Wednesday, 2 February 2022

Agreements in restraint of Trade

                                    Agreements in restraint of trade

Section 27 of the Indian contract act, 1872 states that any agreement that debars a person from starting or continuing his trade or profession in return for some consideration is considered to be void. Agreement in restraint of trade is defined as the one in which a party agrees with any other party to restrict his/her 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/she chooses. 

                          The sale of goodwill and Partnership Act are an exception to the agreements in restraint of Trade. 

The test of reasonability for restraining is done by the following three steps: - 

An agreement in restraint of trade is valid, if – 

  • There is a valid interest that the party imposing the restrain is trying to protect.

  • If the specific rules are not followed. Suppose, if there is a branch of 7UP in India. Now if you start selling it in an orange coloured bottle, then you can be restrained because it is against the rules of the company. 

  • If you enter into a firm and you are told to not go there for three years as you have been detained because of your conduct.

In India, section 27 of the Indian contract Act, 1872 declares all agreements in restraint of trade, void pro tanto that is to that extent with the only exception being sale of good. This means that it is valid till that extent where it started restraining. All other parts of the contract are valid except the part where it shows restrainment. Yet, it is important to understand that these agreements are void not illegal. These agreements are not unlawful to make, they are just not enforceable in a court of law. Unlike common law, partial agreements in restraint of trade or reasonable restrain are not valid under contract act. 

Exceptions to the section 27 of Indian contract at 1872

Sale of goodwill

If a seller sells goodwill of a business to a buyer then the buyer of the goodwill can legally restrain the original owner to carry on a similar business, within specified local limits. Like other assets goodwill can also be sold. Once bought the buyer gains some rights: -

  • He/She can use the name of the Firm or Company whose goodwill has been bought.

  • He/She can represent the firm

  • He/She can restrain the seller of the goodwill from being in contact with the previous customers of the firm

Conditions that make restraint of trade valid in terms of selling goodwill: -

  • Seller can be restrained only from carrying out a similar business

  • The restrain can be applied only to certain local limits.

  • The limits or restraints must be reasonable.

Partnership Act 

There are four provisions in the Partnership Act which validate agreements in restraint of trade. Section 11 enables partners during the continuance of the firm to restrict their mutual liberty by agreeing that none of them shall carry on any business other than that of the firm. Section 396 of this Act enables them to restrain an outgoing partner from carrying on a similar business within a specified period or within specified local limits. Such agreements shall be valid if the restrictions imposed are reasonable. A similar agreement may be made by partners upon or in anticipation of dissolution by which they may restrain each other from carrying on business similar to that of the firm. 

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