Agreement in Restraint of Trade
Agreement in Restraint of Trade
Agreement in Restraint of Trade
has evolved a long way compared to how it was perceived in the yester years. The law has
also as a matter of public policy opposed any interference with respect to an individual’s
freedom of entering into contracts and on imposing restraints on one’s personal liberties.
When the principle of restraint of trade was incorporated in the Indian Contract Act in the
year 1872, most individuals were either employed in the manufacture or sale of goods and
other commodities. But with the advent of various technological advancements coupled with
the huge impact of globalization in our economy with companies investing millions of dollars
in R&D, information technology, patents and the like, the logical question is shouldn’t it be
reasonable to impose certain restrictions against employees from pursing their trade,
profession or business if it impinges and affects the business or relationship of the employer
with its customers or if it means using to their advantage confidential information or secrets?
Employees willingly sign Non-disclosure or Non-confidentiality agreements at the time of
joining any employment, but they mean nothing if the same cannot be imposed post an
employee’s term with the company has ended, especially considering the fact that s/he might
have been privy to certain confidential or sensitive information during his/her tenure. This
piece, therefore, emphasizes the need to bring in a change and do away with the theory of
absolute restraint as discussed in Section 27 of the Contract Act, and bring out a common
ground to protect equally both the employers’ and employees’ rights. Also Read - When
Erudition Meets Imagination : Farewell To Justice Naidu History and Evolution of Section 27
in India Section 27 of the Indian Contract Act, 1872 stipulates that every agreement by which
an individual is restrained from exercising any lawful profession, trade or business of any
kind, as void. However, this Section lays down an exception wherein any agreement not to
carry on business of which goodwill is sold is not considered a restraint. Section 27 which
follows the Field’s Draft Code for New York, ironically was never adopted in New York but
was adopted in four American States (California, North & South Dakota, and Oklahoma).
The original draft of the Indian Law Commission did not contain any specific provision on
the subject. The provision was incorporated in this Act at a time between the resignation of
the Indian Law Commission and the enactment. The object appears to have been to protect
trade. It has been said that Indian trade is in its infancy and the legislature may have wished
to make the smallest number of exceptions to the rule against contracts whereby trade may be
restrained (HaribhaiManekal v. SharafaliIsabki, (1897) 22 Bom 861 at 866). Also Read -
Section 96 Of The New Land Acquisition Act And Its Application To Land Acquisition
Proceedings Under The MRTP Act The Section is general in its terms and unequivocally
declares all agreements in restraint of trade void pro tanto, except in the case specified in the
exception. This Section lays down a very rigid rule invalidating restraints, not only general
restraints but also partial ones, and also restricts the exception to narrow limits. Nevertheless,
if the parties wish to implement it, they would not be acting illegally and the Court cannot
intervene to prevent them from doing so (Boddington vs. Lawton (1994) ICR 478). Section
27 was enacted at a time when trade was underdeveloped and the object underlying the
Section was to protect the trade from restraints. But when trade in India has developed to a
larger extent, there is no reason why a more liberal attitude should not be adopted by
acknowledging such restraints as reasonable. In fact, the Law Commission of India
recommended that this Section be amended to permit reasonable restraint on the right to carry
on trade, which unfortunately was never implemented by the legislature (Law Commission
Of India, 13 report, 1959, para 55). Even the Allahabad High Court has observed that ‘it is
unfortunate that Section 27…seriously trenches upon the liberty of the individual in
contractual matters affecting trade’ (Bholanath Shankar Dar vs. LachmiNarain, AIR 1931 All
83). But a 3 Judge Bench of the Supreme Court of India in Superintendence Co. of India Pvt.
Ltd. v. KrishanMurgai,AIR 1980 SC 1717,while interpreting the contours of Section 27,
categorically arrived at the conclusion that the Section will have to be interpreted literally and
no two meanings can be attributed to it. According to the Court, all restraints on an
individual’s liberty to practice any trade, profession or business of one’s choice is void and
against public policy and the concept of reasonableness & fairness will be not be applicable
to agreements in India as compared to the United Kingdom. Restraints During and Post
Employment Section 27 has labeled all restraints as void. But the common law principle and
judicial interpretation have split restraints into two halves; restraints applicable during
employment and those applicable post-employment. Uniformly throughout various
jurisdictions in the world all restraints imposed on an employee during his employment are
prima facie valid and cannot be treated as void or against one’s fundamental right to practice
any trade, business or profession. By principle, any agreement of service by which an
employee binds oneself, during the term of his/her agreement, not to compete with his/her
employer, directly or indirectly, is not in restraint of trade. This principle was validated by the
Supreme Court in Niranjan Shankar Golikari vs. Century Spg and Mfg. Co. Ltd., AIR 1967
SC 1098. In this case, the respondent company entered into a collaboration with a German
company, which agreed for a consideration, to transfer their technical know-how to be used
exclusively for the company’s tyre cord yarn plant. The agreement provided that the company
would keep the secret during the period of employment. Three years after this, all technical
information, knowledge, know-how experience, data and documents would be passed by the
German company to the respondent company. The coventor was appointed as shift supervisor
on the condition that he would have to sign a contract in the standard form for the term of
five years, which was accepted by him, the covenant being that the coventor would devote
wholly all his time and energy to the business and affairs of the respondent company and
shall not engage directly or indirectly in any business or serve in any capacity in any business
whatsoever other than that of the company, including his leaving the company before the
expiry of the contract. The coventor in this case, after receiving training, resigned and took a
similar employment with another company. The Court while granting injunction to the
respondent company held that the coventor was restricted only to the period of service not to
work with anyone else and it was, therefore, a reasonable and necessary restriction for the
protection of the employer’s interest. The Court further held that there was nothing to show
that the enforcement of the covenant would lead him to a state of idleness or his being
compelled to go back to the employer and that it was not a valid consideration that in another
employment the coventor would get a lesser remuneration than the one paid by his new
employee. In contrast to the above principle expounded by the Court in Niranjan Shankar
Golikari, the Supreme Court in KrishanMurgai has had an opportunity to deal with covenants
post-employment, which principle till date has been followed by all subsequent decisions.
The Court in this case dealt with the enforceability of a service contract post-employment. As
compared to the case in Niranjan Shankar Golikari, which dealt with a restraint operating
during employment, the restrictive covenant here was to operate once the employee’s service
terminated with the employer. The clause in this case read as follows “That you will not be
permitted to join any firm of our competitors or run a business of your own in similar lines
directly and/or indirectly, for a period of two years at the place of your last posting after you
leave the company." The Court while analyzing in depth the various facts and clauses relating
to the case coupled with the interpretation of various national and international decisions
arrived at the conclusion that all restraints imposed on an individual, post his employment
with the employer, is prima facie void and cannot be given effect to. Therefore, what can be
inferred from the above two decisions and principles is essentially as to when the breach of
contract or service is said to have been committed. If the breach of contract is during the
course of one's employment with the company and if the terms of the contract are not too
unreasonable, then under such a circumstance law comes to the aid of protecting the
employer’s interest as no person/individual can exploit his contractual duties which he is
obliged to perform or hold good for the reason of securing another employment or higher
pay. But per contra, as laid out in Section 27 of the Indian Contract Act and the interpretation
laid down by the Supreme Court in KrishanMurgai, all covenants that restricts anyone post-
employment is void, i.e., if the breach of contract or service even if committed post the
termination or cessation of one’s employment cannot be a ground to challenge as the same is
hit by Section 27 and it is an individual’s fundamental right to practice any trade, profession
or business. All contracts which per se restrict an individual’s right to trade, profession or
business can be identified as non-compete contracts or clauses. In fact the Delhi High Court
in Wipro Ltd. v. Beckman Coulter International SA.,2006 (3) ARBLR 118 (Delhi), after a
review of all the decisions of the Supreme Court and the High Courts, summarized the
principles of Section 27 as follows: “1) Negative covenants tied up with positive covenants
during the subsistence of a contact be it of employment, partnership, commerce, agency or
the like, would not normally be regarded as being in restraint of trade, business of profession
unless the same are unconscionable or wholly one-sided; 2) Negative covenants between
employer and employee contracts pertaining to the period post termination and restricting an
employee's right to seek employment and/or to do business in the same field as the employer
would be in restraint of trade and, therefore, a stipulation to this effect in the contract would
be void. In other words, no employee can be confronted with the situation where he has to
either work for the present employer or be forced to idleness; 3) While construing a
restrictive or negative covenant and for determining whether such covenant is in restraint of
trade, business or profession or not, 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, the norm is that the
employer has an advantage over the employee and it is quite often the case that employees
have to sign standard form contracts or not be employed at all; 4) The question of
reasonableness as also the question of whether the restraint is partial or complete is not
required to be considered at all whenever an issue arises as to whether a particular term of a
contract is or is not in restraint of trade, business or profession.” Exceptions To The Principle
of Restraint An extensive analysis of the above points only goes to demonstrate that all
agreements restraining an individual’s liberty to practice his trade, business or profession as
void. This would thereby imply that all other restraints such as non-solicitation, i.e. not to
solicit customers or employees or non-confidentiality clauses, i.e. not to disclose confidential
information and the like, cannot per se be held to be void, even if imposed post one’s
employment. Therefore, to have an understanding on how this principle operates, it is
imperative to demonstrate through application of various provisions of law and judicial
verdicts the several other exceptions that are available besides the one provided in the Section
itself. The terms business, trade and profession have been explained by the Supreme Court in
Sodan Singh v. New Delhi Municipal Committee,(1989) 4 SCC 155, as follows;
“‘Profession’ means an occupation carried on by a person by virtue of his personal and
specialized qualifications, training or skill….. ‘Trade’ in its wider sense includes any bargain
or sale, any occupation or business carried on for subsistence or profit, it is an act of buying
and selling goods and services. It may include any business carried on with a view to profit
whether manual or mercantile. ‘Business’ is a very wide term and would include anything
which occupies the time, attention and labour of a man for the purpose of profit. It may
include in its form trade, profession, industrial and commercial operations, purchase and sale
of goods, and would include anything which is an occupation as distinguished from
pleasure.” In fact the Constitution of India itself provides protection to all individuals to
practice their choice of trade, occupation, business or profession as per Article 19(1)(g). But
this is of course subject to the reasonable restriction imposed in Article 19(6), which implies
that no right is absolute. If this principle is adopted in interpreting contracts, then why can’t
certain restrictions be imposed if they are reasonable in nature, especially if they don’t
impinge upon one’s right to practice any trade, profession or business? When an employee
signs a contract or agreement that very clearly mentions that s/he is not supposed to solicit
any customers of the employer either pre or post-employment or; not disclose any
confidential information or trade secret; or not use for his/her benefit or profit any
copyrightable/patentable/trademarkable information or data, then logically, all these points
cannot be considered as restraints. The law only protects an individual from practicing his
trade, profession or business, but if the same is practiced while infringing someone else’s
rights, it cannot and should not come under the purview of Section 27. When an employee for
instance works as a Project Manager and his role involves interacting and corresponding with
all the customers of his employer and is aware of all the pricing strategies, business models
and the like, there is no reason why he should not be restrained post-employment from either
soliciting with them or exploiting the information, especially considering the fact that he
would not have acquired this information or relationship had he not joined the employer.
Similar is the situation of that of an employee dealing with confidential information or trade
secret, and the like, let’s say in a pharma or IT company or the like. When companies spend
millions in investments, which are either used to build customer relationships or to
developing a unique product, software, process, etc., the employee should not be allowed to
hide under the garb of Section 27 and misuse it to his/her benefit. The law should protect an
employee only for his/her innate skills and that s/he has acquired through experience and not
for capitalizing on those things which s/he might not have a right over to start with.
Therefore, all covenants that do not restrict an individual’s right to trade, profession or
business should not be void. In fact, although the law has not evolved with the changing
times and nor has the legislature taken any serious effort in ensuring a revisit to this
provision, especially after the Law Commission’s recommendation dating back to more than
five decades, internationally most jurisdictions have evolved this concept quite early on either
by incorporating it in their laws or by applying judicial precedents. Even though in India
there is still no legislative change, the Courts have attempted to interpret this Section taking
into consideration the varying periods and provided certain exceptions. These can be
categorized as follows; Non-Solicitation of Customers and Employees A non-solicitation
clause prevents an employee or a former employee from indulging in business with the
company’s employees or customers. When an employee signs this kind of an agreement or
clause, s/he thereby agrees not to solicit the employees or clients of the company for his/her
own benefit during or after his/her employment. This principle of interpreting solicitation
clauses was initially dealt by the Delhi High Court in Wipro Ltd. v. Beckman Coulter
International SA. In this case, Wipro worked as a sole and exclusive canvassing
representative and distributor for Beckman Coulter International, S.A., for a period of 17
years. Subsequently, Beckman Coulter decided to operate directly in India and issued
advertisements seeking employment from people and giving preference to candidates having
experience in having handled Beckman’s or similar products. Wipro approached the Court
seeking injunctive relief and damages alleging that such advertisements were in violation of
the non-solicitation clause signed between the parties. The Court after considering all the
relevant facts and circumstances arrived at the conclusion that since the restrictions had not
been imposed on the employees but on Wipro and Beckman Coulter, Section 27 would not be
attracted and thus the agreement was held not in restraint of trade. Similarly in Desiccant
Rotors International Pvt. Ltd v Bappaditya Sarkar& Anr.,CS (OS) No. 337/2008 (decided on
July 14, 2009), the Delhi High Court while dealing with the enforceability of solicitation
clauses, allowed an injunction against the manager prohibiting him from soliciting
Desiccant’s customers and suppliers to stand in effect. The Court however, held that a
marketing manager could not in the course of his employment be deemed to possess or be
privy to any confidential information and that his written declaration to that effect in his
employment agreement was meaningless and subsequently rejected Desiccant’s claim to
enforce the confidentiality obligations on the manager. The Calcutta High Court in the case
of Embee Software Pvt. Ltd. v. Samir Kumar Shaw, AIR 2012 Cal 141, has brought out the
growing importance in protecting client information. The Court while granting injunctive
relief held that “acts of soliciting committed by former employees takes such active form that
it induces the customers of the former employer to break their contract with the former
employer and enter into a contract with the former employee, or prevents other persons from
entering into contracts with the former employer” cannot be permitted. The Court in fact
went on to opine that client information under certain circumstances can even be considered
as a trade secret and therefore, be of high value to an employer. This decision in fact, echoes
the decision in Crowson Fabrics Ltd. v. Rider,[2007] EWHC 2942, wherein the English
Courts held that acts of an employee by retaining various documents such as customer and
supplier contact details during employment did not amount to a breach of confidentiality, but
such ‘illegitimate’ actions constituted a breach of employees’ duty of fidelity. In
FLSmidthPvt.Ltd. v M/s.Secan Invescast (India) Pvt.Ltd., (2013) 1 CTC 886, the Madras
High Court while dealing with a non-solicitation clause with the customers held that merely
approaching a previous employer’s customers does not amount to solicitation until orders are
placed by such customers based on such approach. The Madras High Court laid down the
standard to establish non-solicitation: “…solicitation is essentially a question of fact. The
appellant should prove that the respondent approached their erstwhile customers and only on
account of such solicitation, customers placed orders with the respondent. Mere production of
quotation would not serve the purpose. It is not as if the appellant is without any remedy. In
case the Court ultimately holds that the appellant has got a case on merits, they can be
compensated by awarding damages. The supplies made by the respondent to the erstwhile
customers of the appellant would be borne out by records. There would be no difficulty to the
appellant to prove that inspite of entering into a non-disclosure agreement, respondent have
solicited customers and pursuant to such solicitation they have actually supplied castings.
When there is such an alternative remedy, question of issuing a prohibitory injunction does
not arise.” The principles mentioned above were similarly resonated in the case of Vogueserv
International Pvt. Ltd. Vs Rajesh Gupta,CS(OS) 1436/2012, wherein an injunction was
granted by the Delhi High Court restraining former employees from soliciting with
customers. Non-Disclosure of Confidential Information/Trade Secrets Similar to the non-
solicitation clauses restraining an employee from approaching customers and employees,
there are various instances where an employee is required take all reasonable steps in
ensuring the confidential information is maintained with the utmost secrecy, except and to the
extent when disclosure is mandatory under any law in force. In Escorts Const. Ltd v. Action
Const.,AIR 1999 Delhi 73, the Delhi High Court restrained Escorts from manufacturing,
selling or offering for sale the Pick-N-Carry Mobile Cranes that were a substantial imitation
or reproduction of the industrial drawings of the Plaintiffs, or from using in any other manner
whatsoever, the technical know-how. Similarly, in Burlington Home Shopping Pvt. Ltd.v.
RajnishChibber,61(1995)DLT6, the Delhi High Court again restrained an employee from
carrying on of any business including mail order business by utilizing the list of clientele or
customers included in the database of the petitioner. The Court went on to hold that such
database in fact amounted to a copyright and thereby deserved protection. In Diljeet Titus v.
Mr. Alfred A. Adebare and Others,2006 (32) PTC 609, the defendant was an advocate
working at the plaintiff’s law firm. On termination of employment, the defendant took away
important confidential business data, such as client lists and proprietary drafts, belonging to
the plaintiff. It was contended by the defendants that they were the owners of the copyright
work as it was done by them during their employment and the relation between parties was
not that of an employer and employee. The Delhi High Court while rejecting this plea went
on to hold that the plaintiff had a clear and definitive right in the material taken away by the
defendant and accordingly restrained the defendant from using the information taken away
illegally. The essence of this decision is that the restraint imposed on the defendants was only
with respect to not using the confidential information they acquired from their employment
and not with respect to carrying on a similar service. It should be noted that the Delhi High
Court did not prohibit the defendants from carrying on a similar service. The Court felt that
such a partial restraint was a necessity in protecting the plaintiff’s interest else, it would lead
to him suffering an irreparable loss or injury. Similarly, the Calcutta High Court in Hi-Tech
Systems & Services Ltd vs
Suprabhat Ray &Ors.,G.A.No. 1738 of 2014 &C.S.No. 192 of 2014, while dealing with an
injunction application in order to restrain the respondents from divulging or using in any
manner the petitioner's computer database containing confidential information and trade
secrets and to procure a breach of contract of the plaintiff with its existing customers or
suppliers, held as follows: “A trade secret or a business secret may relate to financial
arrangement, the customer list of a trader and some of the information in this regard would be
of a highly confidential nature as being potentially damaging if a competitor obtained such
information and utilized the same to the detriment of the giver of the information. Business
information such as cost and pricing, projected capital investments, inventory marketing
strategies and customer's list may qualify as his trade secrets. The Court needs to find out if
the information that were acquired during the course of their employment are now being used
as the spring board to enable the said respondents to exploit such database in the course of
their business.
Since I have held that the said respondents have acted in breach and are in the process of
utilizing such trade secrets and confidential information the said respondents are restrained
from acting as a selling agent of Hora, Germany or Sales representatives for three years from
January, 2014.” Application of Criminal Laws Any breach of the contractual provisions
signed by the employee attract appropriate civil remedies either in the nature of specific
relief, i.e., specific performance of the contract/agreement or by way of granting injunctive
relief or awarding of damages to the extent of loss or injury suffered. But this does in no way
imply that there are only civil remedies available at the disposal of an employer against an
employee. The criminal legislation in India also comes to the aid of employers who are
inclined to take appropriate and necessary legal action, which thereby would attract penal
consequences, for all those found guilty of any illegality or malpractice. There are a plethora
of provisions either it be in the Indian Penal Code of 1860 or the Information Technology Act
of 2002 to punish all those wrongdoers in the case of breach of confidentiality and disclosure
provisions and thereby attract and allow appropriate criminal prosecution and imprisonment
or fine or both. As per the Information Technology Act, remedies have been provided to deal
with hacking, causing damage to computer system, tampering with computer source
document, punishment for violation of privacy policy, etc. and these may also be considered
by the employer as remedies against the employee in case of breach of confidentiality and
disclosure provisions. The Supreme Court in Pyarelal Bhargava v. State of Rajasthan, AIR
1963 SC 1094, dealt with the issue of an alleged theft of confidential information by an
employee who had removed it from the government department and passed it along to a
friend who in turn substituted the documents. This friend further removed certain documents
while substituting them with others and returned the file the next day. The Court while
convicting the employee for theft under Section 378 of the Indian Penal Code held that even a
temporary removal of documents with a dishonest intention could cause loss or harm and
hence, would be considered as theft. In case of Abhinav Gupta v. State of Haryana, 2008
CriLJ 4356, the accused was an ex-employee of a Company and had resigned and joined
another Company after his final clearance. During his course of exit interview he had
continuously maintained that he would not be joining any company which was in direct
competition with his employers. He further agreed that all the confidential information
acquired by him during his tenure at work shall be kept confidential at all times. However,
two weeks later, it came to the knowledge of his employer that he had joined the competitor.
It was also later discovered that the accused had transferred or downloaded various
confidential information of his employer into his personal e-mail id. Screenshots of the mail
id of the accused was produced by employer which showed that such information was passed
on to the competitor company. The Court while holding that the actions of the employee
amounted cheating and dishonestly inducing of property under Section 420 and criminal
breach of trust under Section 406 of the Indian Penal Code also amounted to the act of
hacking as under Section 66 of the Information Technology Act. Other Exceptions The
Supreme Court had in fact derived an exception that related to the restrictions on a
franchisee’s right to deal with competing products during the subsistence of the franchise
agreement. The Court in M/S Gujarat Bottling Co. Ltd. vs. The Coca Cola Co., 1995 (5) SCC
545, held that some terms of commercial contracts have passed into the accepted currency of
contractual or conveyancing relations, and aim at promoting trade and business. Such terms
due to their nature and purpose cannot be said to enter into the field of restraint of trade. The
Court while arriving at its conclusions held that a negative stipulation in a franchising
agreement, restraining the franchisee from dealing with competing goods, during the
subsistence of the franchising agreement, could not be regarded as restraint of the
franchisee’s right to trade. Besides the exceptions derived from various judicial perceptions
and interpretations, the Competition Act, 2002 also deals with Anti-Competitive Agreements
under Section 3. Section 3(1) & (2) are as follows; “(1) No enterprise or association of
enterprises or person or association of persons shall enter into any agreement in respect of
production, supply, distribution, storage, acquisition or control of goods or provision of
services, which causes or is likely to cause an appreciable adverse effect on competition
within India. (2) Any agreement entered into in contravention of the provisions contained in
sub-Section (1) shall be void.” What can be seen is that Section 3(1) is very similar in its
intentions when compared to Section 27 of the Contract Act. But although being similar in
nature, the Act has also provided for exceptions to such agreements which are mentioned in
Section 3(5) as follows: “(5) Nothing contained in this Section shall restrict— (i) the right of
any person to restrain any infringement of, or to impose reasonable conditions, as may be
necessary for protecting any of his rights which have been or may be conferred upon him
under: (a) the Copyright Act, 1957 (14 of 1957); (b) the Patents Act, 1970 (39 of 1970); (c)
the Trade and Merchandise Marks Act, 1958 (43 of 1958) or the Trade Marks Act, 1999 (47
of 1999); (d) the Geographical Indications of Goods (Registration and Protection) Act, 1999
(48 of 1999); (e) the Designs Act, 2000 (16 of 2000); (f) the Semi-conductor Integrated
Circuits Layout-Design Act, 2000 (37 of 2000); (ii) the right of any person to export goods
from India to the extent to which the agreement relates exclusively to the production, supply,
distribution or control of goods or provision of services for such export.” What can be seen
from the above points is that although it can be argued that most of the exceptions dealt with
are rendered by way of judicial interpretation, Section 3(5) of the Competition Act, which is a
subsequent legislation to the Contract Act, clearly has taken into consideration the changing
times and have recognized and protected the employer’s interest. Therefore, the Courts while
interpreting Section 27 of the Contract Act should also make reference to Section 3 of the
Competition Act and see if the same is applicable to the facts and circumstances of a
particular case.