Agreements in Restraint of Trade

In one line

Indian law will not let one person contract another out of earning a living, and unlike English law it does not soften that with a general test of reasonableness.

In the words a student can write in an exam: section 27 of the Indian Contract Act 1872 provides that "Every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void." The only exception on the face of the section is Exception 1, saving an agreement by one who sells the goodwill of a business to refrain from carrying on a similar business within specified local limits, so long as the buyer carries on a like business there, provided the limits appear to the Court reasonable.

Why India took a stricter line than England

English law also disapproves of restraints of trade, but it asks whether the restraint is reasonable between the parties and in the public interest, and enforces it if it is.

The Indian drafters made a different choice, and the wording shows it. Section 27 declares every such agreement void "to that extent", and then supplies one statutory exception. There is no general reasonableness test written into the section, and the word "reasonable" appears only inside Exception 1, applied to the local limits of a goodwill covenant.

The reason usually given is the state of the economy the Act was written for. A general reasonableness test suits a mature commercial system with courts used to weighing competition; a flat rule suits a system where the parties are often unequal and the person restrained is usually the weaker.

The practical consequence, and it is the single most examinable point in this chapter: an Indian court does not ask whether a restraint is reasonable, except within Exception 1. It asks whether the agreement restrains a lawful profession, trade or business at all.

The provision itself

"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 good-will is sold. One who sells the good-will 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 good-will 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."

Exceptions 2 and 3 were repealed by the Indian Partnership Act 1932, section 73 and the Second Schedule. They dealt with restraints agreed between partners, and that ground is now covered by sections 11, 36 and 54 of the Partnership Act 1932, dealt with in section 6 below. A textbook printed before 1932 will still show three exceptions; the Act now has one.