The Legal Lock


Law Notes Law of Contracts

Agreement in restraint trade, sale of goodwill and power of exemption


A partnership is a form of business borne out of a formal agreement, where two or more persons agree to become co-owners, to manage and operate the business in order to share its profit and losses. The partners in a partnership can be organizations, individuals, schools, businesses, governments or combinations. Partnership is a result of a contract that is governed by Partnership Act. In India, we have a definite law which regulates the functioning of a partnership known as Indian Partnership Act, 1932. According to the section 4 of the Indian Partnership Act, 1932 “partnership is the relation between persons who have agreed to share the profits of a business arrived on by all or any of them acting for all”. 

Essential elements of a partnership 

The essential elements of a partnership are:

  1. There should an existing agreement 
  2. There should be 2 or more persons 
  3. A business motive
  4. Sharing of profits and losses
  5. Business should be carried on jointly or by any one of them acting on behalf of all.
  6. Every partner has an unlimited liability 
  7. Continuity

Exception under Indian Partnership Act, 1932

Section 54

Section 54 of the Indian Partnership Act states that-  “Partners may, upon or in anticipation of the firm’s dissolution, make an agreement that someor all of them will not carry out a business similar to that of the firm within specified local limits or within a specifiedperiod and notwithstanding anything contained in section 54 of the Indian Partnership Act, 1932.

This section is an exception to Section 27 of the Contracts Act of 1872 in its entirety. Section 27 of the Indian Contract Act states that- Every agreement prohibiting someone from engaging in a lawful profession, trade, or business of any type is void to that extent. The main reason behind this agreement of restraint is unfair as it impose a restriction on the personal choice and freedom of the contracting party.

 The following are the components of section 54 of Partnership act: 

a. Partners may; 

b. in anticipation of or after the firm’s dissolution; 

c. in an agreement not to carry on a business similar to the firm’s; 

d. within specified local limits or within a specified period . 

e. The limitations must be reasonable.

This section is a carbon copy of Section 27 of the Indian Contracts Act, 1872, which depicts the antiquity of hostility to all agreements in restraint of trade and nowhere depicts the current situation. As a result, this is an exemption to Section 27 as well.

• In case of Firm Daulat Ram vs. Firm Dharm Chand 

There were two ice factory owners who constituted an agreement, saying that only one factory will work at a time and it’s profits to be distributed among them. It was held to be justified.

Section 55

Section 55 of the Partnership Act talks about the sale of goodwill after dissolution. It states that when a firm’s accounts are settled after dissolution the goodwill is included in the assets, subject to a contract between the partners and it can be sold individually or along with other firm property.

Buyer and seller of goodwill have rights such as, where a firm’s goodwill is sold after dissolution, a partner may compete with buyer’s business and publicise it but he may not, 

  1. Use the firm name
  2. Show himself as carrying on the firm’s business
  3. solicit the custom of persons who were customers of the firm before the dissolution of the firm.

Any partner may make an agreement with the buyer upon the sale of firm’s goodwill that such partner will not carry out any business similar to that of the firm within a specified local limit, and such an agreement will be valid, notwithstanding anything contained on section 27 of the Indian Contract Act, 1872 if the restrictions imposed are reasonable.

• In case of CIT vs. B.C. Srinivasa Setty

that everything about the firm, including the owners’ personalities, the nature and character of the business, its name and reputation, its location, and its impact on the current market and socio-economic environment, has an impact on goodwill.

• In case of Churton vs. Douglas

‘Goodwill must mean every advantage-every positive advantage, if I may so express it as opposed to the negative advantage of the later partner not carrying on the business himself-that has been acquired by the old firm in carrying on its business, whether connected with the premises in which the business was previously carried on, or with any other matter carrying the benefit of business.

Section 56

By notification in the Official Gazette, the State Government of any State may direct that the provisions of this Chapter do not apply to that State or any part thereof indicated in the notification