Legal principles governing enforceability of negative covenants in commercial contracts
INTRODUCTION
In a notable development, the Hon’ble High Court of Delhi (‘Hon’ble High Court’), while deciding an application filed under Section 9 of the Arbitration and Conciliation Act, 1996 (‘Act’), affirmed the enforceability of negative covenants placed in commercial contracts after negotiation between the parties1Innovative Facility Solutions (P) Ltd. v. Affordable Infrastructure & Housing Projects (P) Ltd., 2024 SCC OnLine Del 7542.. The Hon’ble High Court was dealing with a short but vexed issue arising from the termination of a service agreement, i.e., whether enforcing a negative covenant in the contract meant to preserve services pending the adjudication of the dispute in arbitration would constitute specific performance. The Hon’ble High Court also analysed applicability of the Specific Relief Act, 1963 (‘Specific Relief Act’) in view of the reliefs sought in the application.
FACTUAL MATRIX
As a brief factual conspectus, disputes arose between the parties out of the Service Agreement dated 30 December 2016 (‘Service Agreement’), which was subsequently amended vide the Addendum Agreement dated 18 March 2021 (‘Addendum Agreement’). Vide the Service Agreement, Innovative Facility Solutions Pvt. Ltd. (‘Petitioner’) was required to provide maintenance services for AIHP Towers and AIHP Horizon as required by Affordable Infrastructure & Housing Projects Pvt. Ltd. (‘Respondent’). On 01 October 2024, the Respondent issued the termination notice alleging deficient services, breach of contract, non-payment of arrears of electricity et. al.; consequently leading to the appointment of another maintenance agency. This led to the filing of the application by the Petitioner seeking enforcement of the status quo provision in the Addendum Agreement, which was a negative covenant intended to maintain ongoing services during dispute resolution.
The relevant clause of the Addendum Agreement which set-outs the negative covenant read as follows:
“6.3. The Parties further agree that in case of any dispute arising during the Initial Term, in connection with the services provided or any other terms of this Agreement shall initially be resolved through mutual discussions between the Parties. If the Parties are unable to resolve the dispute through mutual discussion, the Parties agree to resolve such dispute through arbitration, as provided under Clause 11 of this Agreement. Further, in case of any dispute arising during the Extended Term, which the Parties are unable to resolve through amicable discussions, within 30 days of initiating such discussions, either Party shall have the right to terminate this Agreement by giving a 90 (Ninety) days’ prior written notice (commencing after the conclusion of the initial discussion period). Notwithstanding the foregoing, the status quo with respect to the services, consideration, and other obligations shall be maintained during the period of mutual discussions and any subsequent arbitration proceedings, as applicable.
6.4. Any termination of the Agreement shall be without prejudice to any rights or obligations accrued prior to the date of such termination.”
CONTENTIONS
Contentions on behalf of the Petitioner
The primary thrust of the Petitioner’s contention was premised on the enforcement of the negative covenant contained in clause 6.3 of the Addendum Agreement extracted above. The Petitioner also argued that the new Specific Relief Act would be applicable to the facts of the present case, however, the Hon’ble High Court did not agree with the same for reasons that will be discussed in the subsequent section of this case analysis.
Contentions on behalf of the Respondent
The Respondent controverted the Petitioner’s stance on the following basis: (i) enforcement of a negative covenant will constitute specific performance which is impermissible in a determinable contract as per Section 14(d) of the Specific Relief Act; (ii) the ‘coupling factor’ between the enforcement of a negative covenant and positive covenant must be tested;2ABP Network Private Limited v. Malika Malhotra, 2021 SCC OnLine Del 4733 and (iii) in case of determinable contracts, damages/ compensation is an adequate remedy3Ksheeraabd Construction Pvt. Ltd. v. National Highways and Infrastructure Development Corporation Ltd., 2023 SCC OnLine Del 3156
JUDGMENT
The Hon’ble High Court firstly addressed the issue of enforceability of negative covenants in commercial contracts. It noted that in somewhat identical circumstances, the decision in Eptisa Servicios De Ingeniera S.L. v. National Highways and Infrastructure Development Corporation Limited4Eptisa Servicios De Ingeniera S.L. v. National Highways and Infrastructure Development Corporation Limited, 2018 SCC OnLine Del 12053 (‘Eptisa’) assumed significance wherein the Hon’ble High Court had enforced an identical negative covenant which restricted termination from taking effect during pendency of the arbitral proceedings.
In another decision viz., Egis India Consulting Engineers Private Limited v. Pawan Hans Limited5Order dated 29.04.2021 passed in O.M.P. (I)(COMM.) 148 of 2021 (‘Egis India’), the Hon’ble High Court had held that the Parties have crafted a protocol in which, even after a notice of termination of contract has been issued, the termination would not be effectuated if the arbitration proceedings are commenced. Resultantly, the negative covenant stood enforced.
Thus, by extending a similar analogy to the facts and circumstances involved, the Hon’ble High Court noted that Clause 6.3 of the Addendum Agreement stands on an equal footing as the Petitioner and Respondent had consciously agreed to maintain status quo with respect to services during the arbitration proceedings. In this regard, the aspect of coupling factor was also tested and held to be inapplicable since the parties had voluntarily agreed to maintain status quo during pendency of arbitration proceedings. The Hon’ble High Court noted that the Petitioner’s request to enforce this negative covenant aligned with Section 42 of the Specific Relief Act, which allows such enforcement when no specific performance of a positive covenant is involved. As such, it was held that the Respondent’s contention regarding damages/ compensation being an adequate remedy, the same would be inapplicable since the Petitioner only sought enforcement of the negative covenant.
Lastly, with respect to the applicability of the new Specific Relief Act, the Hon’ble High Court referred to the decision of the Hon’ble Supreme Court of India in Katta Sujata Reddy v. Siddamsetty Infra Projects (P) Ltd.6(2023) 1 SCC 355 (‘Katta Sujata’), which held that the 2018 amendments to the Specific Relief Act are prospective in nature and the Service Agreement would not be covered under its ambit.
ANALYSIS
This decision reinforces the legal principles relating to enforcement of negative covenants in commercial contracts which have been fairly negotiated to safeguard the fundamental obligations of parties and ensure smooth services in the eventuality of a dispute. Dispute resolution processes including arbitration can often entail long timelines and enforcement of thoughtfully crafted negative covenants can ensure that the commercial objective underlying the agreement is not frustrated due to disruption caused by invocation and pendency of the arbitration. Negative covenants, unless they contravene public policy or otherwise prohibited legally, reflect the consensus-ad-idem of the contracting parties and their commercial wisdom. The commercial understanding between two parties should not be quarrelled or disturbed and must not be re-written by the courts. In the present case, the Hon’ble High Court upheld the parties’ agreement to ensure continuity in essential services while the arbitral proceedings were underway which also underscores the significance of preserving the efficacy and integrity of the arbitral process.
A peculiar finding in the judgment also pertains to the applicability of the new Specific Relief Act, which was rejected on the basis of the decision of the Hon’ble Supreme Court in Katta Sujata, where the amendments to the Specific Relief Act were held to be prospective in nature. However, in a recent development, the Hon’ble Supreme Court has recalled its earlier decision in Katta Sujata in exercise of its review jurisdiction by finding errors apparent on the face of the record and held it to be applicable retrospectively7Siddamsetty Infra Projects (P) Ltd. v. Katta Sujata Reddy, 2024 SCC OnLine SC 3214. In any event, the decision regarding recalling the prospective applicability of the Specific Relief Act may not cast an influence since the Hon’ble High Court’s decision is premised on enforcement of the negative covenant.
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