Agreement in Restraint of Trade under Section 27 of the Indian Contract Act, 1872: The General Rule, the Sale of Goodwill Exception, Negative Covenants During Employment, and Why the English Test of Reasonableness Does Not Apply

Section 27 declares every agreement by which a person is restrained from exercising a lawful profession, trade or business void to that extent. The word every is the whole of the difficulty. English law asks whether a restraint is reasonable as between the parties and in the public interest, and upholds it if it is. The Indian draftsman rejected that approach and substituted a flat prohibition with a single statutory exception. The result is that arguments about the modest duration or narrow geography of a restraint, which carry the day in England, are beside the point here. What Indian law does permit is a distinction the section itself does not draw: between restraints operating during the subsistence of a relationship and those operating after it ends.

1. The Provision

Section 27, Indian Contract Act, 1872

Agreement in restraint of trade void. Every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.

Exception 1: Saving of agreement not to carry on business of which goodwill is sold. One who sells the goodwill of a business may agree with the 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 the business.

1.1 The three features that govern its operation

It is a statutory prohibition, not a presumption. The section does not say that a restraint is presumptively bad and may be justified; it says the agreement is void. A court cannot therefore uphold a restraint by finding it reasonable, because the statute leaves no room for that inquiry outside the Exception.
The words 'to that extent' permit severance. Only the restraining part of the agreement is void; the rest stands if it can survive without it. This is a narrower severance than Section 24 permits, because it operates on the covenant rather than on the consideration.
The restraint must be on the promisor's own trade. A covenant restricting what a party may do with property, or restricting third parties, is not within the section, which is why exclusive dealing and sole distribution arrangements are frequently outside it.

2. The Sale of Goodwill Exception

The single statutory exception permits a seller of goodwill to covenant not to carry on a similar business, and it is hedged by four conditions, each of which must be satisfied.

There must be a genuine sale of goodwill. The exception protects the buyer's purchase; it does not license a restraint attached to a transaction that is not in substance a sale of goodwill.
The restraint must be confined to specified local limits. An unlimited geographical restraint is outside the exception.
Those limits must appear to the court reasonable, regard being had to the nature of the business. This is the one place in Section 27 where reasonableness enters, and it is confined to the local limits and not to the duration or the scope of the covenant.
The restraint operates only so long as the buyer, or a person deriving title from him, carries on a like business in those limits. Once the buyer ceases to carry on the business there, the covenant ceases to bind.

3. Restraints During and After the Relationship

The single most important distinction in this area is not found in the text of Section 27 at all. It was developed by the courts, and it separates a covenant operating during the subsistence of a contract of employment or agency from one operating after it has come to an end.

📖 Niranjan Shankar Golikari v. Century Spinning and Manufacturing Co. Ltd., AIR 1967 SC 1098

Facts: A company manufacturing tyre cord yarn under a collaboration with a foreign enterprise engaged the appellant as a shift supervisor for five years, having trained him at the collaborator's expense. His contract required him to maintain secrecy of technical information and provided that during the period of employment he would not serve any other person engaged in a similar business. He left before the term expired and joined a competitor. The company sought an injunction.

Held: The Supreme Court granted the injunction. A negative covenant operating during the period of employment, restraining the employee from serving elsewhere in a competing business, is not in restraint of trade within Section 27. Such a covenant does not prevent the employee from exercising his trade; it requires him to serve the employer he has agreed to serve, and it is designed to protect the employer's legitimate interest in confidential information and in the training it has provided. The Court distinguished covenants operating after the term, which stand on a different footing.

Ratio: A negative covenant operative during the subsistence of the employment is enforceable and is outside Section 27, provided it is not unconscionable or excessively harsh and is reasonably necessary to protect the employer's interests.

The reasoning is that a person who has undertaken to serve one employer for a term is not restrained from trading; he is held to the bargain he made about how he will trade during that term. Once the term ends, the analysis reverses: a covenant that then prevents him from working is a restraint on his exercise of his trade, and Section 27 strikes it down. That position is developed in the dedicated topic on post-employment non-compete clauses.

The line that decides validity is the end of the relationship

4. Commercial and Exclusive Dealing Arrangements

Between businesses the analysis is different again, and the courts view such restrictions more liberally than restrictions in an employment contract, because the parties are of comparable standing and the covenant is usually reciprocal. Exclusive supply and sole distribution arrangements are ordinarily upheld where the restriction operates during the subsistence of the agreement and is designed to further the trade rather than to prevent it.

📖 Percept D'Mark (India) Pvt. Ltd. v. Zaheer Khan, (2006) 4 SCC 227

Facts: A sports management agency had an agreement with a cricketer to act as his agent for endorsements and promotional work. The agreement contained a clause giving the agency a right of first refusal, under which, on expiry of the term, the cricketer was obliged to offer any proposed new arrangement to the agency on the same terms before contracting with anyone else. On expiry the cricketer engaged another agency, and the first agency sought interim relief.

Held: The Supreme Court refused relief. A restrictive covenant extending beyond the term of the contract is void under Section 27. A negative covenant operating during the term of the agreement is generally not regarded as a restraint of trade, but one operating after the contract has come to an end is hit by the section. The right of first refusal, operating after expiry, restricted the cricketer's freedom to contract with whom he pleased and could not be enforced. The Court added that such a covenant cannot be enforced by injunction under Section 42 of the Specific Relief Act, 1963 where the underlying agreement has ended.

Ratio: The distinction between covenants operating during and after the term applies to commercial agreements as well as to employment. A restrictive covenant that operates after the contract has expired is void under Section 27, whatever form it takes.

5. Section 27 Compared with English Common Law

Question	English common law	Section 27
Basic position	A restraint of trade is prima facie void but may be justified	Every restraint is void to that extent; there is nothing to justify
Test applied	Reasonableness as between the parties and in the public interest	None, save as to the local limits under the Exception
Partial restraints	May be upheld if reasonable in area, time and scope	Void, since the section does not distinguish partial from total
Post-employment covenants	Enforceable where necessary to protect trade secrets or customer connection and no wider than needed	Void, subject to the treatment of confidentiality obligations
Sale of goodwill	Upheld if reasonable	Upheld under Exception 1, subject to local limits that the court finds reasonable
Severance	The blue pencil test, deleting offending words	The words 'to that extent' permit the restraining part alone to be struck out

The Supreme Court settled the point in Superintendence Company of India (P) Ltd. v. Krishan Murgai, (1981) 2 SCC 246, holding that Section 27 declares every restraint void subject only to the statutory exception, and that the English distinction between reasonable and unreasonable restraints has no application to a post-employment covenant in India. The Indian provision was deliberately drafted differently, and English authority cannot be used to narrow it.

6. Restraints Outside Section 27

A number of arrangements that look like restraints have been held not to engage the section at all, because they do not restrain the promisor from exercising a trade.

Negative covenants during the term, as in Golikari, since the promisor is held to the manner of trading he agreed to.
Restraint during a partnership. Sections 11(2), 36(2) and 54 of the Indian Partnership Act, 1932 expressly permit partners to agree that a partner shall not carry on a competing business while he is a partner, that an outgoing partner will not carry on a similar business within specified periods or local limits, and that partners will similarly restrain themselves on dissolution, in each case subject to the restrictions being reasonable.
Confidentiality and trade secret obligations. A covenant not to disclose or use the employer's confidential information does not prevent the employee from exercising his trade and is enforceable even after employment ends, provided the information is genuinely confidential and not merely the general skill and knowledge the employee acquired.
Non-solicitation covenants, which restrain the soliciting of employees or customers rather than the carrying on of a trade, and which are treated separately in their own topic.
Exclusive dealing and sole agency arrangements operating during the term, which are ordinarily viewed as trade-furthering rather than trade-restraining.

⚠ Confidentiality is not a way around Section 27

A confidentiality clause is enforceable because it protects information, not because it disguises a restraint. Where a clause is framed as a confidentiality obligation but in substance prevents the employee from working in the industry at all, the court looks at the effect and applies Section 27. The line the courts draw is between the employer's trade secrets and confidential information, which may be protected, and the employee's general skill, experience and knowledge acquired in the course of the employment, which belongs to him and which he is entitled to use for his own advantage.

7. The Position Stated Shortly

Section 27 declares every agreement restraining a person from exercising a lawful profession, trade or business void to that extent.
It is a statutory prohibition and not a presumption, so a restraint cannot be upheld by proving it reasonable.
The sole exception is the sale of goodwill, subject to specified local limits that the court finds reasonable and to the buyer continuing a like business there.
The words 'to that extent' permit the restraining covenant alone to be severed.
Golikari: a negative covenant operating during the employment is outside Section 27 and is enforceable if reasonably necessary and not unconscionable.
Percept D'Mark: a covenant operating after the term, including a right of first refusal, is void under Section 27, and the during-and-after distinction applies to commercial agreements too.
Krishan Murgai: the English test of reasonableness has no application to a post-employment restraint in India.
Partnership restraints are expressly saved by Sections 11(2), 36(2) and 54 of the Indian Partnership Act, 1932.
Confidentiality obligations protect information and are enforceable after employment, but they cannot be used to impose a disguised restraint, and general skill and knowledge belong to the employee.

8. Related Topics and Provisions

Topic or provision	Connection
Post-Employment Non-Compete Clauses in India	The position after employment ends, in full
Non-Solicitation Clauses	Covenants restraining solicitation rather than trade
Void Agreements under Sections 24 to 30	Section 27 among the classes declared void
Nature and Sources of Contract Law	Why English authority cannot narrow a differently drafted Indian provision
Section 27, Indian Contract Act	The rule and the goodwill exception
Section 28, Indian Contract Act	The parallel provision on restraint of legal proceedings
Sections 11(2), 36(2) and 54, Indian Partnership Act, 1932	Restraints between partners
Section 42, Specific Relief Act, 1963	Injunction to enforce a negative covenant
Article 19(1)(g), Constitution of India	The freedom to practise a profession, against which restraints are assessed