Understanding Agreements in Restraint of Trade: Legal Boundaries and Exceptions

Picture a fresh graduate signing an offer letter that says she cannot work for any competing company for two years after leaving, anywhere in India. Is that clause enforceable? Section 27 of the Indian Contract Act, 1872 answers questions exactly like this one, and it does so with a rule that is far stricter than what most people expect from contract law.

What section 27 actually says 🔗

Section 27 declares that every agreement which restrains a person from exercising a lawful profession, trade, or business is void to that extent. Notice the phrasing: the agreement is not fully void, only the restraining part of it. If a contract has ten clauses and one of them stops a party from doing lawful business, only that one clause loses legal effect.

This provision traces its roots to English common law, where courts grew wary of contracts that could create monopolies or choke off healthy competition. India imported this idea when the Contract Act was drafted, but with a twist that students often miss.

India’s stricter approach compared to England 🔗

English law allows a restraint of trade if it is reasonable in terms of time, geography, and scope, a principle settled in the celebrated case of Nordenfelt v. Maxim Nordenfelt Guns and Ammunition Co. Indian law takes a more rigid position. Section 27 does not distinguish between total and partial restraints, treating both as void unless a statutory exception applies. Reasonableness, which is the deciding factor in England, simply does not enter the picture under the plain wording of Section 27.

Total and partial restraints: both fall under the axe 🔗

A total restraint stops someone from carrying on any trade at all. A partial restraint limits activity to a specific area, time period, or type of business. Under English law, a partial restraint can survive if it is reasonable. Under Indian law, both are void unless they fit within one of the recognised exceptions.

The foundational case here is Madhub Chander v. Raj Coomar, decided by the Calcutta High Court in 1874. Two rival shopkeepers in the same locality struck a deal: one would shut his shop, and the other would pay him for doing so. The court held this agreement void, even though the restraint applied only to a single locality and not the whole country. This case set the tone for how Indian courts would read Section 27 for decades to come.

Everyday examples students encounter 🔗

Two situations show up repeatedly in business transactions:

• Exclusive supply agreements: A distributor agreeing to buy stock only from one manufacturer, and nowhere else, can amount to a restraint depending on how it is structured.
• Employment contracts with restrictive covenants: Clauses that stop an employee from joining a competitor, either during service or after leaving, are the most litigated form of restraint of trade in Indian courts.

Why the law takes such a firm stand 🔗

The reasoning behind Section 27 rests on public policy. Restraining a person from earning a livelihood curtails their freedom to trade, and courts have repeatedly held that such curtailment works against both the individual and the wider economy. The Law Commission of India’s 199th Report notes that restraining a person from carrying on a trade generally aims at avoiding competition and carries a monopolistic tendency, working against both individual and societal interest. Encouraging free trade and healthy competition ultimately benefits consumers through better prices and choices, which is exactly what Section 27 tries to protect.

The recognised exceptions 🔗

Section 27 is not absolute. The Act itself, along with related legislation, carves out situations where a restraint on trade is allowed to stand.

Sale of goodwill 🔗

When a business owner sells the goodwill of their business, they can agree not to start a similar business within specified local limits, for as long as the buyer or their successor continues running a similar business there. But this freedom has a limit built into the exception itself: the restriction must appear reasonable to a court, taking into account the nature of the business, as laid down in the first exception to Section 27. Reasonableness returns to the picture here, but only within this specific exception.

Partnership agreements 🔗

Partnership law recognises four distinct situations where a restraint on trade among partners is valid, all borrowed from the Indian Partnership Act, 1932. As one legal commentary summarises, despite the general rule in Section 27, partners can validly agree to restraints in four situations covered under sections 11(2), 36(2), 54, and 55(3) of the Indian Partnership Act. These cover restrictions during the continuation of the partnership, restrictions on an outgoing partner, and restrictions agreed upon at the time of dissolving the firm or selling its goodwill.

Employment contracts and restrictive covenants 🔗

This is where most commerce students and working professionals actually feel the impact of Section 27. Two very different questions arise: can an employer restrict what an employee does while still employed, and can an employer restrict what a former employee does after leaving?

During employment: usually valid 🔗

Courts have consistently held that restrictions operating while the employment contract is still in force do not amount to a restraint of trade at all. The landmark authority is Niranjan Shankar Golikari v. The Century Spinning and Manufacturing Co. Ltd., where the Supreme Court examined a negative covenant preventing an employee from working for a competitor during his contract period. The Court held that such negative covenants are valid so long as the restriction is reasonable and not opposed to public policy, since the employee is contractually bound to serve the employer exclusively during that period. The company’s interest in protecting technical know-how and trade secrets in the tyre cord manufacturing business justified the restriction.

After termination: the stricter test 🔗

Post-employment non-compete clauses face a much tougher standard. Courts generally treat these as void restraints of trade, because post-employment restraints such as non-compete clauses are void unless they fall within the narrow exception carved out for the sale of goodwill. The reasoning is straightforward: once someone leaves a job, they should be free to earn a living using the skills and experience they gained, and an employer has no lasting claim over that freedom simply because the former employee happens to be a competitor.

There is one important carve-out within this space. Restrictions aimed specifically at protecting genuine trade secrets or confidential information, rather than merely preventing competition, have sometimes been upheld even after employment ends, since protecting confidential business information is treated differently from restraining a person’s right to work.

When courts see regulation, not restraint 🔗

Not every clause that touches trade automatically falls foul of Section 27. Indian courts have developed a functional distinction: agreements that merely regulate the manner or terms of conducting a business are treated differently from agreements that restrain a person from carrying on that business altogether. An exclusive dealing arrangement, for instance, where a manufacturer and distributor structure how goods will be sold, may simply be organising trade rather than restraining it, provided it does not stop either party from carrying on their business independently. This distinction matters enormously in commercial contracts today, particularly in franchise and distribution agreements, where exclusivity clauses are common business practice rather than an attempt to eliminate competition.

Why this matters for commerce students 🔗

Section 27 sits at the intersection of contract law and everyday business practice. Every internship offer letter, franchise agreement, partnership deed, or business sale you encounter after graduation could contain a clause that brushes up against this provision. Understanding where the line falls between a valid business arrangement and a void restraint gives you a real edge, whether you end up drafting contracts, negotiating employment terms, or running a business of your own.

What do you think? If you were drafting an employment contract for your own start-up, how would you balance protecting your company’s trade secrets against an employee’s right to work freely after leaving? Do you think India’s stricter approach to restraint of trade, compared to England’s reasonableness test, still makes sense in today’s competitive job market?

References

1. https://indiankanoon.org/doc/1431516/
2. https://thelegalschool.in/blog/section-27-indian-contract-act
3. https://blog.ipleaders.in/overview-of-section-27-of-indian-contract-act-1872/
4. https://blog.ipleaders.in/section-27-of-indian-contract-act-1872/
5. https://www.advocatekhoj.com/library/lawreports/unfair/6.php?Title=Unfair+%28Procedural+and+Substantive%29+Terms+in+Contract&STitle=Section+27+of+the+Indian+Contract+Act
6. https://vidhijudicial.com/ica:-sec27-.html
7. https://indiankanoon.org/doc/452434/
8. https://www.mondaq.com/india/contract-of-employment/1231912/validity-of-restrictive-covenants-in-contracts
9. https://samistilegal.in/enforceability-of-restrictive-covenants-in-employment-agreements/