Delhi High Court Vacates Injunction on Non-Compete Clause, Rules Post-Termination Restraints Void

New Delhi – In a significant ruling on employment contracts and restrictive covenants, the Delhi High Court has held that a non-compete clause cannot be enforced after an employee's resignation, deeming it a void restraint of trade under Section 27 of the Indian Contract Act, 1872. Justice Jasmeet Singh further rejected the argument that the duration of a non-compete clause could be extended by the period of its alleged breach.

The Court appointed retired Supreme Court Judge, Justice S.K. Kaul, as the sole arbitrator to adjudicate the underlying disputes between drone technology firm Neosky India Limited and its former key employees.

Case Background

The dispute arose from a Share Subscription and Shareholders Agreement (SSHA) and a Non-Compete Agreement (NCA) dated May 25, 2022, between Neosky India Limited and the founding members of Throttle Aerospace Systems (TAS), a drone company in which Neosky had invested Rs. 40 crores for a 60% stake.

The agreements bound the respondents—former key managerial personnel of TAS—to a five-year service term and a three-year non-compete period. However, three key employees, including CEO Nagendran Kandasamy, resigned on July 3, 2023, and subsequently incorporated a new entity, Zulu Defence Systems Pvt. Ltd., on October 6, 2023, which Neosky alleged was a direct competitor.

Neosky obtained an interim injunction on May 31, 2024, restraining the former employees from engaging in competing business activities. It later filed a petition under Section 11 of the Arbitration and Conciliation Act, 1996, to appoint an arbitrator after the respondents failed to do so.

Arguments of the Parties

Petitioners (Neosky India Ltd.): - Represented by Mr. Tanmaya Mehta, Neosky argued that the respondents committed a clear breach of the SSHA and NCA by establishing Zulu Defence, a competing drone manufacturing venture. - They contended that the non-compete clause was valid and that substantive disputes existed, warranting referral to arbitration. - Neosky also sought to implead Zulu Defence and its new directors (non-signatories to the original agreements), arguing they were "alter egos" of the respondents and vehicles for the breach.

Respondents (Former Employees): - Senior Advocate Mr. J. Sai Deepak, representing the key respondents, argued that the non-compete clause was a post-termination restraint and therefore void under Section 27 of the Indian Contract Act, 1872. - They asserted their right to resign and pursue their profession, protected under Article 19(1)(g) of the Constitution. - While not opposing arbitration in principle, they contested the continuation of the "legally untenable" interim injunction.

Court's Analysis and Key Rulings

The High Court meticulously analyzed the scope of judicial intervention under Section 11 and the enforceability of the non-compete clause.

On Appointment of Arbitrator and Non-Signatories

Justice Jasmeet Singh affirmed the limited scope of a Section 11 petition, stating the court's role is confined to determining the prima facie existence of a valid arbitration agreement. All other issues, including the merits and validity of contractual clauses, fall under the arbitrator's jurisdiction, per the kompetenz-kompetenz principle.

"It is neither appropriate nor permissible for this Hon’ble Court to enter into an adjudication of the merits of the underlying dispute... The rationale behind this approach is to ensure that preliminary objections or complex factual disputes... are appropriately considered by the Arbitral Tribunal itself," the judgment noted.

Regarding the non-signatories (Zulu Defence and its directors), the Court, citing the Supreme Court's decision in Cox and Kings Ltd. v. SAP India Pvt. Ltd. , left the question of their impleadment to the arbitrator. The determination of whether they are "veritable parties" to the dispute requires a detailed factual examination beyond the scope of a referral court.

On the Non-Compete Clause and Interim Injunction

The core of the judgment dealt with the Section 9 petition and the interim injunction. Neosky had argued that since the respondents breached the non-compete clause during its term, the period of breach should be added to the original three-year term.

The Court firmly rejected this argument, drawing a clear line between restraints during employment and those sought to be enforced post-termination.

"A clear distinction exists between a non-compete clause that operates during the subsistence of employment or an Agreement, and one that is sought to be enforced post-termination. While a restrictive covenant during the term of employment may be legally permissible, any such restraint operating after the termination of employment or expiry of the agreement is subject to the rigours of Section 27."

The Court found that since the respondents had resigned and the three-year term of the NCA had expired by efflux of time on May 25, 2025, the injunction was no longer sustainable.

"Allowing them to be extended based on prima facie observations would violate Section 27 of the Indian Contract Act, 1872, and would amount to imposing an unreasonable restriction on the respondents’ right to practice their trade or profession."

Final Decision

The Delhi High Court allowed the petition for the appointment of an arbitrator, referring all disputes, including the impleadment of non-signatories, to Justice S.K. Kaul (Retd.).

Simultaneously, the Court vacated the interim injunction restraining the respondents from engaging in competing business, holding that the non-compete clause had ceased to be enforceable. The Section 9 petition was directed to be treated as an application under Section 17 to be decided by the arbitrator.