Here is the summary of Section 27 in The Indian Contract Act, 1872:
27. Agreement in restraint of trade, void
Every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.
Exception: 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.
Section 27 of Indian Contract Act stipulates that an agreement, which restrains anyone from carrying on a lawful profession, trade or business, is void to that extent.
However, as exception, if a party sells his goodwill to another, he can agree with the buyer that he will not carry on a similar business within the specified local limits.
Upon a literal construction, Section 27 of the Indian Contract Act invalidates all the agreements that impose a total bar on the exercise of a lawful business.
Although the section states that all agreements in restraint of any profession, trade or business are void, on many occasions, business exigencies require impositions of certain restraints.
As per various judicial pronouncements, the reasonable restraint is permitted and does not render the contract void ab initio.
Reasonable restrictions can be placed in the following ways:-
- Distance: suitable restrictions can be placed on employee to not practice the same profession within a stipulated distance, the stipulation being reasonable.
- Time limit: if there is a reasonable time provided in this clause then it will fall under reasonable restrictions.
- Trade secrets: The employer can put reasonable restrictions on the letting out of trade secrets.
- Goodwill: There is an exception under section 27 of the Indian Contract Act on the distribution of goodwill.
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 covenantee.
Following are the main points of the summary of Section 27 by the Delhi High Court in Wipro Ltd. v. Beckman Coulter International SA case:
- Negative covenants, such as non-compete, non-solicitation, and non-disclosure, in any contract, would not commonly be regarded as being in restraint of trade unless the same is unreasonable or wholly one-sided;
- After termination, negative covenants in employment contracts aimed to restrict the employee’s right to seek employment, or to do business in the same field as the employer, would be in restraint of trade and, therefore, would be void. In other words, no employee can be forced to either work for the present employer or be idle;
- While determining whether the negative covenant is in restraint of trade, the courts take a stricter view in employer-employee contracts than in other contracts, such as partnership contracts, collaboration contracts, franchise contracts, agency/ distributorship contracts, commercial contracts. The reason being that in the latter kind of contracts, the parties are expected to have dealt with each other on more or less an equal footing, whereas in employer-employee contracts, usually, the employer has an advantage over the employee and employees have to either sign contracts or not be employed at all;
- Negative covenants may be in restraint of trade even when those are reasonable or are partial.