INTRODUCTION

Negative covenants in agreements, whether general, partial, blanket or limited, may be permitted only if they do not bring unreasonable benefit to the benefactor of the covenant. Specifically, a negative covenant in a contract may be necessary to promote the freedom of trade of contracting parties. This sentiment is born from Section 27of the Indian Contract Act, 1872 (“Act”) which stipulates that any contractual agreement that prevents a party to the agreement, from exercising any lawful profession, trade or business of any kind, is void.

Section 27 has been drafted in a manner that provides for an absolute protection against any and all kinds of restraint of trade, whether reasonable or not. The rigidity of the language in the Section does not permit much room for wider interpretation and as such this is the crux of the debate surrounding the validity of this provision. It is interesting to note that the Act was drafted at a time when trade was underdeveloped and the underlying object of this provision was to promote restraint-free trade. The current trade economy however has evolved into a more complex and dynamic phenomenon than the one envisaged during the enactment of the Act. Therefore, even reasonable restrictions which were necessary to ensure that the enforcing parties remain competitive, were being absolutely protected. So much so, that the Law Commission of India in its 1958 report, recommended that this provision be amended to permit reasonable restraints on the freedom to conduct trade. Even the Allahabad High Court had observed in Bholanath Shankar Dar vs. Lachmi Narain that “it is unfortunate that Section 27…seriously trenches upon the liberty of the individual in contractual matters affecting trade”. However, the first recorded case where the Supreme Court adjudicated on the validity of Section 27 of the Act was the 1967 case of Niranjan S. Golikari v. Century Spinning Co. The Supreme Court held that the condition imposed in this case was restrictive in nature as it is related to the period of employment, and to work similar or substantially similar to the one carried on by the appellant when he was in the employment of the respondent company. This restriction was deemed reasonable and necessary for the protection of the company’s competitive interest. The Court acknowledged the right of the aggrieved party to enforce Section 27 of the Act and concluded by stating that the restrictive condition contained in the employment agreement did not amount to a restraint of trade and hence would not fall under the purview of Section 27.

A slew of cases followed the rationale held in this case, but in 1980, a 3 judge bench of the Supreme Court in Superintendence Co. of India Pvt. Ltd. v. Krishan Murgai followed a different path in determining the interpretational boundaries of Section 27. After careful examination of Section 27, the Supreme Court concluded that the purpose of this particular provision in the Act could only be fulfilled by a direct and literal interpretation of the same. The Supreme Court held that the contours of Section 27 could not be moulded to suit the requirements of each case differently. The Supreme Court arrived at the conclusion that any and all restraints put on a contracting party’s liberty to practice any trade, profession or business of their choice would be held as void and against public policy. Furthermore, the principle of reasonableness of restraint so imposed would not be applicable to agreements under the Act because of the manner in which Section 27 had been drafted.

This rationale was upheld by other judgments that followed this case. However, the differential interpretations offered for the same statutory provision signified a state of flux in the interpretation of Section 27. This was especially true with respect to contractual arrangements where one party to the agreement held more bargaining power than the other. For instance, employment contracts where the employee was at the mercy of the employer and practically wielded no bargaining power in the negotiation. In light of this, Percept D’Markr (India) Pvt. Ltd. v Zaheer Khan (“Zaheer Khan case”) in 2003 was a watershed moment in balancing the scales in favour of the party aggrieved by the enforcement of the restrictive covenant.

FACTS

Percept D’Mark was a company engaged in the business of celebrity endorsement, sports management and marketing. They entered into a promotion agreement (“Agreement”) with Zaheer Khan, an Indian cricketer of repute, in November 2000. The object of the agreement was to manage the brand development and media affairs of Zaheer by Percept. In the Agreement, a condition was laid down, which stated that upon termination of the Agreement, Zaheer had to compulsorily give Percept an opportunity to match any offer made to him by a third party if he chose to not renew the agreement and enlist another service provider. This clause – more popularly referred to as the ‘Right of First Refusal’ (“ROFR”) was available to Percept before Zaheer entered into an agreement with an interested third party. It allowed them to match any offers made by third parties and retain Zaheer as a client, if they were so inclined. Zaheer was free to enter into a contract with any third party if the subsequent offer made by Percept didn’t match the third party’s offer.

On July 29, 2003, Percept sent a draft proposal to extend the Agreement with Zaheer. Ten days later, Zaheer replied to the proposal stating he did not wish to renew the contract or extend the agreement. A day before the expiry of the Agreement, Zaheer sent a letter to Percept arguing that the ROFR clause in the Agreement, constituted a restraint of trade and therefore the Agreement was void under Section 27 of the Act. Zaheer argued that the Agreement was one sided and unfair.  After the expiry of the Agreement, Zaheer entered into an agreement with a third party without entertaining Percept’s ROFR. This was challenged by Percept in the Bombay High Court and on appeal, was put forth the Supreme Court for deliberation.

ISSUES

The main issues in the case as earmarked by the Supreme Court were:

  • Whether the ROFR clause in the Agreement was void?
  • Whether Percept can compel Zaheer to extend the agreement?

JUDGMENT

The Supreme Court analysed and thoroughly examined the scope and effect of the ROFR clause in light of settled law on post-contractual covenants.  While deliberating on the balance of convenience, the Supreme Court employed an age-old tactic of comparing the losses suffered or injuries sustained by both parties if injunctive relief were to be provided, and then arriving at a conclusion. The Supreme Court thus observed that Percept could be adequately compensated in terms of money if the injunction was refused. On the other hand however, a grant of injunction would result in irreparable injury and grave injustice to Zaheer. The Supreme Court was of the opinion that it would be a grave injustice to compel Zaheer to enter into a contract in which he was not interested. The Supreme Court opined that a relationship between an athlete and a sports management agency is a relationship built on mutual faith, confidence and continued trust. Any order compelling Zaheer to enter into an agreement will be against his will and therefore against the spirit of contract law. Another important aspect of this case was that unlike previous restraint of trade cases which dealt with mostly employer-employee tussles, the Agreement was one of agency and not employment. The Agreement therefore, was of a personal nature whereby Percept (the agent) had been acting on behalf of Zaheer (the principal) and in such a scenario enforcing the ROFR may result in forcing the principal to be represented by an agent beyond the term of their Agreement provided the Agreement had not been breached and been lawfully terminated. Therefore, Percept was held to be in restraint of trade and the Supreme Court allowed Zaheer the freedom to enter into any agreement post the natural or agreement-specific termination of the Agreement. This ruling however, did not preclude Percept’s right to enforce on Zaheer, a restraint of trade with outside parties during the subsistence of the Agreement.

LEGACY

The main takeaway from the case was that every agreement in restraint of trade after its termination could be held void. Once the contract comes to an end either by natural or lawful termination, a restrictive covenant which restrains the right to trade freely cannot be enforced and the party seeking its enforcement shall not be entitled to injunctive relief. The rationale held in this case was reiterated in another landmark case of Percept Talent Management Pvt. Ltd. v. Yuvraj Singh & Globosport India where the validity of the controversial ROFR clause was to be examined by the Bombay High Court.

In this case, like the Zaheer Khan case, the contract was one involving the performance of services which were of a personal and confidential nature. The agreement between Yuvraj and Percept contained a ROFR clause wherein upon termination of the agreement, Yuvraj was precluded from entering into an agreement with a third party until an opportunity was granted to Percept to match the offer. Upon termination of the agreement with Percept, Yuvraj agreed to enter into a new agreement with Globosport. Percept, upon learning of this development, approached the Bombay High Court contesting Yuvraj’s breach of the ROFR requirement under their agreement. The Bombay High Court observed that such an agreement exists because of founded on the pillars of trust, confidence and the basic principles which underlie a fiduciary relationship. Such a relationship cannot survive if trust and confidence doesn’t exist between the parties. It was held that the law shall not enforce and compel parties to observe a relationship where the basic foundation of it has disappeared. In the words of Justice D.Y Chandrachud “the law does not enforce the husk where the substance doesn’t survive”. The Bombay High Court borrowed heavily from the Zaheer Khan case stating that the agreement between Yuvraj and Percept contained a restrictive covenant which effected a restraint of trade on Yuvraj, as it clearly restricted him from entering into contractual arrangements with parties of his choice (post the termination of original agreement). It was held that this kind of restrictive covenant which operates beyond the term of a negotiated agreement between the parties that has been held by the Supreme Court to be void as being in restraint of trade. Therefore, the Bombay High Court declined to provide injunctive relief to Percept.

A similar position was taken by the Delhi High Court in the case of Infinity Optimal Solutions Pvt. Ltd. v Vijender Singh. It was held therein that a contract between parties can be terminated by either party irrespective of the fact that there was a termination clause in the contract or not. The right of termination cannot be restricted to one party in a contract alone. Justice Shiv Narayan Dhingra opined that performance of such a contract cannot be specifically enforced and the only remedy is to claim damages. However, if it can be shown by the aggrieved party that the termination of the contract has resulted in loss or damages in that case monetary compensation can be granted. Judge Dhingra further examined the ambit of Section 27 of the Act. Referring to the Supreme Court Judgment in the Zaheer Khan case, the Delhi High Court ruled in favour of Vijender Singh and held that Vijender Singh cannot be restricted from terminating the agreement with Infinity Optical Solutions and entering into a contract with a different entity.  It was held that even in the absence of a specific clause authorizing and enabling either party to terminate an agreement, a commercial transaction could be terminated even without assigning a reason by serving a reasonable notice as prescribed by the underlying agreement and ultimately if it is found that the termination was in contravention of any term or condition of the agreement, then the appellant would be granted compensation in form of monetary damages. However, if post-termination, one of the parties to the contract decided to enter into a fresh agreement with a third party, then specific performance or injunctive relief could not be claimed.

CONCLUSION

From an operational standpoint, it would make sense to support the invalidity of post-termination negative covenants like non-compete and ROFR because forcing parties to contract is not the intention of the Act, especially in management services or agency contracts wherein the agreement is fiduciary in nature and requires dissemination of personalized services. This has been ground zero on which the abovementioned judgments have arrived at their respective rationales. However, an argument can be made that athletes or sports professionals, especially reputable ones wield significantly higher bargaining power than the management service provider they contract with. Therefore, if they provide their express consent to the terms of the agreement, they must be held accountable for the same because they were not forced to engage in a dire situation wherein they were coerced into signing the agreement.

Developments in contract law must be considered and if such restrictive clauses become industry accepted boilerplate provisions, then the blanket invalidity of such restrictive clauses may not always align with industry standards and the principles of natural justice. Unless a restrictive clause in a contract serves no protective purpose other than to unfairly harm the aggrieved party, a ruling on whether a contractual clause constitutes restraint of trade must consider the balance of convenience between its pro-competitive justifications and anti-competitive effects within the context of the specific industry.

ROFR has endured a negative reputation due to the parasitic nature of this clause. However, it does offer a number of practical benefits, especially in the sports and entertainment industry. Providing an early backer the opportunity to continue the contractual relationship in the future on market-set terms when the sportsperson has established himself/herself, is a priceless tool in the hands of a young upstart. The ability to offer the cushion of ROFR to redeem and be rewarded for investment into risky capital, is a weighty bargaining chip in the hands of the sportsperson when he/she has little else in the name of leverage. The clause plays the role of unlocking value for the sportsperson once his or her commercial value has been realised while still keeping early supporters engaged. A prime example of this is the National Basketball Association and the National Football League in USA which allows player contracts to be structured in a manner that after the passage of a specified period of time in the term of the contract, players may test the market as restricted free agents, whereby they engage with other teams freely and bring the best offer available in the market to the team they are currently contracted with. If the principal team matches the best offer, the player stays on till he/she becomes an unrestricted free agent.

Through the course of researching and writing this piece, I have arrived at the conclusion that in order to harness our national talent, there are lessons to be learnt from countries far ahead in the development curve. Such restrictive clauses are accepted industry practises in those countries where the investors have proven willing to invest in potential through the use of restrictive contractual covenants such as ROFRs and non-competes in order to hedge their bets. The trick lies in creating a wholesome incentive structure that doesn’t necessarily cause harm to either party to the contract. It is also worth noting that ROFRs can be utilized in multiple ways and can assume different connotations in different situations. A ROFR in a contract for a personal service becomes a leverage tool, whereas in a pure investment transaction, a ROFR clause is merely a tool to protect the investor’s interest and not necessarily a leverage play.

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