An agreement restraining a person from carrying on a lawful profession, trade or business is void to that extent. The objective of such a provision was to protect trade from restraints, at a time when trade was still advancing as 'trade in India was in its infancy; and the legislature may have wished to make the smallest number of exceptions to the rule against contracts whereby trade may be restrained'1
However, with the passing of time, restrictions of trade which confine the operation of agreements also started evolving with the evolution of commerce and communication. The Allahabad High Court observed that 'it is unfortunate that s.27...seriously trenches upon the liberty of the individual in contractual matters affecting trade'.2 But now that trade in India has advanced to a large extent, there should be a more liberal attitude towards restraints, if they are reasonable between the parties and towards the general public.3
In this article, I delve into the landmark judgement "Gujarat Bottling Co. Ltd. v. Coca Cola Company4", in which the Supreme Court looks into the law relating to the validity of contracts / commercial agreements containing negative covenants.
GUJARAT BOTTLING COMPANY LIMITED AND OTHERS V. COCA COLA COMPANY AND OTHERS5
Gujarat Bottling Company Limited ("GBC") and Coca Cola Company ("Coke") entered into two agreements, in 1993 and 1994. The 1993 agreement was an agreement for grant of franchise by Coke to GBC to manufacture, bottle, sell and distribute beverages known and sold under the trademarks (these had been acquired by Coke) "Gold Spot", "Thums up", "Limca", "Maaza" and "Rim Zim" ("1993 Agreement").
Paragraph 14 of the 1993 Agreement is relevant and reads as: "As such the Bottler covenants that the Bottler will not manufacture, bottle, sell, deal or otherwise be concerned with the products, beverages of any other brands of trade marks/trade names during the subsistence of this Agreement including the period of one year's notice as contemplated in paragraph 21."
Paragraph 14 is a negative covenant as it restricts GBC from manufacturing, bottling, selling, dealing, or performing any activity in connection to the products not only during the term of the 1993 Agreement but also "including the period on one year's notice...". Paragraph 21 of the 1993 Agreement stipulated the termination without notice by either party, upon giving 1 year's written notice.
Under the agreement signed between GBC and Coke in 1994, the period of termination was reduced to 90 days, there was no restrictive provision, and the 1993 Agreement was not expressly substituted ("1994 Agreement").
In 1995, the shareholding of GBC was subsequently transferred to Pepsi. Then GBC served Coke with a 90-day termination notice, to terminate the 1993 Agreement. GBC contended that the 1993 Agreement was replaced by the 1994 Agreement and, therefore, the termination procedure under the 1994 Agreement was applicable. There was no communication between GBC and Coke whereby the termination notice period was reduced from 1 year to 90 days under the 1993 Agreement.
As such, the Supreme Court stated that "for the present, we will proceed on the basis that the 1993 Agreement subsists and it does not stand terminated on the expiry of 90 days from the date of notice dated January 25, 1995."
Shortly after receiving the 90-day termination notice, Coke filed a suit in the Bombay High Court, seeking GBC to refrain from dealing with Pepsi for a period of 1 year of the termination notice, as per the 1993 Agreement.
The Bombay High Court issued an interim injunction restraining GBC from manufacturing, bottling, selling, or dealing of the products with anyone other than Coke. Thereafter, GBC filed an appeal, and the judgement was in favour of the injunction restraining GBC from concerning itself with the products/beverages of any brand other than Coke. Aggrieved, GBC filed an appeal in the Indian Supreme Court.
One of the issues considered by the Supreme Court in this case was whether paragraph 14 of the 1993 Agreement was in restraint of trade under section 27 of the Indian Contract Act, 1872 ("Act"), and therefore was it void?
The Supreme Court referred to multiple observations and stated that agreements such as franchise agreements often incorporate a condition that the franchisee shall not deal with competing goods. Such a condition restricting the right of a franchisee is for facilitating the distribution of goods of the franchiser and cannot be regarded as a restraint of trade.
The purpose of the restrictive covenant in the 1993 Agreement can be construed as a means to further trade, which would be done through GBC promoting the sale of Coke's products.
The Supreme Court further stated that the negative stipulation in paragraph 14 is operative only during the period of agreement is in operation because of the express use of the words "during the subsistence of this agreement including the period of one year as contemplated under paragraph 21". Except in cases where the contract is wholly one sided and when the restriction operates during the term of the contract, the doctrine of restraint of trade is not attracted. It will apply when the restriction operates after the termination of the contract.
In this case, the Supreme Court also referred to Niranjan Shankar Golikari v. Century Spinning and Manufacturing Company Limited6 where it held that: "... considerations against restrictive covenants are different in cases where the restriction is to apply during the period after the termination of the contract than those in cases where it is to operate during the period of the contract."
The counsel for GBC contended that the above observation should be confined only to employment contracts, not to other contracts. The Supreme Court disagreed and found no rational basis to confine this principle to employment contracts only. It stated that the underlying principle governing contracts in restraint of trade is the same.
Finally, the Supreme Court held that the negative stipulation contained in paragraph 14 of the 1993 Agreement is valid, and it does not constitute restraint of trade under section 27 of the Act.
The legal position relating to post contractual covenants or restrictions has been settled by Indian courts. While construing section 27 of the Act, neither the test of reasonableness nor the restraint being partial is applicable, unless it falls within the express exception set out in section 277. In 1958, the 13th report of the Law Commission of India recommended that section 27 be suitably amended to allow restrictions, to the extent they are reasonable, in the interest of the parties as well as of the public. However, no action has been taken regarding this recommendation.
1. Oakes & Co. v Jackson, (1876) ILR 1 Mad 134
2. Bholanath Shankar Dar v Lachmi Narain, AIR 1931 all 83.
3. Law Commission of India, 13th Report, 1958
4. AIR 1995 SC 2372
5.AIR1995 SC 2372
6. AIR 1967 SC 1098
7. Percept D'Mark (India) (P) Ltd v Zaheer Khan AIR 2006 SC 3426
Originally published May 31, 2021
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.