LAW OF CONTRACT AGRE AG REEM EMEN ENT T I N RE RES S TR TRAI AINT NT O F T RA RAD D E RISHABH SINGH B.A,L.L.B (2ND SEMESTER) 201289 D.S.N.L.U
3/11/2013
NEW LIGHT THROUGH OLD WINDOW “AGREEMENT IN RESTRAINT OF TRADE”
CONTENT
INTRODUCTION
TYPICAL RESTRICTIVE CLAUSE
KINDS OF RESTRAINT
RESTRAINT OF TRADE UNDER THE COMMON LAW
EMPLOYER MUST HAVE A VALID INTEREST
RESTRAINT MUST BE REASONABLE
EXCEPTION
CONTRACTS OF EXCLUSIVE DEALING
RESTRAINTS ON SONGWRITERS AND OTHER ENTERTAINERS
IS RESTRAINT GOOD OR BAD FOR HEALTHY BUSINESS?
CONCLUSION
Page 1 of 14
INTRODUCTION
This research work deals with an area of law which under classical contract theory brought two principles into direct conflict. On the one hand, classical theory endeavoured to promote „freedom of contract‟ – it is the parties who determine their obligations, and the courts should only intervene in exceptional circumstances. On the other, underlying classical theory was an acceptance that the „free market‟, in which competition takes place between those s eeking to make contracts, is the ideal economic framework for the operation of exchange transactions. What happens when the freedom to contract is used to restrict competition? The answer of the common law was limited. A range of contracts or contractual provisions which were regarded as being „in restraint of trade‟ were treated as being „illegal‟, on grounds of public policy, and therefore unenforceable. The main use of this approach, however, as will be seen below, was in relation to restrictions contained in contracts of employment or in contracts for the sale of a business, purporting to limit the economic activity which the employee or the seller could engage in after leaving the employment or selling the business. The broader problems of „anti-competitive‟ practices, and in particular the problems arising from situations of monopoly or near monopoly in a particular market, were never tackled by the common law. There is now, however, extensive statutory intervention to control this area, with much of the current law being shaped by the rules applicable in the European Economic Community. The approach taken here is to deal only with the common law rules on „restraint of trade‟. Agreement in restraint of trade is defined as the one in which a party agrees with any other party to restrict his 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 chooses. “Providing for restraint on employment in the employment contracts of the employees in the form of confidentiality requirement or in the form of restraint on employment with competitors has become a part of the corporate culture. In other words “one in which a party agrees with any other party to restrict his liberty in the future to carry on trade with other persons who are not parties to the contract in such a 1 manner as he chooses”. Contracts in restraint of trade are one of the most important categories of unenforceable agreements at common law. In today‟s world agreement in restraint of trade has a much wider scope and it is called „restrictive practice‟, but the legal and economic problem are same.in this type of agreement one or both the parties come under a contract in which they limit their freedom to carry on their business or profession in a particular way, by agreeing not to compete with each other in a particular area or place, by agreeing not to disclose each other ‟s trade secret, by agreeing not to come under contract with any other parties until the expiry of the current contract. Regulation on personal liberty are regulated because it is thought that they may unduly restrict the freedom of the concerned individuals. For e.g.- if a person A joins a company ABC, then the company in a contract can restrict his freedom in order to protect the trade secret and safeguards of the company. Agreements in restraint of trade are also widely thought to be problematic because of their possible effect on the broader public interest. More specifically, restrictive agreement are often attacked on the basis that they unduly restrict the free flow of labour and goods on which a market economy depends.Essentialy the question is the extent to which the law should interfere with the freedom of contracting parties to do business in such a way as to 1
Aya law of contract,7th edion,2004
Page 2 of 14
limit or restrict competition, in earlier times, the traditional approach of the courts was to leave the parties to use their own method of conducting business, even if this was likely to lead to the creation of monopolies, unfair competition, or the enforcement of restrictive practices of various kinds. According to section 27 “every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that extent is void”.an agreement which unnecessarily curtails the freedom of a person to trade is against public policy, restraining a person from carrying on a trade generally aims at avoiding competition and has monopolistic tendency and this is both against an individual‟s interest as well as the interest of the society and on that ground such restraint are discouraged by law.in today‟s world everyone has right to do free trade practice anywhere in a country of which he is resident and to restrain someone in doing so is illegal and also voidable by law. TYPICAL RESTRICTIVE CLAUSE 1. 2. 3. 4.
Non-disclosure clauses Non-compete clauses during employment Non-compete post-employment clauses 2 Non- use post-employment clauses
1. Non-disclosure clauses- It includes covering confidentially during employment as well as after employment ceases such clauses typically prevents an employee from sharing confidential information with outsiders. 2. A Non-compete clause during employment-these clauses prevents the employee from engaging in activities that clash with his employment responsibilities. 3. Non-compete post–employment clauses -some employers do not want their employees to join competitors even after the employee has quit the job. Restriction in this category may also prevent an ex-employee from starting a competing business or even advising a relative who is in a similar type of business. 4. Non-use post-employment clauses – such clauses are stricter than the previous one. They not only prevent from using information gained during employment for competition use. They go a step further and even stop an ex-employee from making a non-competitive use of the information. APPLICABLE LAWS
1. Indian Contract Act 1872 –section 27 2. Constitution of India Article 19(1)g 3. Competition Act 2002 section 3(1),(2),(4)section 4 1. Indian Contract act 1872 - it makes void all contract that impose „restraint of trade‟. The provisions are as follows A. every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind is to that extent is void. B. the only exception that is permitted to the above is when goodwill of a business is sold. The exception is not relevant to the discussion in this article 22
Sri rama rao,law of contracts,2002
Page 3 of 14
2. Constitution of India- Article 19 (1) g of the Indian constitution guarantees that a ll the citizens shall have the right to practice any profession, or to carry on any occupation, trade or business
However the right to carry on a profession trade or business is not unqualified.it can be restricted and regulated by the authority of law. The restrictions have to be reasonable and public interest. Moreover, it is important to understand that fundamental right are available only against the state or in other words government or government undertaking. Fundamental rights have almost no scope when the relationship is between a private employer and individual employee. 3. Competition Act 2002
a. According to section 3(1) of the competition act 2002, “no enterprise or association of enterprises shall enter into any agreement in respect of productivity,supply,distribution,storage,acquisition or contract of goods or provision of services, which causes or is likely to cause an appreciable adverse effect on competition within India b. According to section 3(2) of the competition act, 2002 any agreement entered into in contravention of the provision. c. Agreements which cause or are likely to cause appreciable adverse effect on competition in market in India are anti-competitive and are voided. d. According to the section 4 of the competition act,2002 e. No enterprise or group shall abuse its dominant position. f. There shall be an abuse of dominant position under sub -section(1) KINDS OF RESTRAINT
The law of restraint of trade was traditionally thought to be applicable solely to contractual clauses that prohibit a person from working in a certain trade or profession, usually subject to limitation of time and space. 1. They are found in contracts for the sale of the goodwill of a business or professional practice or a sale of goodwill necessarily involves some degree of limitation on the seller‟s freedom to compete. Example- the seller of a shop would like to be assured that the buyer will not immediately set up a competing business next door and draw back most of his old customers. Hence the seller will want the buyer to agree that he will not enter into competition with him. 2. this kind of clauses are often found in written contracts of employment, the employer put a condition or agreement in front of his employer that he/she will not work for a competing employer or set up a competing business of her own after he/she leaves her
Page 4 of 14
present work. These kind of clauses are often found in analogous non-employment 3 relationship Example- A relationship between a singer and his music publisher, a professional sports person. RESTRAINT OF TRADE UNDER THE COMMON LAW
4
Contractual provisions which attempt to restrict the ways in which one of the parties may do business, or earn a living, have at different times been treated by the common law as being 5 prima facie void , or prima facie valid.4 The current position derives from the House of Lords‟ decision in Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd . Key Case 6
Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd (1894)
Facts: Thorsten Nordenfelt had established a valuable business in the manufacture of machine guns, operating in Sweden and England. His customers included most national governments across the world. He sold the business to a company, which then transferred it to Maxim Nordenfelt. At that time Thorsten Nordenfelt entered into an agreement with Maxim that he (Thorsten) would not for a term of 25 years engage in the manufacture of guns, explosives, etc, other than on behalf of the company. Thorsten broke this covenant, alleging that it was unenforceable as being in restraint of trade. Held
The House of Lords affirmed the decision of the Court of Appeal that the covenant, though operating as a world-wide ban, was not wider than was necessary to protect the interests of Maxim Nordenfelt. 7
Lord Macnaghten stated the House‟s view of the correct approach to contracts of this type The public have an interest in every person‟s carrying on his trade freely: so has the individual. All interference with individual liberty of action in trading, and all restraints of trade of themselves, if there is nothing more, are contrary to public policy, and therefore void. That is the general rule. But there are exceptions: restraints of trade and interference with individual liberty of action may be justified by the special circumstances of a particular case. It is a sufficient justification, and indeed it is the only justification, if the restriction is reasonable – reasonable, that is, in reference to the interests of the parties concerned and reasonable in reference to the interests of the public.
3
Ayah’s introducon to the law of contract, sixth edi on,oxford,page no.216 Trebilcock, 1986 5 Claygate v Batchelor (1602) Owen 143. 6 *1894+ AC 535 7 Ibid, p 565 4
Page 5 of 14
EMPLOYER MUST HAVE A VALID INTEREST
Looking at the first of these requirements, an employer will have a legitimate interest in restricting the activities of a departing employee, where that employee has either acquired trade secrets, or has gained influence over the employer‟s customers, either because they rely on the employee‟s skill and judgment, or because they have dealt exclusively with that 8 employee. As was made clear by the House of Lords in Herbert Morris Ltd v Saxelby, it is not sufficient simply that the employee may compete with the former employer, or use „skill 9 and knowledge acquired by the employee in his employer‟s business‟. Examples from the cases where a restraint on an employee has been held to protect a 10 11 legitimate interest include a hairdresser, a sales representativ and a tailor. In relation to the sale of a business, the interest which the buyer is trying to protect is likely to be the „goodwill‟ in the business, that is, the existing trade which has been built up by the seller. The buyer will probably have paid a substantial sum as part of the purchase price for the benefit of taking over the „goodwill‟. In that context, the buyer has a legitimate interest in preventing the seller from setting up a business which will attract all the old customers. The courts have been prepared to recognise that the categories of legitimate interest are not closed. For example, in Greig v Insole,12 which concerned restrictions placed on professional cricketers by the cricketing authorities, Slade J recognised that there might be a public interest that the game of cricket should be properly organised and administered. On the facts, however, the restraint was in any case unreasonable. In Eastham v Newcastle United Football 13 Club Ltd , however, Wilberforce J was unable to find a legitimate interest in relation to restrictions on freedom of transfer for professional footballers. It seems then that, although in theory the categories of interest are open, the courts are likely to be very cautious in finding new interests. RESTRAINT MUST BE REASONABLE
The reasonableness or otherwise of the restraint must be looked at in the context of the interest which is being protected. There are three main factors to consider: (1) the geographical area covered; (2) the length of time involved; and (3) the scope of the activities covered. For example, if a business is sold in one town, a restriction preventing the opening of a similar business anywhere in the country would be unlikely to be regarded as reasonable. 14 In Mason v Provident Clothing Co, a canvasser who had been employed to sell clothes in Islington was restrained from entering into similar business within 25 miles of London. This was held to be too wide. As regards time, this will again depend on the type of contract. In many employment cases, a restraint of one or two years at most will be all that is reasonable. In Fitch v 15 Dewes, however, a lifelong restraint on a solicitor‟s managing clerk was upheld. The justification was that the business was one to which clients were likely to return over a long period. In Beckett Investment Management Group Ltd v Hall, for example, the Court of 8
*1916+ 1 AC 688. Ibid, p 710. 10 Marion White Ltd v Francis *1972+ 1 WLR 1423 11 Lucas (T) & Co Ltd v Mitchell *1974+ Ch 129; *1972+ 3 All ER 689. 12 *1978+ 3 All ER 449. 13 *1964+ Ch 413; *1963+ 3 All ER 139 14 *1913+ AC 724 15 *2007+ EWC Civ 613: *2007+ ICR 1539. 9
Page 6 of 14
Appeal held that a 12-month restraint on a financial adviser who had left the claimants‟ firm to set up his own business, was reasonable, though indicated that anything longer would 16 probably not have been. In Fitch v Dewes, however, a potentially lifelong restraint on a solicitor‟s managing clerk was upheld. Key Case
Fitch v Dewes (1921) Facts: The defendant was employed as a managing clerk of the plai ntiff‟s solicitors‟ practice in Taworth. His contract contained a clause that purported to restrict his work if he left the practice. He was not to work in a solicitor‟s office within seven miles of Tamworth for a period that could be extended to the rest of his lif e. Following the termination of his employment, the defendant intentionally committed a breach of the covenant to test its validity. Held: The House of Lords held that the clause did not exceed what was reasonably necessary to protect the plaintiff‟s business. The justification was that the business was one to which clients were likely to return over a long period.
EXCEPTION
One who sells goodwill of a business with a 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 goodwill from him, carries on a like business therein provided that such limits appear to the Court reasonable, regard being had to the nature of business. Although the section states that all agreements in restraint of any profession, trade or business are void, the current trend as per various judicial pronouncements leads to the conclusion that reasonable restraint is permitted and does not render the contract void ab initio. Reasonableness of restraint depends upon various factors, and the restraint in order to prevent divulgence of trade secrets or business connections has to be reasonable in the interest of the parties to ensure adequate protection to the covenanted. The above section implies that to be valid an agreement in restraint of trade must be reasonable as between the parties and consistent with the interest of the public. PUBLIC INTEREST
There is some controversy as to whether the public interest part of the rules concerning enforceable restraint of trade does in fact exist. If it does, then it means that even if a restraint satisfies the other conditions (that is, of legitimate interest and reasonableness), it may still be struck down as being contrary to the public interest. This might be the case, for example, in relation to a restraint on the work of a leading artist, playwright, doctor or scientist, whose work might well be for the public benefit. The principle was stated in Wyatt v Kreglinger and 17 Fernau. The plaintiff‟s pension was made contingent upon his not taking any part in the wool trade. The Court of Appeal held that this stipulation was void, irrespective of whether it was reasonable as between the parties, because it was contrary to the public interest. This was 16 17
*1921+ 2 AC 158. *1933+ 1 KB 793
Page 7 of 14
18
followed in the similar case of Bull v Pitney Bowes. It seems difficult, however, to find later authorities that have applied the principle, though Lord Denning supported it in relation to a solicitor in Oswald Hickson Collier & Co v Carter Ruck .19 In subsequent cases, such as 21 Deacons v Bridge 20 and Kerr v Morris, the courts have refused to apply the principle to the circumstances before them, while not denying its existence. CONTRACTS OF EXCLUSIVE DEALING
It was confirmed by the House of Lords in Esso Petroleum Co Ltd v Harpers Garage 22 (Stourport) Ltd that a contract in which one party agrees to take all supplies of a particular product from one source (sometimes known as a „solus agreement‟) could amount to an unreasonable restraint on trade. Such arrangements are particularly common in relation to the 23 supply of petrol, and in relation to the supply of beer, etc, t o public houses. The House of Lords recognised in Esso v Harpers, as had been acknowledged in a report from the 24 Monopolies Commission published not long before its decision, that solus agreements are not necessarily disadvantageous to the public. It is a question of whether the restraints imposed by them are „reasonable‟ overall. Such contractual arrangements may well also fall foul of the restrictions on anti-competitive agreements contained in s 2 of the Competition Act 1998, or Art 81 of the EC Treaty, but they may nevertheless be found to be unlawful at 25 common law. Key Case
Esso Petroleum v Harpers Garage (1968) Facts: The case concerned two solus agreements in relation t o two garages run by the defendant. In respect of both, there was an agreement to take all supplies of petrol from Esso, and to keep the garage open at all reasonable hours. In relation to garage A, the agreement was to last for four years and five months. In relation to garage B, the agreement was to last for 21 years, and was linked to a mortgage over the premises held by Esso, which was also irredeemable for 21 years. The defendants started to sell cut price petrol of other brands. Esso sought an injunction to prevent them doing this. The defence was based on „restraint of trade‟. Held: The House of Lords held that contracts of this type could be regarded as being in restraint of trade. As with the categories looked at above, the question was then whether the restraint was reasonable as between the parties, and reasonable in the public interest. In relation to garage A, the five year restraint was reasonable. The 21 years in relation to garage B, however, was unreasonable, particularly as it was linked to a mortgage.
18
*1966+ 3 All ER 384 *1984+ AC 720; *1984+ 2 All ER 15 20 *1987+ Ch 90; *1986+ 3 All ER 217 21 *1984+ AC 705; *1984+ 2 All ER 19. 22 *1968+ AC 269; *1967+ 1 All ER 699 23 Byrne v Tibsco Ltd *1999+ UKCLR 110; Inntrepreneur Estates (GL) Ltd v Boyes *1993+ 2 CMLR 293 24 Report on the Supply of Petrol to Retailers in the United Kingdom , 1965 HC 265. 25 The statutory provisions have a minimum threshold based on the market share of t he contracng pares; the common law has no such restricon 19
Page 8 of 14
RESTRAINTS ON SONGWRITERS AND OTHER ENTERTAINERS
A particular area of difficulty has arisen in relation to contracts entered into by songwriters, or pop musicians, with music publishers or recording companies. These often require the artists to commit themselves to one company for a lengthy period of time, with no necessary obligation on the company to promote, or even publish, the artists‟ work. The validity of this kind of „exclusive dealing‟ agreement was considered in the following case. Key Case 26
Schroeder Music Publishing Co Ltd v Macaulay (1974)
Facts: The plaintiff was a young and unknown songwriter who entered into a standard form agreement with music publishers (the defendants). The copyright in all the plaintiff‟s compositions for the next five years was assigned to the defendants, with an automatic extension for a further five years if royalties exceeded £5,000. The defendants could terminate the agreement on one month‟s notice, but there was no si milar power for the plaintiff. The defendants were under no obligation to publish any of the plai ntiff‟s work. The plaintiff sought a declaration that the agreement was in restraint of trade and void. Held: The House of Lords held that, where there was unequal bargaining power, a standard form agreement has to be looked at to see if, amongst other things, the restrictions it contains only go so far as is reasonably necessary to protect legitimate interests. In this case, the contract was in unreasonable restraint of trade because, whereas the plaintiff was totally committed to the defendants, the defendants were not obliged to publish anything. The decision in Schroeder v Macaulay was applied in the similar case of Clifford Davis 27 Management Ltd v WEA Records Ltd . In Panayiotou v Sony Music Entertainment (UK) 28 Ltd , on the other hand, a recording contract which was probably in restraint of trade when entered into had been renegotiated after the performer concerned (George Michael) had become famous. His subsequent attempt to challenge the renegotiated agreement failed because, although it contained some unfavourable conditions, the performer had received full legal advice. Moreover, the renegotiated agreement was part of a settlement of the dispute of the original contract. In this context, public policy favoured giving effect to the settlement, and therefore the revised contract. In any case, the recording company had a legitimate interest to protect, in that it wished to sell as many records as possible, and the restrictions on the performer were not unreasonable as a means of protecting that interest.
IS RESTRAINT GOOD OR BAD FOR HEALTHY BUSINESS?
Somewhere restraint is good and somewhere it is bad. For example- if a person works in a shop A which is famous for its biryani, this is because of a secret recipe which the shop owner has been using for over 150 years, then they have the right to restrict their employer to set up a competitive business in any other places or o work with any other employer.in order to protect their trade secret from the other competitors. If they have the patent right for the recipe.so in this case it can be consider as a healthy practice of restraint of trade.in other 26
*1974+ 3 All ER 616. *1975+ 1 All ER 237 28 *1994+ Ch 142; *1994+ 1 All ER 755 27
Page 9 of 14
example if a medicine company discovered a new formulae for the cure of cancer and applied for the patient right, then they have right to restrict their employees to work with any other firm in order to protect their secret or in order to protect the thing to get misused. In other case if an employer restrain his employee to work in any other place after leaving the job just for harassing the person then this can be said to have wrong practice of restraint of trade, because this is the violation of article 21 each and every person has right to choose his profession and place of his workplace. For example- if A works with a company B and he is in a contract that he will not join any other company after he quits to his job and during his contract he is being unduly harassed, he is not being paid his wages on time, he is being tortured at his workplace by superior authorities, then he is free to leave his job and join any other company, if he proves this in the court of law. An agreement in restraint of trade lies between two different principles of public policy. A person entering into a contract of his own free shall be bound by the same. At the same time it is necessary that he should have liberty to exercise his powers and capacities for his own and the community‟s benefit. Public policy requires that every man, even though at liberty to work for himself, is not at liberty to deprive himself or his labour, skill or talent by any contract that he enters into. A person may be restrained from carrying on his trade by reason of an agreement voluntarily entered into by him with that object. In such a case the general principle of freedom of trade must be applied with due regard to the principle that public policy requires the utmost freedom to the competent parties to enter into a contract and that it is public policy to allow a trader to dispose of his business and to afford to an employer an unrestricted choice of able assistance and the opportunity to instruct them in his trade and its secrets without fear of their becoming his competitors. Where an agreement is challenged on the ground of its being in restraint of trade, the onus is upon the party supporting the contract to show that the restraint is reasonably necessary to protect his interests. Once, this onus is discharged by him, the onus of showing that the restrain is nevertheless injurious to the public is upon the party attacking 29 the contract. A covenant in restraint of trade lies between two different principles of public policy. A person entering into a contract of his own free shall be bound by the same. At the same time it is necessary that he should have liberty to exercise his powers and capacities for his own and the community‟s benefit. Public policy requires that every man, even though at liberty to work for himself, is not at liberty to deprive himself or his labour, skill or talent by any contract that he enters into. A negative covenant that the employee would not engage himself in a trade or business or would not get himself employed by any other manner with whom he would perform similar or substantially similar duties, is not therefore, a restraint of trade unless the contract as aforesaid is unconscionable or excessively harsh or unreasonable or one sided. A contract which is in restraint of trade cannot be enforced unless (a) it is reasonable as between parties and (b) it is consistent with the interest of the public.
29
Contract-1,r.k bangia,sixth edion,Allahabad law agency,page no. -240
Page 10 of 14
The non-compete covenants used in agreements can be categorized into in term and post term covenants. In an employment contract, the basic interests of the employer which are required to be protected include trade secrets and business connections and other such confidential information. In case of restraints in contracts of employment the nature of business and employment is relevant in assessing the reasonableness of the abovementioned restraints. An employee owes a duty to the employer to not disclose to others or use to his own advantage the trade secrets or confidential information which he had access to during the course of employment and he could be restrained from or sued for divulging or utilizing any such information in his new employment. But once again, he cannot be prevented from taking up the employment. Also, the employer cannot prevent the use of employee‟s knowledge, skill or experience even if the same is acquired during the course of employment. Restrictive covenants are different in cases where the restriction is to apply during the period after termination of the contract than in those cases where it is to operate during the period of the contract. Negative covenants operative during the period of contract of employment when the employee is bound to serve the employer exclusively are generally not regarded as restraint of trade and do not fall under Section 27 of the said Act. A negative covenant, one that the employee would not engage himself in a trade or business or would not get employment under any other employer for whom he/she would perform similar or substantially similar duties, is not a restraint of trade unless the contract is unconscionable or excessively harsh or unreasonable or one sided. Negative covenants tied up with positive covenants during the subsistence of the contract, be it of employment, partnership, commerce, agency or like, are not normally regarded as being in restraint of trade, business or profession unless the same are unconscionable or wholly one sided and thus do not fall under Section 27 of the said Act. During the period of employment, the employer has the exclusive right to the services of the employee. A restraint operating during the term of the contract fulfils one purpose, that of furthering the contract, such a restraint is designed to fulfil the contract. Where the contract of employment contains such a covenant and the employee leaves the service the negative covenant can be enforced to the extent that the unexpired part of the term or service would be essential for the fulfilment of the contract. However, even the restraints, which operate only during currency of employment, may be subject to the doctrine of restraint of trade, if the restraints are such that one of the parties is so unilaterally fettered that the contract loses its character of a contract for the regulation and promotion of trade and acquires the predominant character of restraint of trade. The Supreme Court in the. Niranjan Shankar Golikari vs The Century Spinning And Mfg Co. 30 ... on 17 January, 1967 mentioned above considered the question of negative covenants. In this case an employee was given special training by his employer, on condition that he would serve the company for 5 years, and that if he left his employment before such period, he would not directly or indirectly engage in the same business and also pay liquidated damages. The Supreme Court held that that the negative covenants, which operate during the period of service, are generally not regarded as restraint of trade and therefore not fall within Section
30
AIR 1967 SC,1098
Page 11 of 14
27 of the Act, unless the contract is unconscionable or unreasonable. It was therefore held that this was a valid contract. Post term restrictive covenants have been held invalid through various judicial pronouncements. An employer is not entitled to protect himself against competition on the part of an employee after the employment has ceased. However, a purchaser of a business is entitled to protect himself against competition per se on the part of the vendor and it has been upheld that a employer has no legitimate interest in preventing an employee after he/she leaves his service from entering the service of a competitor merely on the grounds that the employee has started working with a competitor, unless the same leads to misuse or an unauthorised disclosure of confidential information, which has been provided to the employee during his course of employment. Thus, the post-service restraint is only legally enforceable in cases where the employer has placed some reasonable restraints on the employee of the company to ensure that the latter shall not disclose any confidential information of the former to any business competitor even after the termination of the service. Such post service restraint has been held to be enforceable and falls outside the purview of Section 27 of the said Act. Apart from the non-compete covenants in the employment agreements; another clause refers to the non-solicitation or non- poaching. Non-solicitation agreements are those agreements by which the employee promises not to solicit the employer‟s clients or one party agrees to refrain from employing the employees of the other party for a given period after the termination of the employment. Generally, negative covenant during the period of the agreement is considered not to be hit by law but there are certain non - solicitation agreements which are prima facie negative in nature but still stand as an exception and are enforceable even after the conclusion of the employment and are held by the Courts to be valid in law. General injunctions against non- poaching by the competitor may not be granted as such clauses may be viewed against public interest. However, where the individuals are the beneficiaries of specific ideas or skills or training that they have acquired by working with the employer, the employer may get a specific restraining order, pertaining to these employees. The Supreme Court in the Golikari case, referred to earlier, considered the refusal of the employer to accept the resignation of the employee and who wanted to work with a competitor in the same line of business, for which he was specifically trained and in respect of which he had signed a non -compete clause. The injunction sought by the employers for preventing the employee from divulging secrets was not held to fall foul of Section 27 of the said Act. The courts held that the confidentiality clause was not too wide or unreasonable for protection of interests of the respondent company. Franchise agreements contain covenants relating to confidentiality in relation to know- how and other forms of intellectual property and the franchisor has legal recourse in cases where: an employee comes into possession of a trade secret, know-how and confidential information in the normal course of business and passes off such information, an unauthorized person incites such an employee to provide him with such information, or under a license for the use of know-how, a licensee is in breach of condition, either expressed in an agreement or implied from the conduct, to maintain secrecy. Page 12 of 14
Non-competition clauses are those, which oblige the franchisor or master franchisee not to operate a competing franchise within a certain radius or for a period after the termination of the franchise agreement. The enforceability of such clause varies widely and depends on its reasonableness. 31
In the case of Gujarat Bottling Co. Ltd. and others v. Coca Cola Co . and others An agreement for grant of franchise by Coca Cola to Gujarat Bottling Company to manufacture, bottle, sell and distribute beverages under trademarks held by the franchisor contained the negative stipulation restraining the franchisee to “ manufacture, bottle, sell, deal or otherwise be concerned with the products, beverages of any other brands, or trademarks/ trade names during subsistence of this agreement including the period of one year‟s notice”. It was held that the negative stipulation was intended to promote the trade. Moreover, operation of the stipulation was confined only to subsistence of the agreement and not after termination thereof. Hence, stipulation could not be regarded as in restraint of trade. It was observed by the Supreme Court „There is a growing trend to regulate distribution of goods and services through franchise agreements providing for grant of franchise by the franchisor on certain terms and conditions to the franchisee. Such agreements often incorporate a condition that the franchisee shall not deal with competing goods. Such a condition restricting the right of the franchisee to deal with competing goods is for facilitating the distribution of the goods of the franchisor and it cannot be regarded as in restraint of trade.‟ In the case of V.V. Sivaram and others v. FOSECO India Limited 32, a n employee was restrained from using secrets and confidential information, which he gained during job, even after moving out of the job. The employee had access to confidential information pertaining to several products including the patent „Turbostop‟. He left under voluntary retirement scheme. Injunction restraining him from manufacturing and marketing a product similar to „Turbostop‟ was held to be not violating Section 27. It can be understood from the above judgments that although non -compete clauses in franchise agreements are not seen as being in restraint of trade, they should not be excessively harsh or unreasonable in case of which the court may refuse to enforce it in its entirety. Thus, it can be concluded that the non - compete covenants are usually opposed to freedom of contract and are likely to be easily charged as agreement in restraint of trade. The non compete covenants are generally considered to be valid during the time of employment though the Courts have been less willing to enforce agreements relating to post -employment restraints on the employee. The fundamental principle is that an agreement in restraint of trade is void to the extent of the restraint. It is for the courts to determine whether the contract is reasonable, and the test is whether it is prejudicial or not to the public interest, since these contracts are considered on grounds of public policy. This implies that the restraint must be reasonable in the interests of both contracting parties and also in the interests of the public. One of the few instances in which non-competition clauses will generally be enforceable is in the context of the sale of a business, where the owners of the business will agree to a non compete in exchange for consideration for the goodwill associated with the business (for 31 32
AIR 2372, 1995 SCC (5) 545 2006 133 CompCas 160 Kar, 2006 (1) KarLJ 386 Page 13 of 14
example, in a stock sale where the promoters will sell their stock in the business to a buyer in exchange for consideration). To be enforceable, the non -compete will need to be reasonably limited in time and scope, and consideration will need to be attributed to the goodwill in the transaction, as evidenced in the documentation. Similarly, a non-compete clause in a joint venture in which shareholders mutually agree not to compete with each other on certain terms and conditions, which include time and geographic restrictions, will generally be enforceable in India. CONCLUSION
To sum up the entire issue the following points may be considered 1. When you purchase a business (and along with it, the goodwill), reasonable restraints my be included to prevent the seller from setting up a competing business after selling his business to you. 2. For the restraint to be valid the party imposing it must have a legitimate interest to protect, such as trade secrets, customer contacts, or goodwill (in the purchase of a business). 3. During the term of the shareholders‟ agreement, a shareholder can be prevented from setting up a competing business (as it is reasonable restriction). 4. After the termination of the shareholders‟ agreement, a shareholder can be prevented from setting up a competing business only if it would cause irreparable injury to the existing business and the balance of convenience lies in favour of issuing the order. 5. A restraint will need to be reasonable to protect that interest. The courts will look at the geographical area covered, the length of the restraint, and the scope of activities covered. Therefore prima facie it may be concluded that while restraining covenants would be valid during the subsistence of the agreement however only in exceptional circumstances depending upon the facts and merits of each case can a post termination restrictive covenant be held to be valid.
SUGGESTION
Everything in this world has negative and positive thing present in it, just like a coin which has 2 aspects. Agreement in restraint of trade is somewhere good for public but somewhere it is a disguise, in a monopolistic market it is not good because it restricts the growth and provides hindrances to the society towards its development. Whereas it is good in few cases. For example – in case of a concept and technology which can be used for the development of human but disclosure of it can be proved lethal for human life, example-nuclear energy, War technology which is used for protection of human beings.so in my opinion agreement in restraint should be used in a constructive way rather than to prevent someone from growth.company should be lineant while enforcing contract with anyone which cannot provide hindrances to the person growth and development.
Page 14 of 14
