Section 27 of the Indian Contract Act, 1872: Agreement in restraint of trade, void

The provision

Every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void. This is subject to an exception for the sale of goodwill.

Indian Contract Act, 1872, Section 27. Official text.

What Section 27 Prohibits

Section 27 of the Indian Contract Act makes void any agreement that stops someone from doing their lawful profession, trade, or business. The law treats such restraints as contrary to public policy because they prevent people from earning a livelihood and reduce competition in the market. If you sign an agreement that restrains you from working in your field, that restrictive clause is unenforceable and you can ignore it.

The Goodwill Exception

There is one critical exception: agreements restraining trade made in connection with the sale of goodwill are valid and enforceable. This means when you sell a business, brand, or customer relationships (goodwill), the buyer can require you not to compete for a reasonable period within a reasonable geographical area. Courts have recognized that this protects the value the buyer is purchasing. Without this exception, a business seller could immediately start a rival business and destroy the asset the buyer just paid for.

What This Means for Your Contracts

Non-compete and non-solicitation clauses are extremely common in employment agreements, service contracts, and partnership agreements in India. However, courts interpret Section 27 strictly. A restraint will be struck down unless it can be justified under the goodwill exception.

For employment contracts, bare non-compete clauses ("you cannot work in this industry for 2 years") are generally void. Courts have held that employment is not a "sale of goodwill" in the traditional sense. However, restraints tied to protecting legitimate business interests (client confidentiality, trade secrets, specific customer non-solicitation) may survive if they are reasonable in scope, duration, and geography.

When drafting restraint clauses, be precise: define the restricted activity narrowly, specify a reasonable time period (courts often accept 6 months to 2 years depending on industry), and limit the geographical area to where the business actually operates. Include clear recitals explaining why the restraint is necessary (e.g., protection of confidential information or customer relationships established during employment).

For sale transactions, the goodwill exception provides solid ground for restrictive covenants. Courts are more receptive to enforcing seller non-competes when the seller is receiving payment for business value. Still, proportionality matters: a 5-year worldwide restraint may fail even in a goodwill context.

Always consider whether your restraint could survive judicial scrutiny under Section 27. Overly broad clauses create litigation risk and may be partially or wholly unenforceable.

Litigation Risk and Enforceability

If a dispute arises, the burden falls on the party enforcing the restraint to prove it falls within the goodwill exception or is otherwise reasonable and necessary. Courts have the discretion to modify or sever unreasonable terms. Relying on void restraint clauses as your primary control mechanism leaves you exposed if the other party breaches.

This page explains the law in general terms for information only. It is not legal advice. Always read the provision in its official source and take advice on your specific facts.