What does the Non-Compete Clause in your Contract mean? PART 2

Introduction 

As explained in Part 1 of this Article, Section 28 of the Contracts Act 1950 provides that all restraint of trade or non-compete clauses are prima facie void unless they fall within any of the three exceptions provided therein. In this Article, we will first discuss the applicability of Exception 2 and 3 of section 28, followed by the nexus between restraint of trade and restriction of trade.
 
Exception 2: Partners may, upon or in anticipation of a dissolution of the partnership, agree that some or all of them will not carry on a business similar to that of the partnership within such local limits as are referred to in exception 1.
 
In simpler words, Exception 2 of section 28 provides that non-compete clauses / agreements that restrain a party from carrying out similar business upon dissolution of a partnership are valid, subject to certain qualifications.
 
The court in Wrigglesworth v Wilson Anthony [1964] 1 MLJ 269 propounded that for Exception 2 to be applicable, the partnership in question had to subsist before the execution of the non-compete agreement, and that such non-compete agreement was executed in anticipation of the dissolution of the partnership. Hashim J stated that:

“… I am of the opinion that exception 2 does not apply in this case as at the time of the execution of the agreement defendant was not then a partner of the plaintiff’s firm. The marginal note to exception 2 refers to agreement between partner prior to dissolution.”

The Court of Appeal in Nagadevan a/l Mahalingam v Millennium Medicare Services [2011] 4 MLJ 739 reiterated the above position and held that:

“It is apparent from the wordings thereof that the said exception only apply to an agreement made between partners, and that the same was made upon or in anticipation of the dissolution of the partnership. In the present case it is without doubt that the appellant was not even a partner of the firm at the time of the execution of the agreement … Since the appellant was not even a partner of the firm then, it cannot be said that the said agreement was made in anticipation of the dissolution thereof.”

Hence, the applicability of Exception 2 of section 28 depends on the following determining factors:

1. Whether the partnership in question existed before the execution of the non-compete clause / agreement; 
2. Whether the non-compete clause / agreement was executed in anticipation of the dissolution of said partnership; and
3. Whether the party involved was a partner at the time of the execution of the dissolution of said partnership.

Exception 3: Partners may agree that some one or all of them will not carry on any business, other than that of the partnership, during the continuance of the partnership.

Unlike Exception 1 and 2, Exception 3 provides that a non-compete clause / agreement shall be enforceable during the contractual period. 

This can be seen in Polygram Records Sdn Bhd v The Search & Anor [1994] 3 MLJ 127 where the court stated the following:

“An analysis of these cases indicates that the English courts have considered the doctrine of restraint of trade in two different circumstances: (a) restrictions which are imposed to apply after the expiration of the contract; and (b) restriction imposed during the currency of the contract …”.

The Court in agreeing with the circumstances considered by the English courtsfurther stated the following:

“… To otherwise hold that every contract which contains a covenant restricting a party from practising his trade or profession, both during the currency of the employment, and the post-employment period, as a contract in restraint of trade under s 28, would have far-reaching consequences on normal commercial contracts, such as the present one.”

Hence, for a non-compete clause / agreement to be valid and enforceable during the period of the contract, it has to fall within the ambit of Exception 3 of section 28, failing which, such non-compete clause / agreement shall be rendered void by virtue of section 28.

Restraint of Trade & Restriction of Trade

While it has been established that any non-compete clause / agreement will prima facie be rendered void by virtue of section 28 unless it falls under the ambit of theexceptions provided therein, the courts have also made it clear that not all clauses / agreements restricting the exercise of a trade will be deemed a restraint of trade clause. 

The court will first determine if the disputed clause / agreement therein is restraining a party’s trade or merely restricting the manner of the exercise of said trade. 
Thorne J in The Hua Khiow Steamship Co. Ltd v Chop Guan Hin [1930] 1 MC 175 held the following:

“… it is perhaps a little difficult to state in general terms the precise difference between a contract which restrains the exercise of trade, and a contract which limits the manner in which that trade shall be carried on … the Section does not apply to every contract made by a trader in the course of carrying on his business whereby he reduces his own power to contract … not every contract which hampers his own freedom of contract is necessarily a restraint upon the exercise by him of his trade within the meaning of this Section. He may trade even though by contract he has bound himself to trade in a particular manner.”

In the event a clause / agreement is merely restricting the manner of the exercise of a trade, such clause / agreement would not be rendered void under section 28.

Conclusion 

In a nutshell, a non-compete clause / agreement is generally void under section 28 of the Contracts Act 1950, unless the same falls under the ambit of the exceptions provided therein. 

However, prior to determining the applicability of section 28, the courts will first determine whether the clause / agreement in dispute is restraining the exercise of a trade or merely restricting the manner of how a trade is practised. 

Clauses / agreements that fall under the exceptions to section 28, or which merely restrict the manner in which that trade shall be carried on, will be enforceable and not be rendered void.