On 17 October 2024, the Bombay High Court had the occasion to pronounce on the validity of a post termination non-compete clause in a commercial contract and whether it could be relied upon to grant an injunction in support of an arbitration under s. 9 of the Arbitration & Conciliation Act, 1996. The Court evaluated the effect of a non-compete clause operating post termination of the agreement as a pure question of law. After an extensive evaluation of the provisions of s. 27 of the Indian Contract Act 1872 and the case law of the Supreme Court, it held that no such injunction could have been granted because restrictive covenants post termination are unenforceable in law and have no commercial justification.
Indus Power Tech Inc. (“Indus”/ “Appellant”) entered into a Master Supply Agreement (“MSA”) with Echjay Industries Private Limited on 31 March 2015 (“Echjay”/ “Respondent”). Under the MSA, Echjay was required to supply materials to Indus, which was in business of supplying engineering products to various North American manufacturers.
On 27 January 2023, Echjay served a notice for termination of the MSA upon Indus. Thereafter, Echjay filed Commercial Arbitration Petition (L) No.16800 of 2023 before a Single Judge Bench of the Bombay High Court seeking to restrain Indus from sourcing engineering components from an Indian entity, in accordance with clause 3 of the MSA.
The relevant clauses of the MSA are reproduced as under –
“3. Non-compete/Non-solicitation:
The Supplier agrees that the Company shall have exclusive rights to deal with all customers or clients introduced to it by the Company (hereinafter referred to as “Customers”) from within the geographical boundaries of United States of America, Canada and Mexico (hereinafter “Territory”). Current list of such Customers is detailed in Annexure-I and all transactions with the Customers in the Territory shall be through and shall accrue to the benefit of the Company. During the term of this Agreement and for a period of twenty-four (24) months after termination of this Agreement for any reason, the Supplier shall not sell or solicit business from, or conduct business with the Customers. Similarly, the Company will also not source forgings from any other forging Company from India unless pursuant to Supplier’s refusal to quote or supply such items.”
“15. Termination for Cause:
Either party may terminate this Agreement prior to the expiration of the initial or any renewal term of this Agreement only for “cause” upon one hundred eighty (180) days’ prior written notice to the other Party setting forth the breach complained of.”
The Single Judge found that there was sufficient evidence that Indus sourced products from an Indian entity on the basis of which the Court granted an injunction vide judgement dated 8 August 2023 (“Impugned Judgement”) in favour of Echjay restraining Indus from sourcing engineering components from any other supplier.
Thereafter, upon being dissatisfied by the Impugned Judgement of the learned Single Judge, Indus filed an appeal under Section 37 of the Arbitration & Conciliation Act, 1996 before the Division Bench of the Bombay High Court.
Whether Clause 3 of the MSA, which is a non-compete clause can operate beyond the termination of the MSA?
Section 27 of the Indian Contract Act, 1872 –
“Section 27: Agreement in restraint of trade void: Every agreement by which anyone 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 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.”
A. Primary Contentions of Indus:
It was contended by Indus that Clause 3 of the MSA would only be operative during the subsistence of the MSA and it will not be operative beyond the termination of the MSA. Upon issuance of the notice of termination on 27 January 2023, the MSA ceased to be operative on 28 July 2023 i.e., after a period of 180 days in terms of Clause 15 of the MSA.
It was further contended that Clause 3 would be in contravention of Section 27 of the Indian Contract Act, 1872 as it unlawfully restrained Indus from pursuing lawful trade.
It was also submitted that the plea concerning the validity of Clause 3 can be adjudicated by the High Court in appellate proceedings as it was a pure question of law as per Rajendra Shankar Shukla v. State of Chattisgarh,[1] and no factual adjudication is requisite for consideration of the issue.
B. Primary Contentions of Echjay:
It was contended on behalf of Echjay that since the contention regarding the voidness of Clause 3 of the MSA had not been taken in the proceedings prior, Indus should not be permitted to raise the said contention in appellate proceedings. Thus, the Court could not consider the issue.
It was further contended that the despite the expiration of 180 days in terms of Clause 15, Indus and Echjay had taken up several purchase orders. This displayed that despite the termination of the MSA, the parties continued to have business relations with each other, which was contrary to the stance taken by Indus.
It was also stated that in absence of perversity and arbitrariness by the judge, there is no reason for the Court to interfere with the Impugned Order.
After considering the submissions, in relation to the issue at hand, the Court relied on Mohali Area Development Authority & Ors. v. Manju Jain & Ors.,[2] wherein it was stated that “It is settled legal proposition that pure question of law can be raised at any time of the proceedings but a question of fact which requires investigation and inquiry, and for which no factual foundation has been laid by a party before the court or tribunal below, cannot be allowed to be agitated in the writ petition.”
The Court also relied on National Textile Corporation Ltd. v. Naresh Kumar Badrikumar Jagad,[3] wherein it was propounded that “a new ground raising a pure legal issue for which no inquiry/proof is required can be permitted to be raised by the court at any stage of the proceedings.”
Thus, the Court stated that if a question of law is to be raised in appellate proceedings, it can be done notwithstanding the fact that the plea was not raised before the Single Judge. Hence, the Court held that the issue raised in the appeal could be considered.
With regard to operation of Clause 3 of the MSA, the Court noted that there is a difference in the implementation of Clause 3 during the subsistence of the MSA, and after the subsistence of the MSA. The Court stated that the operation of a non-compete clause such as Clause 3 is valid when the MSA is in effect, however, it can be deemed to be a restraint on the parties after the termination of the MSA. The Court placed reliance on the case of VFS Global Services Pvt. Ltd v. Suprit Roy,[4] wherein it was observed by the Apex Court that the restraints beyond the termination of the agreement amount to an unlawful restraint of trade.
Further, in the case of Superintendence Co. v. Krishan Murgai,[5] it was upheld that the doctrine of restraint of trade never applied during the continuance of a contract of employment; it applies only when the contract comes to an end.
Therefore, the Court held that Indus cannot be restrained from undertaking business pursuant to the termination of the MSA. The injunction was set aside.
Clauses akin to section 3 of the MSA are legion in every day commercial contracts. In fact, willingness to agree to such a term is one of the most important considerations for entering into many contracts in the first place. While broadly worded restraints of trade clearly ought to be unenforceable in law- as they have been under the common law for several hundred years- the doctrine ought not to be used as a blunt tool to render unenforceable terms that are often keenly negotiated and are commercially justifiable.
Courts ought to carefully examine such clauses and consider upholding as reasonable those where restrictions are limited in time and in geography, as well as those where consideration has been exchanged in return for a robust non-compete.
The Contract Act was enacted in 1872 and has largely stood the test of time. However, multiple provisions- particularly those in relation to what may be termed as “restraint of trade”, or for that matter damages, ought to be tweaked in order to better reflect commercial reality. Ironically, on this position, uncodified English common law has taken a much more sensible approach in recent years. However, bound by the strict words of statute, we are unable to take advantage of the same.
This judgement, based as it is purely on the law and without looking at facts, risks overstating a principle of public policy. There are plenty of reasons why short term, carefully calibrated clauses ought not to be rendered unenforceable under s. 27 of the Contract Act. Both the legislature and the courts ought to consider the future of “restraint of trade” dispassionately and in the light of modern commercial reality. Strict enforcement of carefully negotiated contract terms between parties that are not substantially unequal in bargaining power is in furtherance of trade and not restraint thereof.
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[1] 2015 INSC 532.
[2] (2010) 9 SCC 157.
[3] (2011) 12 SCC 695.
[4] 2008 (3) Mh. L. J. 266.
[5] (1981) 2 SCC 246.
© 2024 Chandhiok & Mahajan, Advocates and Solicitors
This alert is for information purposes only and does not constitute legal advice.
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