once again, he cannot be prevented from taking up
the employment. Also, the employer cannot prevent the use of employee’s knowledge, skill
or experience even if the same is acquired during the course of employment. Restrictive
covenants are different in cases where the restriction is to apply during the period after
termination of the contract than in those cases where it is to operate during the period of the
contract.

Negative covenants operative during the period of contract of employment when the
employee is bound to serve the employer exclusively are generally not regarded as restraint
of trade and do not fall under Section 27 of the said Act. A negative covenant, one that the
employee would not engage himself in a trade or business or would not get employment
under any other employer for whom he/she would perform similar or substantially similar
duties, is not a restraint of trade unless the contract is unconscionable or excessively harsh or
unreasonable or one sided.

Negative covenants tied up with positive covenants during the subsistence of the contract, be
it of employment, partnership, commerce, agency or like, are not normally regarded as being
in restraint of trade, business or profession unless the same are unconscionable or wholly one
sided and thus do not fall under Section 27 of the said Act. During the period of employment,
the employer has the exclusive right to the services of the employee. A restraint operating
during the term of the contract fulfils one purpose, that of furthering the contract, such a
restraint is designed to fulfil the contract. Where the contract of employment contains such a
covenant and the employee leaves the service the negative covenant can be enforced to the

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extent that the unexpired part of the term or service would be essential for the fulfilment of
the contract. However, even the restraints, which operate only during currency of
employment, may be subject to the doctrine of restraint of trade, if the restraints are such that
one of the parties is so unilaterally fettered that the contract loses its character of a contract
for the regulation and promotion of trade and acquires the predominant character of restraint
of trade.

The Supreme Court in the. Niranjan Shankar Golikari vs The Century Spinning And Mfg Co.
... on 17 January, 196729 mentioned above considered the question of negative covenants. In
this case an employee was given special training by his employer, on condition that he would
serve the company for 5 years, and that if he left his employment before such period, he
would not directly or indirectly engage in the same business and also pay liquidated damages.
The Supreme Court held that that the negative covenants, which operate during the period of
service, are generally not regarded as restraint of trade and therefore not fall within Section
27 of the Act, unless the contract is unconscionable or unreasonable. It was therefore held
that this was a valid contract.

Post term restrictive covenants have been held invalid through various judicial
pronouncements. An employer is not entitled to protect himself against competition on the
part of an employee after the employment has ceased. However, a purchaser of a business is
entitled to protect himself against competition per se on the part of the vendor and it has been
upheld that a employer has no legitimate interest in preventing an employee after he/she
leaves his service from entering the service of a competitor merely on the grounds that the
employee has started working with a competitor, unless the same leads to misuse or an
unauthorised disclosure of confidential information, which has been provided to the
employee during his course of employment.

Thus, the post-service restraint is only legally enforceable in cases where the employer has
placed some reasonable restraints on the employee of the company to ensure that the latter
shall not disclose any confidential information of the former to any business competitor even
after the termination of the service. Such post service restraint has been held to be
enforceable and falls outside the purview of Section 27 of the said Act.

Apart from the non-compete covenants in the employment agreements; another clause refers
to the non-solicitation or non-poaching. Non-solicitation agreements are those agreements by

29
AIR 1967 SC,1098

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which the employee promises not to solicit the employer’s clients or one party agrees to
refrain from employing the employees of the other party for a given period after the
termination of the employment. Generally, negative covenant during the period of the
agreement is considered not to be hit by law but there are certain non- solicitation agreements
which are prima facie negative in nature but still stand as an exception and are enforceable
even after the conclusion of the employment and are held by the Courts to be valid in law.

General injunctions against non-poaching by the competitor may not be granted as such
clauses may be viewed against public interest. However, where the individuals are the
beneficiaries of specific ideas or skills or training that they have acquired by working with
the employer, the employer may get a specific restraining order, pertaining to these
employees.

The Supreme Court in the Golikari case, referred to earlier, considered the refusal of the
employer to accept the resignation of the employee and who wanted to work with a
competitor in the same line of business, for which he was specifically trained and in respect
of which he had signed a non-compete clause. The injunction sought by the employers for
preventing the employee from divulging secrets was not held to fall foul of Section 27 of the
said Act. The courts held that the confidentiality clause was not too wide or unreasonable for
protection of interests of the respondent company.

Franchise agreements contain covenants relating to confidentiality in relation to know- how

and other forms of intellectual property and the franchisor has legal recourse in cases where:
an employee comes into possession of a trade secret, know-how and confidential information
in the normal course of business and passes off such information, an unauthorized person
incites such an employee to provide him with such information, or under a license for the use
of know-how, a licensee is in breach of condition, either expressed in an agreement or
implied from the conduct, to maintain secrecy.

Non-competition clauses are those, which oblige the franchisor or master franchisee not to
operate a competing franchise within a certain radius or for a period after the termination of
the franchise agreement. The enforceability of such clause varies widely and depends on its
reasonableness.

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In the case of Gujarat Bottling Co. Ltd. and others v. Coca Cola Co.30and others An
agreement for grant of franchise by Coca Cola to Gujarat Bottling Company to manufacture,
bottle, sell and distribute beverages under trademarks held by the franchisor contained the
negative stipulation restraining the franchisee to “ manufacture, bottle, sell, deal or otherwise
be concerned with the products, beverages of any other brands, or trademarks/ trade names
during subsistence of this agreement including the period of one year’s notice”. It was held
that the negative stipulation was intended to promote the trade. Moreover, operation of the
stipulation was confined only to subsistence of the agreement and not after termination
thereof. Hence, stipulation could not be regarded as in restraint of trade. It was observed by
the Supreme Court ‘There is a growing trend to regulate distribution of goods and services
through franchise agreements providing for grant of franchise by the franchisor on certain
terms and conditions to the franchisee. Such agreements often incorporate a condition that the
franchisee shall not deal with competing goods. Such a condition restricting the right of the
franchisee to deal with competing goods is for facilitating the distribution of the goods of the
franchisor and it cannot be regarded as in restraint of trade.’

In the case of V.V. Sivaram and others v. FOSECO India Limited31, a n employee was
restrained from using secrets and confidential information, which he gained during job, even
after moving out of the job. The employee had access to confidential information pertaining
to several products including the patent ‘Turbostop’. He left under voluntary retirement
scheme. Injunction restraining him from manufacturing and marketing a product similar to
‘Turbostop’ was held to be not violating Section 27.

It can be understood from the above judgments that although non-compete clauses in
franchise agreements are not seen as being in restraint of trade, they should not be
excessively harsh or unreasonable in case of which the court may refuse to enforce it in its
entirety.

Thus, it can be concluded that the non- compete covenants are usually opposed to freedom of
contract and are likely to be easily charged as agreement in restraint of trade. The non-
compete covenants are generally considered to be valid during the time of employment
though the Courts have been less willing to enforce agreements relating to post-employment
restraints on the employee. The fundamental principle is that an agreement in restraint of

30
AIR 2372, 1995 SCC (5) 545
31
2006 133 CompCas 160 Kar, 2006 (1) KarLJ 386

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trade is void to the extent of the restraint. It is for the courts to determine whether the contract
is reasonable, and the test is whether it is prejudicial or not to the public interest, since these
contracts are considered on grounds of public policy. This implies that the restraint must be
reasonable in the interests of both contracting parties and also in the interests of the public.

One of the few instances in which non-competition clauses will generally be enforceable is in
the context of the sale of a business, where the owners of the business will agree to a non-
compete in exchange for consideration for the goodwill associated with the business (for
example, in a stock sale where the promoters will sell their stock in the business to a buyer in
exchange for consideration). To be enforceable, the non-compete will need to be reasonably
limited in time and scope, and consideration will need to be attributed to the goodwill in the
transaction, as evidenced in the documentation. Similarly, a non-compete clause in a joint
venture in which shareholders mutually agree not to compete with each other on certain terms
and conditions, which include time and geographic restrictions, will generally be enforceable
in India.

12. CONCLUSION & SUGGESTION

To sum up the entire issue the following points may be considered

1. When you purchase a business (and along with it, the goodwill), reasonable restraints my
be included to prevent the seller from setting up a competing business after selling his
business to you.
2. For the restraint to be valid the party imposing it must have a legitimate interest to
protect, such as trade secrets, customer contacts, or goodwill (in the purchase of a
business).
3. During the term of the shareholders’ agreement, a shareholder can be prevented from
setting up a competing business (as it is reasonable restriction).
4. After the termination of the shareholders’ agreement, a shareholder can be prevented
from setting up a competing business only if it would cause irreparable injury to the
existing business and the balance of convenience lies in favour of issuing the order.
5. A restraint will need to be reasonable to protect that interest. The courts will look at the
geographical area covered, the length of the restraint, and the scope of activities covered.
Therefore prima facie it may be concluded that while restraining covenants would be valid
during the subsistence of the agreement however only in exceptional circumstances

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depending upon the facts and merits of each case can a post termination restrictive covenant
be held to be valid.

Everything in this world has negative and positive thing present in it, just like a coin which
has 2 aspects. Agreement in restraint of trade is somewhere good for public but somewhere it
is a disguise, in a monopolistic market it is not good because it restricts the growth and
provides hindrances to the society towards its development. Whereas it is good in few cases.
For example – in case of a concept and technology which can be used for the development of
human but disclosure of it can be proved lethal for human life, example-nuclear energy, War
technology which is used for protection of human beings.so in my opinion agreement in
restraint should be used in a constructive way rather than to prevent someone from growth.
Company should be lineant while enforcing contract with anyone which cannot provide
hindrances to the person growth and development.

BIBLIOGRAPHY

BOOKS

 The modern law of contract-Richard stone

 Law of contracts- Avatar Singh
 Law of contracrs- Dr. R.k. Bangia
 The Indian Contract Act, 1872 -Pollock and Mulla

REFERENCES

 www.slideshare.net
 www.wikipedia.com
 www.vakilno.1.com
 www.e-lawresorces.co.uk
 www.business.gov.in

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