Non-Compete Clause Post-Agreement Termination Prima Facie Void Under S.27 Contract Act: Bombay High Court in S.37 Arbitration Act Appeal - 2025-06-02

Bombay High Court: Non-Compete Clause Unenforceable Post-Agreement Termination, Violates Section 27 of Contract Act

Mumbai, Maharashtra – The Bombay High Court, in a significant ruling, has held that a non-compete clause in an agreement, to the extent it operates beyond the termination of the said agreement, is prima facie a restraint of trade and therefore void under Section 27 of the Indian Contract Act, 1872. Justice A.S. Chandurkar , delivering the judgment for the Bench, set aside a Single Judge's order that had granted an injunction based on such a post-termination non-compete clause. The appeal was filed under Section 37 of the Arbitration & Conciliation Act, 1996.

The Court allowed a new plea challenging the validity of the clause to be raised at the appellate stage, deeming it a pure question of law.

Background of the Dispute

The dispute arose from a Master Supply Agreement (MSA) dated March 31, 2015, between Indus Powertech Inc ("the Company," appellant) and Echjay Industries Private Limited ("the Supplier ," respondent). Under the MSA, the Supplier was to provide various products to the Company, which specialized in supplying engineering components to North American manufacturers.

Clause 3 of the MSA contained a non-compete/non-solicitation provision. It stipulated that during the MSA's term and for 24 months post-termination, the Supplier would not deal with customers introduced by the Company in the USA, Canada, and Mexico. Reciprocally , the Company agreed not to source forgings from any other Indian forging company unless the Supplier refused to quote or supply.

On January 27, 2023, the Supplier terminated the MSA for "cause" under Clause 15, with a 180-day notice period (expiring July 28, 2023). Subsequently, on June 21, 2023, the Supplier filed an application under Section 9 of the Arbitration Act, seeking to injunct the Company from sourcing forgings from another Indian entity, RKFL, citing Clause 3 of the MSA.

The learned Single Judge, on August 8, 2023, granted the injunction, finding that the Company had sourced parts from RKFL in breach of Clause 3, as there was no basis to hold that the Supplier had failed to supply.

Appellant's Contentions: Post-Termination Restraint Unlawful

Before the Division Bench, Mr. Ravi Kadam, Senior Advocate for the Company, argued primarily that: 1. Clause 3 of the MSA, being a non-compete clause, could not operate post-termination of the agreement (i.e., after July 28, 2023). 2. Enforcing such a clause post-termination would constitute a restraint of trade, making it void under Section 27 of the Indian Contract Act, 1872. 3. This plea, though not raised before the Single Judge, was a pure question of law based on the MSA's interpretation and could be raised in appeal, relying on precedents like Rajendra Shankar Shukla & Ors vs. State of Chattisgarh & Ors .

Respondent's Counter-Arguments: New Plea Impermissible

Mr. Sharan Jagtiani, Senior Advocate for the Supplier , contended that: 1. The Company should not be permitted to raise the plea of voidness of Clause 3 for the first time in appeal. 2. The parties continued business even after the termination notice, and the Company's conduct before the Single Judge was contrary to its new stand. 3. The injunction was correctly granted, and Clause 3 did not amount to an unlawful restraint of trade, citing Wipro Ltd vs. Beckman Coulter International S.A.

Court's Analysis: New Plea Admissible, Non-Compete Void Post-Termination

Admissibility of New Plea: The High Court extensively reviewed jurisprudence on raising new legal pleas at the appellate stage. Citing the Supreme Court in Rajendra Shankar Shukla & Ors and National Textile Corporation Ltd. v. Naresh Kumar Badrikumar Jagad , the Bench observed:

"The aforesaid would indicate that if a question of law is sought to be raised based on the construction of a document or on the basis of admitted facts, it would be open for the appellate Court to consider the same notwithstanding the fact that said aspect was not raised in the Court of first instance."

The Court found that determining the legal effect of Clause 3 post-termination was a "purely a legal issue not requiring any factual adjudication," thus permitting the plea.

Validity of Non-Compete Clause Post-Termination: The Court then examined Clause 3 in light of Section 27 of the Indian Contract Act. It highlighted the distinction between the operation of non-compete clauses during the currency of an agreement and post-termination.

Referring to the Supreme Court's decision in Percept D’Mark (India) Pvt. Ltd. vs. Zaheer Khan & Anr , the Bench noted:

"The legal position clearly crystallised in our country is that while construing the provisions of Section 27 of the Contract Act, neither the test of reasonableness nor the principle of restraint being partial is applicable, unless it falls within the express exception engrafted in Section 27."

The Court also cited Gujarat Bottling Co. Ltd and Others vs. Coca Cola Co. and Others , which established that negative covenants operative during the contract period are generally not restraint of trade, but the doctrine applies to restrictions operating after contract termination.

The Bench concluded:

"It thus becomes clear from the aforesaid that though a non-compete clause that can operate validly during the term of the agreement, it would not be valid post-termination of the agreement as it would result in restraint of trade prohibited by Section 27 of the Act of 1872. In the present case, since the MSA was terminated on 27/01/2023 by the Supplier and the notice period of one hundred eighty days had already expired prior to the passing of the impugned order of injunction, we are of the view that the Company cannot be restrained from undertaking its business after termination of the agreement."

The Court further stated that any post-termination transactions between the parties would not compel the Company to continue the arrangement in the face of Section 27, as estoppel cannot defeat a statute.

Final Decision and Implications

The Bombay High Court allowed the Commercial Appeal, setting aside the Single Judge's judgment dated August 8, 2023. The Arbitration Petition filed by the Supplier under Section 9 was dismissed.

The Court held:

"Clause 3 of the MSA to the extent it operates beyond the termination of the MSA cannot be the basis for grant of an order of prohibitory injunction against the Company."

It was clarified that the observations made were solely for deciding the Section 9 application and would not prejudice the parties' rights in the main arbitration proceedings. All contentions of the parties were kept open for arbitration.

At the request of the Supplier , the Court directed that its judgment would operate after a period of four weeks from the date of the order, effectively continuing the interim arrangement for that limited duration.