What Are “Restraint of Trade” Clauses?
If you read enough contractual agreements, you will occasionally stumble upon a clause in a contractual agreement that states that a party is restricted from acting in a certain manner for a certain period and/ or within certain local limits. Generally, such a clause is called a “restraint of trade clause”. More of it below.
What is it all about?
As mentioned, such a clause can usually be found in a contract, usually somewhere along the lines where one party agrees with another party to restrict the liberty on how he will conduct himself in the future for a certain period/ on how he will conduct himself within a certain distance from the other party.
You will see this a lot when both parties make a living in the same line of businesses/ trade, between a buyer and seller of a business, employer-employee scenario, or even in a partnership agreement. This is to ensure that the party who has the leverage in terms of knowledge and expertise will not use their knowledge and expertise to suppress the playing field.
Having said that, everything can be abused, And such a clause is no exception. This is where the law in regards to this topic kicks in.
The law in regards to this topic
Under section 28 of the Contracts Act, the general rule is that every agreement which contains a restraint of trade clause by which anyone is restrained from exercising a lawful profession, trade, or business of any kind, is illegal and unenforceable. This principle was expounded in detail in the Indian case of Wipro Ltd v Beckman Coulter International SA, where the High Court in New Delhi states that:
- 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 or profession unless the same are unconscionable or wholly one-sided;
- 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; and
- 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. Why? 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.
Essentially and as mentioned above, the general rule is that such clause cannot be inserted into a contractual agreement. However, there are certain exceptions.
The Act noted 3 exceptions:
- When a person sells the goodwill of a business, the seller may agree with the buyer to refrain from carrying on a similar business:
- Within a specified local limits;
- So as long as the buyer carries on a similar business as the buyer; and
- Provided that the limit is reasonable in the eyes of the court.
- When partners in a partnership agrees that some or all of them will not carry on a business similar to that of the current partnership within the local limits prescribed above when the partnership is dissolved; and
- When partners in a partnership agreement that some or all of them will not carry on similar business with that of the current partnership during the continuance of the current partnership.
And there you have it, hopefully this little snippet will help you understand a little bit more on this topic.
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