Restraint of trade | A forfeiture clause in the employment contract provides that “if a person engages in a competing business/service within two years period after leaving the company… Whether the clause is enforceable or is violative of Section 27 of the Indian Contract Act?

Question: Restraint of trade | A forfeiture clause in the employment contract provides that “if a person engages in a competing business/service within two years period after leaving the company, the outstanding incentive amount due to him can be forfeited”. Whether the clause is enforceable or is violative of Section 27 of the Indian Contract Act? [DJS 2018]

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Answer

Section 27 in The Indian Contract Act, 1872 follows as “Agreement in restraint of trade, void.—Every agreement by which anyone 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 the 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.”

The facts of the present case have been borrowed from the case of Deepayan Mohanty v. Cargill India Pvt Ltd & Ors. (2018) Delhi HC. In the case, the forfeiture clause stated: If a person engages in a competing business/service within the two years period after leaving Cargill, the outstanding amount can be forfeited.

It is the settled position, in India at least, that no employer has a right to restrain an employee from taking up competing employment after the term of employment. Such a clause is invalid and unenforceable as per Section 27 of the Indian Contract Act, 1872.

But what Cargill is doing in the present case is not restraining him from pursuing his competing business but refusing to disburse the balance incentive award amount to him since he allegedly engaged in a competing business. Thus, the amount belonging to the employee is being withheld by Cargill. Ideally, the entire amount ought to be disbursed at the time when it was awarded but as a part of Cargill‟s company policy, it is being deferred.

If the deferment is to enforce a clause that is otherwise unenforceable, the forfeiture based on the said clause, is itself illegal. The amount does not belong to Cargill. It belongs to the employee and Cargill is merely making the employee agree to take the amount with interest after the period of two years. That does not mean that under the garb of paying interest, Cargill can forfeit something on the basis of an invalid and unenforceable clause in the agreement.

The terms used in the clause, namely, “forfeiture“, and “awarded but not yet distributed” clearly show that the amount vests in the employee and only the disbursement is deferred. The fact that interest is being paid on the unpaid incentive amount also shows that the intention of Cargill seems to be merely enforcing conditions on employees which cannot otherwise be enforced in law, at least in India.

The condition in an employment contract that an employee cannot engage in competing for business after employment for any period is also in restraint of trade.

The legal position clearly crystallized in Indian Law of Contract is that while construing the provisions of Section 27 of The Indian Contract Act,1872 neither the test of reasonableness nor the principle of restraint being partial is applicable, unless it falls within express exception engrafted in Section.

Thus, the forfeiture clause is clearly not enforceable, as it stands in violation of Section 27 of the Indian Contract Act,1872 as it is in restraint of trade.

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Law of Contract Mains Questions Series: Important Questions for Judiciary, APO & University Exams

1. Law of Contract Mains Questions Series Part-I
2. Law of Contract Mains Questions Series Part-II
3. Law of Contract Mains Questions Series Part-III
4. Law of Contract Mains Questions Series Part-IV
5. Law of Contract Mains Questions Series Part-V
6. Law of Contract Mains Questions Series Part-VI
7. Law of Contract Mains Questions Series Part-VII
8. Law of Contract Mains Questions Series Part-VIII
9. Law of Contract Mains Questions Series Part-IX
10. Law of Contract Mains Questions Series Part-X