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

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 Arbitration and Conciliation Act, 1996 is limited to a prima facie determination of the existence of a valid arbitration agreement and whether the subject matter is arbitrable. The court relied upon Interplay between Arbitration Agreements under A&C Act, 1996 & Stamp Act, 1899, In re, where it was held:

“One of the main objectives behind the enactment of the Arbitration Act was to minimise the supervisory role of Courts in the arbitral process… A referral court at Section 8 or Section 11 stage can only enter into a prima facie determination. The legislative mandate of prima facie determination ensures that the referral courts do not trammel the Arbitral Tribunal's authority to rule on its own jurisdiction.”

The court noted that the respondents didn't dispute the existence of arbitration clauses in the SSHA and NCA. It held that objections regarding the validity of the non-compete clause pertained to the 'merits' of the dispute which must be decided by the arbitral tribunal. The court relied upon M/s Kuldeep Kumar Contractor v. Hindustan Prefab Ltd. and observed, “even where the validity of the underlying contract is under challenge, the Arbitration Clause embedded within it is not rendered inoperative”.

The court held that the requirement of prima facie existence of an arbitration agreement under Section 11 of Arbitration Act was satisfied.

On Impleadment of Non-Signatories (Respondent Nos. 6, 7 And 8) to Arbitration Proceedings

The court relied upon Cox and Kings Ltd. v. SAP India Pvt. Ltd. and Adavya Projects (P) Ltd. v. Vishal Structurals (P) Ltd. to hold that whether non-signatories are “veritable parties” is a matter for the arbitral tribunal under Section 16 per the kompetenz-kompetenz principle.

The court observed that “the concept of a veritable party to an Arbitration Agreement refers to a non-signatory who, though not formally a party to the written Arbitration Clause, has such a close legal or factual relationship with the signatories and the underlying contract that it would be unjust or improper to exclude them from the arbitral proceedings.”

Accordingly, it held that the determination of whether respondent nos. 6 - 8 are amenable to the Arbitration Proceedings be best left to the Arbitrator.

The court thus allowed the petition and appointed Justice S.K. Kaul (Retd.) as the sole arbitrator.

On 'Enforceability of Post-Service Non-Compete Clauses'

The petitioners had filed a petition under Section 9 seeking injunctive relief to protect their rights under the NCA. The Court had restrained Respondent Nos. 1-4 from engaging in a competing business. The court pointed out that the scope of section 9 petition is restricted to preservation of rights and does not extend to interpretation of terms of the contract.

The court relied upon the judgment in Vijaya Bank v. Prashant B. Narnaware, where the Supreme Court held that a restrictive covenant during the subsistence of an employment contract does not amount to a restraint of trade under Section 27 of the Contract Act but post-termination restraints are void under Section 27. In Percept D'Mark (India) (P) Ltd. v. Zaheer Khan, it was held that restrictive covenants beyond the term of contract are not enforceable.

The court held that the NCA applied to the respondents only during their tenure as “Promoters” for a fixed three-year term from 25.05.2022. Since respondent nos. 1-3 resigned on 03.07.2023 and the competing entity was incorporated thereafter; the employment relationship had ceased.

“It is now well settled that post-service restrictive covenants in employment contracts, which operate after cessation of employment, are unenforceable under Indian law.”, the court stated. It noted that accepting the petitioner's contention to extend the NCA period to account for the alleged breach would double the restraint period and lead to untenable consequences.

The court held that the NCA ceased to apply upon the resignation of respondents. It stated that any extension would violate Section 27 of the Indian Contract Act and Article 19(1)(g) of the Constitution. The court therefore vacated the interim injunction and ordered the matter to be decided by the Arbitrator under section 17 of the Arbitration Act.

Case Title: Neosky India Limited & Anr. v. Mr. Nagendran Kandasamy & Ors.

Citation: 2025 LiveLaw (Del) 977

Case No.: Arb. P. No. 1860 of 2024 with O.M.P.(I) (COMM.) 183/2024 & CCP(O) 57/2024, CCP(O)93/2024, I.A. 42241/2024, I.A. 42243/2024, I.A. 42244/2024, I.A. 42839/2024, I.A. 42847/2024

Counsel for Petitioners: Mr. Tanmaya Mehta, Ms. Nupur Kumar, Ms. Rashmi Gogoi, Mr. Ambuj Tiwari, Mr. Arjun Nagrath, Advs.

Counsel for Respondents: Mr. J. Sai Deepak, Sr. Adv. with Mr. Utkarsh Joshi, Mr. Anirudh Suresh, Ms. Anjali Menon, Ms. Kanishka Sharma, Advs. Mr. Venkatesh Kumar, Adv. for R-4 and 5.

Judgment pronounced on: 11.08.2025