Post-Termination Restrictive Covenants In Employment Contracts Are Void U/S 27 Of Contract Act: Delhi High Court

The Delhi High Court bench of Justice Jasmeet Singh has held that post-service restrictive covenants in employment contracts, which operate after cessation of employment, are void and are not enforceable under Section 27 of the Indian Contract Act, 1872 (“Contract Act”) and violate Article 19(1)(g) of the Constitution. The court vacated the injunction granted in an application under section 9 of the Arbitration and Conciliation Act, 1996 (“Arbitration Act”), which restrained the Respondents from engaging in a competing business post-termination of their employment agreements. Brief Facts Neosky India Limited (“Petitioner No. 1”) is a public limited company and a subsidiary of Rattan India Enterprises Ltd.. Throttle Aerospace Systems Private Limited (“TAS”/ “Petitioner No. 2”), is a private limited company in the space of civil drones in which Petitioner No. 1 has invested. Respondent Nos. 1–4 were employed with TAS and collectively hold 40% shareholding. On 25.05.2022, the petitioners executed a Share Subscription and Shareholders Agreement (“SSHA”), a Non-Compete Agreement (“NCA”) and Employment Agreements with Respondent Nos. 1-5. The transaction involved a proposed infusion of ₹40 crores, whereby Petitioner No. 1 was to acquire 60% equity in Petitioner No. 2. Petitioner No. 1 infused ₹20 crores upfront; the balance ₹20 crores was to be infused after 18 months. Clause 13.7 of the SSHA required Respondent Nos. 1–5 to serve for five years and refrain from engaging in competing businesses. The NCA prohibited them from engaging in competing businesses for three years during the term of the agreement and for one year after its expiry. On 03.07.2023, Respondent Nos. 1–3 resigned and allegedly incorporated Zulu Defence Systems Pvt. Ltd. (“Respondent No. 6”) on 06.10.2023 to run a competing drone venture. They appointed Respondent Nos. 7 and 8 as directors. The petitioners allege this act breached the non-compete obligations. The petitioners filed a petition under section 9 of the Arbitration Act. The Court restrained Respondent nos. 1-4 from competing with or disclosing information related to the petitioners in its order dated 31.05.2024. The petitioners also filed a contempt petition alleging wilful disobedience of this interim order. On 18.07.2024, the petitioners issued a notice invoking arbitration under the SSHA and NCA. The respondents failed to appoint an arbitrator within 30 days. Consequently, the petitioners filed the petition under Sections 11(4) and 11(6) of Arbitration Act seeking appointment of an arbitrator. Submissions Tanmaya Mehta, counsel for the petitioners, submitted that respondent No. 1 incorporated Respondent No. 6 to operate a directly competing drone manufacturing business in breach of the SSHA, Employment Agreements and NCA. He submitted that the breaches give rise to substantive disputes within the scope of the arbitration clauses. He pointed out that respondent Nos. 1–5 did not dispute the existence of these clauses. Mr. Mehta argued that objections to validity or enforceability of the non-compete clause must be decided by the arbitral tribunal under Section 16. He went on to submit whether non-signatories are bound by the arbitration clause is for the tribunal to decide. He submitted that respondents have facilitated the continuing breach and therefore prayed that respondent Nos. 6-8 be referred to arbitration along with respondent Nos. 1-5. J. Sai Deepak, senior counsel for Respondents, argued that the interim order should be vacated because the non-compete clause lapsed on 25.05.2025. He argued that the restraint is a post-service non-compete restriction which is void per section 27 of Contract Act and violative of Arts. 19(1)(g) and 21. Without opposing reference to arbitration, he objected to being forced into arbitration while bound by an invalid interim order. Venkatesh Kumar, counsel for respondent nos. 4-5 submitted that no dispute or breach is alleged against these respondents; they are impleaded only because they signed the agreements. He argued that they should not be compelled to arbitrate in the absence of disputes against them. Counsel for respondent nos. 6–8 submitted that no arbitration agreement existed between them and the petitioners as they are not signatories to the SSHA or NCA. He contended that Zulu Defence Systems Pvt. Ltd. operates in a different domain, i.e. tactical and kamikaze drones for military unlike TAS's civil drone business. He stated that respondent nos. 1 and 3 resigned on 03.07.2024 and fully divested their shares. He argued that mere past association with respondent No. 6 is not sufficient to bind them to arbitration; impleading them would amount to misuse of the arbitration process. Observations On Existence of a Valid and Enforceable Arbitration Agreement The court observed that the scope of inquiry under Section 11 of the...

Post-Termination Restrictive Covenants In Employment Contracts Are Void U/S 27 Of Contract Act: Delhi High Court

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Post-Termination Restrictive Covenants In Employment Contracts Are Void U/S 27 Of Contract Act: Delhi High Court

Tazeen Ahmed

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