Nirali Katira- A-013- Sem VIII- 4th year- Contract- II

Agreement in Restraint on a Partner

Introduction

Section 36(1) of the Indian partnership act deals with the rights of the outgoing partner; It

imposes certain restrictions but allows an outgoing partner to carry on the business competing

with that of the firm following are some of the restrictions regarding the same:

 Cannot use the firm name.

 Cannot represent himself as a member of the partner.

 Cannot solicit the customs of the person who was dealing with the firm before he ceased

to be a partner.

Section 36(2) of the Indian partnership act deals with the agreement in restraint of the trade.

According to this section, an outgoing partner may make an agreement with his partners that,

when he ceases to be a partner of the firm, he will not carry on any business related to that of the

firm within a specified period or local limits.

Section 27. 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. 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
 Nirali Katira- A-013- Sem VIII- 4th year- Contract- II

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.

In Electrosteel Castings Ltd vs Saw Pipes Ltd, (2005), the words “lawful profession” in Section

27 include both an independent professional and salaried professional. Self-employment and all

modes of economic survival or of earning one’s livelihood are covered.

Common Law Rule

The background for delegitimizing an agreement in restraint of trade lies in the history of conflict

between free markets and the freedom of contracts. Ensuring freedom to the contract would

mean legitimizing agreements in restraint of trade, which would result in parties agreeing to curb

competition. Under the common law, the current position is derived from the case of-

Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd

In this case, Thorsten Nordenfelt was a manufacturer of guns in Sweden and England. Thorsten

sold his business to a company, which then transferred the business to Maxim Nordenfelt. At this

time, Thorsten entered into an agreement with Maxim that he would not engage in the

manufacture of guns for 25 years, other than what he manufactures on behalf of the company.

Later, Thorsten broke his vow claiming that the agreement was not enforceable as it was in

restraint of trade. The decision of the court was in Thorsten’s favour.

The doctrine of restraint of trade has been reconsidered by the House of Lords in Esso Petroleum

Co Ltd. vs. Harper’s Garage Ltd. In this case, their Lordships struck down an exclusive dealing

agreement because it extended to a period of 21 years, which was unreasonable. A five year
 Nirali Katira- A-013- Sem VIII- 4th year- Contract- II

period would have been held to be reasonable. They said that the doctrine applied only if a man

contracted to give up some existing freedom which he had.

In common law, a test of reasonability is followed. An agreement in restraint of trade is valid, if:

1. There is a valid interest that the party imposing the restraint is trying to protect.

2. The restraint is no more than that which is necessary to protect this interest.

3. Restraint is not contrary to public interest.

Position in India

Section 27 of the Indian Contract Act declares all agreements in restraint of trade, void pro tanto,

with the only exception being Sale of Goodwill. Yet, it is important to understand that these

agreements are void, not illegal. Which means, these agreements are not unlawful to make, they

are just not enforceable in a court of law if either of the parties fails to perform his part of the

agreement. Unlike the common law, even partial agreements in restraint of trade or reasonable

restraint are not valid under the Contract Act.

Illustrations

1. Shalini has a business of office supplies and books in a locality in Bareilly. A person

Zahida is planning to open her business of similar goods in the same locality. Fearing

competition in the market, Shalini enters into an agreement with Zahida not to open her

business in the area for 15 years, and as a consideration promises to pay a certain sum of
 Nirali Katira- A-013- Sem VIII- 4th year- Contract- II

money to her every month. Later, Shalini fails to pay the sum agreed upon. Zahida tries to

take the matter in a court of law. The agreement being void, Zahida has no case.

2. Q: Peter, John, and Oliver are partners in a shirt manufacturing company. Peter is entitled

to three-eighths of the partnership property and profits. After a couple of years of

business, Peter becomes bankrupt while John and Oliver continue the business without

paying out Peter’s share of the firm’s assets or settling accounts with his estate. Does

Peter get a share of the profits?

Answer: Yes. Peter is entitled to three-eighths of the profits made in the business from the

date of his bankruptcy until the final liquidation of the partnership affairs.

3. Q: Peter, John, and Oliver are partners in a travel company. Oliver retires after selling his

share in the partnership firm. However, Peter and John fail to pay the agreed value of the

share to Oliver. Can Oliver recover the amount?

Answer: Yes. The value of Oliver’s share on the date of his retirement from the firm will

be pure debt on the firm. This debt will be applicable from the date on which he ceased to

be a partner of the firm as per the agreement between him and his partners. He can

recover his share amount along with the interest.

 Nirali Katira- A-013- Sem VIII- 4th year- Contract- II

4. Ram and Shyam were businessmen in Calcutta. The Shyam suffered loss due to the

Ram’s competition and entered into an agreement with the Ram that if he closed his

business there, he would pay him all the advances he had made to his workmen. When

the Shyam failed to pay, Ram filed a suit to recover the amount but failed to do so

because it was an agreement in restraint of trade, therefore not enforceable in a court of

law.

Few Case laws:

Pradeep Arora & Ors. vs Samantha Kochhar (2016)

In this case there were 5 partners, four of them were the petitioner and the fifth one was

respondent. They entered into a partnership; The dispute between the parties was related to

arbitration. The respondent claims the petition whereas the petitioner filed a counterclaim. One

of the claims of the respondent was for the recovery of a sum of Rs.24,50,000 invested by her in

the partnership business with the interest of 12% on the capital contribution by the claimant from

the date of investment till the time of termination that is 22nd March, 2011 amounting to Rs.

2,04,280 with the interest of 24% was claimed from 22nd September, 2011 till the date of filing

the claim and future interest as well. Several issues were raised regarding the counterclaim. In

the end, it was held that the court does not find any relevance in the previous judgment. The

Supreme Court emphasized that the accounts would have to be rendered. It is pointed out that the

firm was an unregistered firm and therefore, an individual person in their personal capacity does

not file a suit against the partner for return of the amount which was invested in the firm as a

capital contribution.
 Nirali Katira- A-013- Sem VIII- 4th year- Contract- II

Mrs. Halima Bai vs Sparkle-Ads-Firm (2014)

In this case the appeal is directed against the decree and judgement passed during the final

application in the court of chennai. In the partnership firm there were four partners. Two of them

were plaintiffs and the other 2 were defendants in the partnership deed. The partnership firm was

engaged in advertising business and allied matters. Each of the partners has contributed a sum of

Rs.10,000/- towards a share capital and the partnership was one at will. The plaintiff expressed

her willingness to retire from the partnership firm and sent a letter. In that letter it was

acknowledged by the defendant and confirmed that the plaintiff was deemed to have retired from

the partnership firm. It was contended by the plaintiff that the partnership firm did not settle her

accounts on retirement despite several demands and that she demanded to settle all her shares in

respect to transactions. After all this the court held that there is no doubt that section 27 talks

about the rights of outgoing partners. It was said that she cannot claim profits of the partnership

firm subsequently as there is no contribution from her side and the claim of 1/4th share of the

plaintiff is arrived due to her contribution towards capital. The outcome is that the appeal was

dismissed after confirming the judgement and decree of the court.

Commissioner Of Income-Tax vs Sant Lal Arvind Kumar (1981)

In this case there are four partners, Shri Sant Lal, Shri Hukam Chaad, Smt. Premwati and Gaytri

Devi. The original partnership deed contained no provision that the death of any partner would

not dissolve the firm. A partnership deed was executed under which the three other partners
 Nirali Katira- A-013- Sem VIII- 4th year- Contract- II

constituted a partnership with a grandson of Shri Sant Lal and this partnership continued to carry

on the business as previously carried by the previous four partners. Shri Sant Lal had 30% share

in the firm out of which 25% was given to his grandson and 5% was added to the share of

Smt.Gayatri Devi. The assesses s claim that on the death of Shri Sant Lal the earlier firm had

been dissolved, consequently there were two separate and independent firms in existence for the

two periods. The minority judgement in the allahabad high court decision earlier referred to

present a point of view that even though a case falls under Section 187 there should be separate

assessments of the firm as it stood before the change and after the change. Thus if this section is

applied, the partners of the firm will not suffer any disadvantage because the income of the

previous year will be allotted on a time basis and the cases under reference only to the partners

who were there during the relevant period.

For the reasons mentioned above the court form a opinion that:

 The tribunal was right in holding that an assessment should be made on the firm.

 The appellate tribunal was right in directing that to separate assessments should be on the

firm;

 They make no order as to costs.

 The firm gets dissolved and there is no basis for urging that the income tax officer

entitled the consequences.

Coca Cola Company, (AIR 1995 SC 2372)

 Nirali Katira- A-013- Sem VIII- 4th year- Contract- II

In this case the defendant and the plaintiff used to carry on the business of ferrying boats and

arrived at a business settlement whereby the defendant promised to pay a certain amount to the

plaintiff in order that the plaintiff abstain from carrying on his boat business for a period of three

(3) years, the court held that the agreement was void as the restraining covenant was a vital part

of the agreement and did not fall under the “goodwill exception” to section 27 of the Indian

Contract Act, 1872.

Statutory Exceptions

Sale of Goodwill

The only exception mentioned in Section 27 of the Contract Act is related to sale of goodwill.

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.

Meaning of Goodwill :- There should be real goodwill to be sold. The Goodwill which has been

the subject of sale is nothing more than the probability that the old customer will resort to old

place.

Partnership Act

Partners may agree that

 Nirali Katira- A-013- Sem VIII- 4th year- Contract- II

• A partner shall not carry on any business, other than that of the firm, while be partner.

[Section 11(2) Indian Partnership Act, 1932].

• A partner on ceasing to be a partner will not carry on any business. similar to that of the

firm within a specified period or within local limits. The agreement shall be valid if the

restrictions are reasonable. [Section 32 (2) Indian Partnership Act, 1932]

• Partners may in anticipation of dissolution make an agreement that some or all of them

will not carry on a business similar to that of the firm within a specified period or within

specified local limits and such, agreement shall be valid if the restrictions imposed are

reasonable. [Section 54 Indian Partnership Act, 1932]

• A partner may, upon sale of goodwill of a firm, make an agreement that such partner will

not carry on any business similar to that of the firm within a specified period or local

limits provided the restriction is reasonable. [Section 55, Indian partnership Act, 1932

• Section 36 the Partnership Act,1932 is related to restrain an outgoing partner from

carrying on a similar business within the specified period and specified local limits,

The agreement should specify the local limits or the period of restraint, and The restriction

imposed must be reasonable.

Firm Daulat Ram vs. Firm Dharm Chand, AIR 1934 Lah 110, where two ice factory owners

constituting a partnership agreed that only one factory will be worked at a time and its profits

distributed among them. The restraint was held to be justified.

 Nirali Katira- A-013- Sem VIII- 4th year- Contract- II

Conclusion

Partnership is a very common type of business which is prevailing worldwide, as it contains

many disadvantages and advantages. In partnership firms the outgoing partner has certain rights

and liabilities for the same. When the partner leaves the firm either due to the retirement or due

to the death it is called as the outgoing partner. There are various criteria to leave the partnership

firm which are given in the Indian Partnership Act,1932. The Indian Partnership Act provides

complete guidelines, as it covers all the aspects related to the partnership.