Draft Smart, Not Stifling: Reasonable Restrictive Covenants

1. INTRODUCTION

The march of civilisation has always been marked by the contest between freedom and restraint. History is replete with examples where human enterprise was shackled; whether through bonded labour, feudal obligations, or monopolistic privileges granted to a few. Over time, society recognised that progress demands liberty: liberty to think, to create, and to trade. The abolition of bonded labour was not merely a moral necessity but an economic one. It freed individuals to pursue livelihoods of their choice, and in turn, unleashed innovation and growth. At its core, a free society thrives on the principle that individuals must have the autonomy to determine how they use their skills and resources, subject only to reasonable limits imposed in the collective interest. This foundational value is directly implicated in the modern economy. If restraints on livelihood and trade were historically instruments of control, today they emerge in more nuanced, contractual forms. Investors, acquirers, and employers often seek to protect legitimate interests like goodwill, intellectual property, customer relationships, and confidential know-how. Yet, when such protection slips into overreach, it risks recreating the very fetters that the law and public policy once struggled to dismantle. The law therefore faces a timeless balancing act: how far should contractual freedom extend when it collides with individual freedom of trade?

The balance is found in Section 27 of the Indian Contract Act, 1872 ("ICA"). On its face, the provision adopts a sweeping prohibition stating that "every agreement restraining lawful trade is void", however it also carries with it a carefully crafted exception; where the goodwill of a business is sold, reasonable restrictions on competition may be sustained. This dual structure reflects the delicate balance between enabling commerce and safeguarding liberty. Contracts are vehicles of private autonomy, but that autonomy cannot override public policy.

Against this backdrop, Restrictive Covenants ("RC") emerge as one of the most debated contractual devices in transactions. RC are contractual guardrails that protect the legitimate interests of an investor, acquirer, or strategic partner by regulating the conduct of promoters, sellers, or key managerial personnel post-investment. Unlike operational covenants, RC are not designed to dictate how the business is run on a day-to-day basis. Instead, they ensure that the value paid for-be it customer relationships, proprietary know-how, or workforce loyalty is not undermined by competing activities, solicitation, or misuse of confidential information once the seller exits.

The enforceability of RC is not one size that fits all scenario; rather, it depends on the context in which they arise. Indian courts have consistently drawn a distinction between covenants in employment agreements and those embedded in acquisition transactions. In the employment context, RC are generally upheld during the subsistence of employment, as they are considered integral to the contract of service and not a restraint of trade. However, restrictions extending beyond the period of employment have typically been struck down on the ground that the right to livelihood must prevail over contractual promises. Conversely, in the acquisition context, courts have been more receptive to enforcing RC, particularly where they are closely tied to the transfer of goodwill. In such cases, restraints on the seller's ability to compete may survive beyond the duration of the transaction, provided they are confined within reasonable limits as to geography and scope, and are proportionate to the nature of the business being acquired.

2. COMMON TYPES OF RC

Importantly, RC's are not one-sided. Well-drafted RC represents a strategic compromise between the buyer's need for protection and the seller's right to pursue a business career. Following are the commonly included in RC:

1. A non-compete provision prevents the seller from setting up any business that directly competes with the target company for a specified period and geographic area.
2. A non-solicitation provision is aimed at protecting the company's human capital and customer relationships. The seller with the access to key employees and significant customer accounts, which could easily be diverted to a competitor or a new venture, compromising the buyer's commercial objectives underlying the acquisition.
3. A non-disclosure and confidentiality provision ensure that sensitive business information such as trade secrets, customer databases, strategic plans, and financial forecasts remains confidential and is not exploited for personal gain.

In the context of acquisition transactions, these RC acquire particular strategic significance. Unlike employment or franchise agreements, where they serve to protect immediate business interests, in acquisition transactions they safeguard the buyer's investment by preventing post-transaction competition that could dilute goodwill, destabilize customer relationships, erode the acquired business market position, or compromise its competitive advantage.. Properly structured, these covenants ensure that the strategic and financial objectives of the acquisition remain intact over the long term.

3. NAVIGATING ENFORCEABILITY CHALLENGES IN RC

While RC serve as vital instruments for protecting the buyer's post-acquisition investment, their enforceability remains one of the most debated aspects in India. Section 27 of the ICA starts from a position of prohibition, treating restraints on trade as void unless they fall within the narrow goodwill exception. Courts have thus taken on the role of striking a balance ensuring that contractual freedom and commercial necessity are respected, but without sanctioning restraints that would unduly restrict trade, practice of profession, innovation, or livelihood. It is against this backdrop that judicial precedents become critical. Through case law, courts have elaborated on the scope of Section 27 of ICA and when RCs can be enforced.

In the case of Niranjan Shankar Golikari v. The Century Spinning & Manufacturing Co. (MANU/SC/0364/1967, decided on January 17, 1967), the Hon'ble Supreme Court distinguished between RC operative during the period of a contract of employment and those applying after its termination. It held that covenants operative during the contract, where an employee is bound to serve exclusively, are generally not regarded as restraint of trade rather further the trade and protect commercial interest and therefore do not fall under Section 27 of the ICA, unless they are unconscionable, excessively harsh, unreasonable, or one-sided. This principle was reiterated in Taprogge Gesellschaft MBH v. IAEC India Ltd. (MANU/MH/0332/1988, decided on October 15, 1987), where the Bombay High Court held that a post-service restrictive covenant is absolutely void under Section 27 unless it falls within Exception 1 (sale of goodwill).

In a recent ruling reflecting present-day commercial dynamics, the Apex Court in Vijaya Bank & Anr. v. Prashant B. Narnaware(2025 INSC 691, decided on May 14, 2025), upheld a covenant requiring employees to serve a minimum of three years, backed by liquidated damages in case of premature resignation. The court held that such a stipulation did not amount to a restraint of trade under Section 27 of ICA, since it operated during the subsistence of employment and was directed at securing continuity rather than curbing future employability. Crucially, the court balanced commercial realities with individual rights, noting that public sector banks faced high costs and systemic delays in recruitment, and therefore had a legitimate interest in reducing attrition and preserving efficiency. At the same time, it emphasised that the clause did not render resignation illusory, as the employee in fact paid the amount and moved on. The judgment also reflects sensitivity to bargaining power unlike commercial contracts where parties negotiate on equal terms, employment agreements invite closer scrutiny. Here, the clause survived because it preserved continuity without foreclosing the employee's right to exit. The decision illustrates how courts calibrate RC to protect legitimate business interests while avoiding undue encroachment on personal liberty.

The case of Gujarat Bottling Co. Ltd. and Ors. Vs. Coca Cola Company and Ors. (MANU/SC/0472/1995, decided on August 4, 1995) involved a legal battle between two multinational soft drink corporations, Coca Cola and Pepsi, over a franchise agreement. The Hon'ble Supreme Court looked into the RC of the agreement which stated that GBC would "not manufacture, bottle, sell, deal or otherwise be concerned with the products, beverages of any other brands or trade marks/trade names during the subsistence of this Agreement including the period of one year's notice". The court highlighted the distinction between restraints operating during the subsistence of a contract and those applying after its termination. It reaffirmed the principle laid down in N.S. Golikari and Superintendence Company and extended the scope of this principle beyond employment contracts to other commercial contracts. The court reasoned that the restrictive stipulation in the agreement was intended for the advancement of trade by ensuring GBC's undivided loyalty in promoting Coca Cola products during the currency of the franchise agreement. Thus, the court concluded that the restrictive stipulation in the agreement was not in restraint of trade and did not attract the bar of Section 27 of the ICA.

A similar approach was adopted by the Delhi High Court ("DHC") in Wipro Ltd. v. Beckman Coulter International S.A. (MANU/DE/2671/2006, decided on July 11, 2006) wherein Wipro Limited (Petitioner) was the exclusive representative/distributor for Beckman Coulter International S.A. (Respondent) for 17 years in India. The concerned agreement included a 'non-solicitation of employees' clause which prohibited both parties for two years after termination from soliciting, inducing, or encouraging each other's employees to leave or join a competitor. The Respondent decided to begin direct operations in India and issued an advertisement giving a 'distinct advantage' to candidates with experience in handling Respondent's products. The Petitioner alleged this advertisement was a violation of the non-solicitation clause and sought an injunction to prevent Beckman Coulter from employing its former employees and claimed damages. The core issue dealt by the DHC was whether the post-termination 'non-solicitation of employees' clause was valid and enforceable or void under Section 27 of the ICA. The court held that the non-solicitation clause, being a restriction placed upon the contracting parties (Wipro and Beckman Coulter) and not directly on the employees, did not amount to a restraint of trade, business, or profession and was not hit by Section 27 of the ICA as being void. The court also distinguished the employer-employee contracts from contracts between principals and distributors as the latter ones are viewed more liberally due to a greater equality in bargaining power. The clause was held to be valid as it prohibited enticing employees but did not restrict employees from seeking new employment on their own or responding to general advertisements.

One of the landmark cases which examined the scope of Section 27 in acquisition transaction isAffle Holdings Pte Limited vs. Saurabh Singh and Others (MANU/DE/0152/2015, decided on January 22, 2015). The core issues in this case were regarding the enforceability of a post-termination non-compete clause restraining the promoter of the target company from engaging in a business similar to that of the target company for 36 months after the 'completion date' pursuant to a share purchase agreement (SPA), following the acquisition of a business, and whether it falls under Section 27 of the ICA, specifically its exception 1 (sale of goodwill). The DHC found that while a negative covenant in an employment contract prohibiting competitive business post-termination is generally void under Section 27, however the case at hand was different in the following manner:

1. The non-compete obligation stemmed from the SPA, which was an agreement for the sale of an entire business and its goodwill. Given the substantial consideration paid for acquiring target company's business and goodwill, the court held that the case fell within exception 1 to Section 27 of the ICA; and
2. The prohibition on the promoter of the target company from indulging in competitive business was considered "reasonable both in time and space" (36 months after the completion date) and therefore was not held to be in restraint of trade, void, or illegal.

Another judgment that examined the scope of Section 27 of the ICA was by the DHC in the case of Arvind Singh and Another vs. Lal Pathlabs Private Limited and Others (MANU/DE/0936/2015, decided on March 26, 2015). In this case, the Respondent, i.e., Lal Pathlabs Private Limited had acquired 100% of the shareholding of M/s. Amolak Diagnostics Private Limited and its goodwill from the Appellants i.e., Dr. Arvind Singh and another, pursuant to which the Appellants were restricted, under a provision in the share purchase agreement, from engaging in any business that was in competition with the respondent. A single bench of DHC held that such a clause was enforceable and passed an injunction order restraining the Appellants from practicing as radiologists or pathologists in the city of Udaipur, India for a period of 5 years. This decision was reversed by the double bench of DHC subsequently on the premise that the activity of a profession is not akin to that of the business of Respondent and will therefore not fall within the exception under Section 27 of the ICA. Having said that, the court did succinctly note that the Appellants will not be able to "overtly or covertly carry on a business of running a Pathlab or an X-ray Diagnostic Centre by forming a venture where the organizational structure has the essential attributes of a business".

Further in the case of Ozone Spa Private Limited Vs. Pure Fitness and Ors. (MANU/DE/2182/2015, decided on July 29, 2015), the parties entered a 12-year franchise agreement with Ozone Spa (Plaintiff) to operate a gymnasium and spa under 'Ozone Fitness n Spa'. The agreement included RC prohibiting competing businesses during and for three years after the term. The Plaintiff discovered that defendants 1 and 2 were promoting 'Hair Masters Salon' on the Plaintiff's official Facebook page and had incorporated Hair Masters Salon Pvt. Ltd. to operate a competing salon in the same neighborhood. The Plaintiff alleged breach of contract, confidentiality, trademark infringement, unfair competition, including using Plaintiff's know-how and poaching staff. The Plaintiff sought an interim injunction. The defendants argued the franchise agreement did not cover salon services and that the Plaintiff misrepresented facts. The core issue was whether the RC prohibiting competing businesses were enforceable during the subsistence of the contract. The DHC found that the salon business was included within the ambit of the franchised business and reiterated that the RC operative during the subsistence of a commercial contract are generally not regarded as restraint of trade under Section 27 unless unconscionable or wholly one-sided. These covenants are designed to fulfill the contract. Therefore, the non-compete clauses in this case were enforceable during the contractual term. The DHC issued an interim injunction restraining the defendants from operating competing businesses under 'Hairmasters' or any other name within the designated franchise territory or within 4 km of any of the Plaintiff's or its franchisees' locations. This geographic limitation was imposed to ensure the restriction was fair, just, and reasonable, and not overly harsh on the defendants.

Taken together, these judicial precedents reveal a clear pattern: Indian courts are not opposed to RC per se, but they demand that such restrictions strike a fair balance between protecting the buyer's commercial interests and preserving economic freedom. The line of reasoning from employment contracts to commercial distribution and franchise agreements and finally to acquisition transactions demonstrates that enforceability turns not on the label of the covenant, but on its substance, proportionality, and the context in which it operates.

At the same time, the Supreme Court in Percept D'Mark (India) (P) Ltd. v. Zaheer Khan & Anr. (2006 4 SCC 227, decided on March 22, 2006) underscored the limits of enforceability. A post-contractual covenant restraining Zaheer Khan from endorsing competing brands was held void under Section 27 of ICA, reaffirming that restraints extending beyond the subsistence of a contract are impermissible unless they fall within the exception. Importantly, however, the Apex Court clarified that while injunctive relief was unavailable, the aggrieved party could still pursue damages for breach of contract. This holding illustrates that even when RC fail the enforceability test, remedies may yet survive provided parties draft their agreements with severability and damages provisions in mind.

Courts will not countenance fetters on future trade or livelihood, but they will hold parties accountable for promises made and broken within the contractual framework. This naturally leads to the next critical question: what makes a RC "reasonable" in the eyes of the courts?

4. THE ART OF BALANCE: STRUCTURING RC FOR REASONABLENESS AND ENFORCEMENT

As acquisition transactions continue to rise in both scale and sophistication, the reasonableness factors applied by Indian courts depends on careful structuring of the RC. In FLSmidth Pvt. Ltd. v. Secan Invescast (India) Pvt. Ltd. (2013 1 CTC 886, decided on February 1, 2013), the High Court of Madras while analysing the scope of Section 27 of ICA emphasized that restrictions may be valid when reasonable, particularly where they relate to distance, time limits, trade secrets, or goodwill. In recent years, the pattern of judicial analysis has increasingly focused on the necessity of the restriction to protect legitimate business interests. Factors that court typically examine when determining the reasonableness of RC include:

1. Enforceability hinges on basic contract validity: At a broader level, the enforceability of RC cannot be viewed in isolation. The general conditions for enforcement of contracts under the ICA apply with equal force. Section 10 requires valid consideration and lawful objects, while Section 23 renders agreements void if their object is unlawful, opposed to public policy, or otherwise prohibited by law. Similarly, Section 29 invalidates agreements that are uncertain or vague. A RC embedded in acquisition related agreement will not gain legitimacy if it fails these basic tests. A covenant that overreaches, violates public policy by stifling lawful trade, or is drafted with oppressive or unconscionable reasoning for example, exploiting unequal bargaining power to impose disproportionate restraints risks being struck down by the courts.
2. One-sided restraints risk being struck down: The enforceability of RCs depends on the realities of the transaction, the specific business acquired, and the proportionality of the restriction. Equally, one-sided restrictions that disproportionately favor the buyer without regard to the seller's ability to earn a livelihood risk being struck down as unreasonable. For instance, a clause restraining a seller from engaging in 'any business whatsoever' regardless of its connection to the acquired company would be unenforceable.
3. Duration must be proportionate and justifiable: Courts are cautious with post-termination restrictions. While restraints during the subsistence of a contract are often enforceable, any covenant extending beyond termination is likely to be struck down unless it is tied to the sale of goodwill. Even within that exception, the duration must not be excessive; it should reflect industry standards and the period reasonable necessary to safeguard the buyer's stability, integration, and investment. Time limits that align with industry standards and safeguard post-deal stability are more likely to withstand challenge. For example, in Taprogge Gesellschaft MBH (supra) the court recognized recognized that a reasonable post-transaction non-compete was justified to protect proprietary technology.
4. Geographic limits must mirror commercial reality: The territorial reach of a RC does not rescue a post-contract restraint from the prohibition under Section 27; even a narrowly drawn non-compete is void unless it falls within the exception. However, where a covenant operates during the subsistence of an agreement, courts are more receptive if the restraint is confined to the genuine business footprint of the enterprise. A clause restricting competition within the markets where the company actually operates is far more defensible than one extending across regions with no commercial connection. Overly expansive territorial coverage signals overreach and undermines enforceability, whereas tailoring the geography to real commercial presence demonstrates proportionality and purpose.
5. Scope of activities should target direct competition: Restrictions should be limited to activities that would directly compete with the investee business during the subsistence of the agreement. Broad formulations ("any similar business") risk challenge. For example, in Ozone Spa Pvt. Ltd. v. Pure Fitness & Ors. (supra) an interim injunction was issued by the court restraining the defendants from operating competing businesses under "Hairmasters" or any other name within the designated franchise territory or within 4 km of any of the plaintiff's or its franchisees' locations.
6. Protection must tie to legitimate business interests: Courts recognise protection of trade secrets, confidential information, and goodwill as legitimate aims during the life of a contract. Post-termination, such protection must be addressed via confidentiality obligations (which survive termination), assignment of IP, or goodwill-linked covenants.

5. NEGOTIATION AND DRAFTING OF RC: GUIDING PRINCIPLES

In M&A transactions, drafting and negotiating RC is a balancing act. On one hand, buyers seek to protect their investment, goodwill, and intellectual property, while sellers require commercial flexibility and a fair opportunity to pursue future ventures. Given the restrictive landscape under Indian law, where covenants that extend beyond the agreement's term face enforceability challenges, lawyers must be especially careful in structuring these clauses. Here are critical drafting strategies to navigate these complexities:

1. Tie Restrictions to Contract Term: RC must be limited to the term of the agreement.
2. Link Post-Termination Covenants to Goodwill or Exit Events: For post-termination restrictions (especially non-compete covenants), these must be linked to sale of goodwill or tied to exit events like a share sale or asset transfer. Covenants where the restriction relates directly to the value being transferred have higher chance of being enforced by the courts.
3. Focus on Confidentiality Instead of Post-Termination Non-Compete: A confidentiality clause can act as an alternative to a non-compete clause by addressing some of the same concerns related to protecting the company's business interests, without imposing restrictions on an individual's future employment or business activities. While a non-compete, clause restricts the seller from engaging in similar business activities (or competing with the company) for a defined period and within a certain geographical scope, a confidentiality clause focuses on protecting sensitive information and intellectual property, thus offering a different but equally effective form of protection. Confidentiality Clause ensures that sensitive business information, such as trade secrets, customer lists, marketing strategies, and financial data, remains protected even after the termination of the relationship or agreement.
4. Define Scope with Precision: Overly broad or vague RC are more likely to be challenged. The restriction should be confined to activities that directly endanger the acquired business such as soliciting existing customers or exploiting confidential data rather than a blanket ban on 'any similar business.' For example, a covenant preventing a seller from using the company's client list is far more defensible than one barring the seller from entering an entire industry. Precision shows the clause protects investment value rather than suppressing fair competition.
5. Cross-Border Considerations: For deals with international components, the Indian legal framework may not be the only one at play. Indian law alone cannot determine enforceability where foreign parties, assets, or governing laws are involved. Attention must be paid to conflict of law rules, choice of governing law, and the forum for dispute resolution. To mitigate risk, parties often rely on arbitration clauses seated outside India or structure covenants to comply with the enforceability standards of the most relevant jurisdictions.
6. Mitigate Risks of Unenforceability: Liquidated damages clauses may be incorporated to incentivize compliance with the RC. These clauses offer a financial remedy in the event of a breach, which may provide additional protection when direct enforcement of the covenant is uncertain. Furthermore, including severability clauses ensures that if a particular RC is found unenforceable, the remainder of the agreement stands, protecting the integrity of the contract.

Severability clauses may also be incorporates as in Percept D'Mark (India) Pvt. Ltd. v. Zaheer Khan (Supra), the Supreme Court observed that even if a particular RC is found void for being in restraint of trade, the remainder of the agreement continues to bind the parties. This ensures that contractual remedies, such as damages for breach, remain available without enforcing an impermissible restraint. Drafting RC with clear severability provisions thus allows parties to safeguard their interests while respecting legal and public policy limits.

6. CONCLUSION

While the enforceability of RC in acquisition transactions in India remains a matter of judicial balancing between commercial interests and public policy, prudent drafting and careful structuring can ensure their enforceability and protect buyer's investment in an economy shaped by global capital flows and increasingly complex deal structures. RC in acquisition transactions are not mere boilerplate clauses but delicate instruments of deal protection. Drafted with foresight, they preserve goodwill, protect confidential know-how, and provide the acquirer with a breathing space to consolidate its investment. Drafted poorly, they risk being struck down as overbroad, one-sided, or contrary to public policy, leaving the buyer exposed and the transaction value eroded.

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.