Non-Compete Clauses – An Unenforceable Restrictive Covenant?

The modern business ecosystem thrives on innovation, competition, and the constant pursuit of market dominance. Globally, organisations while entering into contracts, often include restrictive covenants in such contracts, including non-compete clauses, to safeguard the organisation's commercial interests. A standard non-compete clause is designed to prohibit individuals such as employees, business associates and partners, promoters, founders, and even customers/ clients from engaging in competing activities, which may cause monetary loss or loss of opportunity. Typically, non-compete clauses specify the duration of the non-compete restrictions, the geographic area, and the scope.

Non-compete clauses continue to find their way into contracts across industries in India, even though the legal enforceability of such a clause is fraught with challenges. Historically, Indian courts have interpreted non-compete and restrictive provisions strictly, emphasizing that the freedom to trade is a fundamental right protected under Article 19(1)(g) of the Indian Constitution. Furthermore, Section 27 of the Indian Contracts Act, 1872 ("Act") renders the enforceability of restrictive covenants, which restrain an individual from practicing in a lawful profession, trade, or business, as void, subject to limited exceptions.

Recently, the Delhi High Court's ("Court") judgment in Las Ground Force Private Limited and anr. v. Goldair Handling SA (O.M.P.(I) (COMM.) 385/2024 & I.A. 45364/2024) provided an insight into the manner in which the Court analyses such a restrictive covenant, especially if the same is not drafted to convey the specific objectives of the parties involved.

The case involved applications filed under Section 9 of the Arbitration and Conciliation Act, 1996, by Las Ground Force Private Limited ("Petitioner No. 1") and its Special Purpose Vehicle ("SPV") ("Petitioner No. 2") (hereinafter collectively referred to as the "Petitioners"), seeking to restrain Goldair Handling SA ("Respondent") from participating in tenders for ground handling services at Ranchi and Vijayawada airports, initiated by the Airport Authority of India ("AAI").

The dispute arose from shareholders' agreements executed between Petitioner No. 1 and the Respondent to establish SPVs to provide ground handling services at Bagdogra and Udaipur airports. These agreements contained a non-compete clause, specifically Clause 14, which prohibited the parties from engaging in competing businesses during the subsistence of the agreements. Additionally, Petitioner No. 1 and the Respondent had entered into an exclusivity agreement, barring both from participating in similar business ventures without mutual consent during the term of the contract. While the exclusivity agreement was later terminated, the shareholders' agreements for Bagdogra and Udaipur airports continued to subsist.

The Petitioners contended that the non-compete obligations mentioned in Clause 14 of the shareholders' agreements extended beyond the Bagdogra and the Udaipur airports and could be enforced to restrict the Respondent from participating in tenders for providing ground handling services at other AAI-managed airports. The Petitioners also argued that the restrictive covenants within the shareholders' agreements were reasonable and enforceable during the term of the contract. Despite the termination of the separate exclusivity agreement, the Petitioners maintained that the non-compete clause in the shareholders' agreements continued to bind Petitioner No. 1 and the Respondent.

The Respondent countered the claims of the Petitioners by highlighting that the shareholders' agreements were specific to the Bagdogra and the Udaipur airports and had a limited scope. According to the Respondent, the definition of the terms "Business" and "Airport" within the shareholders' agreements meant the Bagdogra and Udaipur airports and clearly restricted the application of the shareholders' agreements to these airports. The Respondent also argued that the termination of the exclusivity agreement rendered any broader non-compete obligations unenforceable. Furthermore, it was highlighted that the concession agreements, which were subsequently executed between Petitioner No. 2 and AAI for the Bagdogra and the Udaipur airports, were non-exclusive, which allowed AAI to potentially enter into a contract with the Respondent for providing services at other the airports. Lastly, it was submitted that a broader interpretation of Clause 14 would unlawfully restrain the Respondent's right to trade, which would be in violation of Section 27 of the Act.

The Court noted that the shareholders' agreements and the terminated exclusivity agreement were explicitly linked to the Bagdogra and the Udaipur airports, and there was no prima facie case to extend Clause 14 to other airports. The Court emphasized that the agreements were created for specific purposes, with respect to specific airports. Additionally, the concession agreements between AAI and the parties were non-exclusive, reinforcing the Respondent's right to individually participate in tenders issued by AAI.

Keeping the above in mind, while assessing the balance of convenience and irreparable loss, the Court ruled in favor of the Respondent. It was held that denying the Respondent the opportunity to bid for other tenders would cause irreparable harm, whereas any potential harm to the petitioners could be compensated through damages, if proven. While the Court declined to address whether Clause 14 violated Section 27 of the Act, deferring this issue to the arbitral tribunal which had already been constituted to adjudicate the dispute, it was observed that granting the relief sought by the Petitioners would stifle competition and contravene the non-exclusive nature of the concession agreements with AAI.

The Las Ground Force judgment demonstrates how Indian courts evaluate the balance of convenience and irreparable loss in disputes concerning restrictive covenants, such as non-compete clauses. The case also demonstrates the need for careful drafting, alignment of contractual obligations, and contingency planning for restrictive covenants.

A critical misstep on part of the Petitioners was allowing the exclusivity agreement to be terminated while relying solely on Clause 14 of the shareholders' agreements. Having an exclusivity agreement in force could have significantly strengthened the Petitioners' argument for the enforcement of the non-compete clause. Furthermore, by ensuring that all subsequent agreements, such as the concession agreements with AAI, were aligned in scope and intent to protect against competing business activities, the Petitioners' arguments could have been better substantiated.

Another issue highlighted by this judgment is the impact that vague and inconsistent language in an agreement can have on the interests of a party. Clause 14 of the shareholders' agreements was linked with specific airports (Bagdogra and Udaipur) and lacked clarity on whether its scope extended beyond those locations. A more elaborate non-compete clause, explicitly defining the term of the non-compete, geographical and business scope, could have mitigated ambiguities.

While entering into contracts which include non-compete obligations, it is advisable to also anticipate the potential unenforceability of the non-compete clause and to include alternative mechanisms, such as robust non-solicitation and confidentiality clauses or revenue-sharing arrangements, which are less likely to be invalidated under Section 27 of the Act or scrutinised by Indian courts. As businesses continue to navigate the complexities of restrictive covenants, proactive legal strategies and alignment of contractual objectives are critical in safeguarding commercial interests.

About the authors: Vrinda Patodia is a Partner and Aakanksha Singh is an Associate at Obhan & Associates.

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