Section 27 of the Indian Contract Act, 1872: Contemporary Perspectives on Restraint of Trade

Section 27 of the Indian Contract Act, 1872: Contemporary Perspectives on Restraint of Trade

1. Introduction

Section 27 of the Indian Contract Act, 1872 (hereinafter “ICA”) provides that “every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind is, to that extent, void.” With the exception of a narrowly-drawn proviso relating to the sale of goodwill, the text is unequivocally absolutist. Yet, Indian courts have long grappled with reconciling this rigidity with commercial realities. Recent decisions—especially Percept D’Mark v. Zaheer Khan[1], Superintendence Co. v. Krishan Murgai[2], Gujarat Bottling v. Coca Cola[3], and Niranjan Golikari v. Century Spg.[4]—demonstrate the evolving judicial approach to distinguishing permissible “regulation” from impermissible “restraint.” This article critically analyses Section 27 through the prism of these authorities, highlighting doctrinal tensions, practical implications, and possible trajectories for reform.

2. Statutory Framework & Historical Context

The framers of the ICA adopted the New York Draft Code’s absolutist formulation, consciously rejecting the English common-law doctrine of “reasonableness” in restraint of trade.[5] Over time, however, Indian courts have imported a limited reasonableness enquiry under the guise of interpreting whether a covenant is truly a “restraint” or merely ancillary to the main bargain. This pragmatic shift has produced a three-tier taxonomy:

  • Covenants operative during the subsistence of a contract – usually upheld, as they are viewed as facilitating rather than restraining trade.
  • Post-termination covenants – presumptively void unless saved by statutory exceptions (e.g., goodwill) or characterized as protection of confidential information.
  • Hybrid clauses extending beyond term with conditional triggers – scrutinised for over-breadth and potential chilling of future trade.

3. Key Judicial Developments

3.1 Restrictive Covenants During Contract: Niranjan Golikari

In Niranjan Shankar Golikari v. Century Spinning and Mfg. Co., the Supreme Court upheld an exclusivity covenant binding an employee for the term of employment, emphasising that Section 27 is inapplicable intra-contract because trade is promoted, not restrained, when parties adhere to their agreed roles.[4] The Court granted an injunction, signalling that equitable relief is available where restrictive clauses are reasonable in scope, duration, and geography.

3.2 Negative Covenants within Franchise Relationships: Gujarat Bottling

Gujarat Bottling Co. Ltd. v. Coca Cola Co. reaffirmed that a negative covenant limited to the contract period—prohibiting the franchisee from bottling competing beverages—was not hit by Section 27.[3] The Court drew a functional distinction between “restraint” and “protection”: where a stipulation merely preserves the franchisor’s investment during the contractual term, it is enforceable. Importantly, the Court endorsed interim injunctive relief under Section 9 of the Arbitration and Conciliation Act, 1996 to police such covenants.

3.3 Post-Service Restraints: Superintendence v. Krishan Murgai

The decision in Superintendence Company of India v. Krishan Murgai took a stricter view. A clause restraining a former employee from engaging in competing business for two years post-termination was held unenforceable, not because post-employment covenants are inherently void, but because leave the company was interpreted to exclude employer-initiated termination, rendering the clause inapplicable.[2] The majority nonetheless reiterated that Section 27 bars post-service restraints unless statutorily excepted, casting doubt on importing a common-law reasonableness test after the contract ends.

3.4 Right of First Refusal (ROFR): Percept D’Mark v. Zaheer Khan

In Percept D’Mark, the Supreme Court struck down a ROFR clause that survived the expiry of an athlete-management agreement, holding that obligating the cricketer to offer endorsements first to the former agent constituted an unreasonable post-contract restraint.[1] The Court distinguished between legitimate protection of investment and an attempt to perpetuate control over the athlete’s future commercial engagements. By emphasising the clause’s post-term operation, the Court harmonised its reasoning with the absolutist language of Section 27.

4. Doctrinal Analysis

4.1 Absolutism versus Reasonableness

A persistent tension exists between the statutory text and the judiciary’s pragmatic impulses. While Krishan Murgai re-asserts an absolutist reading, Golikari and Gujarat Bottling effectively apply a reasonableness lens by recasting certain covenants as not amounting to “restraint.” This interpretive manoeuvre avoids direct conflict with the statute but creates analytical opacity.

4.2 Temporal Boundary of Restrictive Clauses

The permissibility of negative stipulations is closely tied to duration. Courts consistently uphold covenants that expire with the principal contract (Golikari, Gujarat Bottling), yet invalidate those extending beyond (e.g., the ROFR in Percept D’Mark). Thus, practitioners must draft clauses that clearly sunset with the contract to minimise Section 27 exposure.

4.3 Protectable Interests

Indian jurisprudence recognises limited legitimate interests justifying restraints: protection of trade secrets, confidential information, and goodwill arising from a sale (statutory exception). Attempts to shield mere freedom from competition, as in Percept D’Mark, face judicial scepticism. The burden rests on the covenantee to demonstrate a substantial proprietary interest proportional to the restraint imposed.

4.4 Interface with Specific Relief Act, 1963

Section 42 of the Specific Relief Act empowers courts to enforce negative agreements by injunction even where specific performance of affirmative obligations is unavailable. Nevertheless, such relief is conditioned on the covenant’s substantive validity under Section 27 ICA. Therefore, injunctive relief is viable during subsistence of a contract (Golikari) but seldom after termination unless the restraint falls within statutory exceptions.

5. Policy Considerations & Comparative Insights

The absolutist statutory stance arguably stifles commercial autonomy in a globalised economy where reasonable post-contractual non-competes are commonplace. Critics suggest amending Section 27 to incorporate a calibrated reasonableness test, aligning Indian law with modern commercial expectations while safeguarding individual livelihood.[6] Until legislative reform materialises, judicial creativity—framed as classification rather than explicit adoption of reasonableness—will likely persist.

6. Drafting Implications

  • Limit restrictive covenants strictly to the operative term of the contract unless covered by the goodwill exception.
  • Articulate the protectable interest (e.g., confidential know-how) and territorial/temporal scope with precision.
  • In agency or management contracts, avoid post-term ROFR or non-compete obligations; instead, rely on liquidated damages or confidentiality covenants.
  • For employment agreements, focus on confidentiality and non-solicitation rather than blanket non-compete clauses post-employment.

7. Conclusion

Section 27 remains a stringent statutory guardrail against restraints on trade. Yet, Indian courts, driven by commercial exigencies, have carved nuanced pathways: endorsing intra-contract restraints, invalidating overreaching post-contract covenants, and cautiously distinguishing protective clauses from suppressive ones. The quartet of leading cases analysed herein illustrates this delicate balance. For now, cautious drafting that respects the temporal and substantive limits elucidated by the judiciary remains imperative. A future legislative recalibration embracing a structured reasonableness standard could provide greater certainty while preserving the employee’s and entrepreneur’s freedom to trade.

Footnotes

  1. Percept D’Mark (India) (P) Ltd. v. Zaheer Khan & Anr., (2006) 4 SCC 227.
  2. Superintendence Company of India (P) Ltd. v. Krishan Murgai, (1981) 2 SCC 246.
  3. Gujarat Bottling Co. Ltd. v. Coca Cola Co., (1995) 5 SCC 545.
  4. Niranjan Shankar Golikari v. Century Spinning & Mfg. Co. Ltd., AIR 1967 SC 1098.
  5. Krishan Murgai v. Superintendence Company of India (P) Ltd., Delhi HC, 1979; cf. Pollock & Mulla, Law of Contract (9th ed.), p. 271.
  6. See Law Commission of India, 13th Report (1958) recommending a reasonableness exception; not enacted to date.