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Sponsorship Contracts – Reasonableness of Contractual Restraints

By Roshan Gopalakrishna and Vidya Narayanaswamy

In this article, we describe and summarise the current state of Indian law in relation to the reasonableness of certain contractual restraints that are conventionally included in sponsorship agreements.

Contractual restraints can include within their ambit terms which provide right or relief to one of the parties but which might be an unreasonable constraint on the other’s freedom. The concept of a post-contractual restraint can include within its ambit any and every term which restricts the freedom of a party after the term of the contract has expired. Here we look at a range of contractual and post-contractual restraints and their treatment under recent case law.

Restraints of Trade

The Indian position on the restraint of trade is governed by section 27 of Indian Contract Act, 1872. It voids ‘every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind’. The only exception made is in the limited case of sale of goodwill.

Only agreements which serve to bar the carrying out of a lawful business agreement are termed ‘restraints’. Mere restrictions on the freedom in carrying out an activity do not qualify as restraints. Also, there may be certain restrictions which do not constrain business activity, but serve to promote it. Thus, restrictions incorporated in a contract would not amount to restraints on trade: (a) if they are restrictions on freedom in carrying out the activity, and not a bar to carrying it out; and (b) if they serves to promote trade rather than restrain it.

In a series of cases, the Supreme Court has held that the only exception to the application of section 27 is that stated in the proviso to the provision itself, i.e., if the restraint is on the carrying on of business, the goodwill of which has been sold. Barring this one exception, the section permits no other types of restraints. Courts have, however, consistently held that section 27 does not apply to restraints that may be imposed on employees during the term of the contract, unless the restraint is unreasonable. So, Courts determine the validity of the restraint at two levels: (a) when it acts; and (b) its reasonableness.

If it acts beyond the term of the contract, it is void, and no consideration of its reasonableness is needed. If it acts only during the term of the contract, its reasonableness will be examined, and upheld if reasonable. If it acts both during and after the contract, and is reasonable, that part of it acting during the contract will be valid.

Right of Exclusive Negotiation

Two of the rights that sponsors often seek for themselves in most sponsorship agreements are the rights of ‘exclusive negotiation’ (a variant of which is also known as the ‘right of first offer’) and the ‘right of first refusal’. Their primary object is to enable the incumbent sponsor to gain precedence over its competitors in securing extension of the existing contract for a longer term. The right of ‘exclusive negotiation’ restricts the right of the party being sponsored to negotiate with anyone other than the current sponsor for a fixed period leading up to the expiry of the contract. By so doing, the current sponsor is entitled to be the first entity to make an offer and to negotiate before other potential sponsors make their offers. It also benefits parties looking for continuous sponsorship deals, since the commencement of negotiations after the existing contract has expired would leave them without a sponsor until they are able to source and procure one. Thus, this right of exclusive negotiation can be a mutually beneficial term. It would not per se amount to a restraint on trade.

Right of First Refusal

The ‘right of first refusal’, as has been most commonly drafted, commences after the contract has expired or otherwise terminated. This apparently allows the incumbent sponsor to match any offer received from other sponsors. If the former sponsor does match the offer, the party sponsored has to renew the contract on the new terms. If the former sponsor refuses to match, the sponsored party is free to enter into a fresh contract with a new sponsor on such disclosed terms. This term primarily benefits the sponsor, unlike exclusive negotiation. However, it does not necessarily harm the party being sponsored since its best offer is being matched.

 

Zaheer Khan case

Zaheer Khan (Zaheer), an Indian professional cricketer, had signed a promotional agreement with Percept D’ Mark India Pvt. Ltd. (Percept) in 2000 for a period of three years, with the original contract term ending in October

In July 2003, the company sent him a draft agreement for renewing the contract for another five years in accordance with the renewal clause contained therein. Zaheer turned down the offer for renewal, as he was being approached by other management agencies. Percept approached the Bombay High Court seeking an injunction against Zaheer signing with a third party. The matter then went on appeal to the Supreme Court. Percept relied on clause 31 (a) and (b) of the contract as per which Zaheer could not accept any offer for endorsements, promotions, advertising or other affiliation with regard to any product or services during the contract term and for a period of 180 days thereafter. Further, prior to accepting any offer, he was under an obligation to provide Percept in writing all the terms and conditions of such third party offer and provide the appellant the right to match such third party offer.

Percept’s main argument was that the terms were in promotion of trade and did not restrain the player in any way. Further, it was urged that all negative covenants were not in restraint of trade although they may have an impact at a stage after the term of the contract. Percept’s other contention was that the contract spoke of the first term being an initial term, and the full term contemplated was beyond the initial term of 3 years. Since the right of first refusal was acting only after the initial term, and not the full term, the restraint, if any, was not post-contractual. Thus, the argument advanced was that the Court ought to look into the reasonableness of the restraint, and hold it to be valid. The final contention was that the right of first refusal was a standalone, separate agreement that stood independent of the original sponsorship contract.

In its decision, the Court held that the relevant clause was void and unenforceable as it clearly restricted the player’s freedom of contract and hence was an impermissible restraint. In such case, the reasonableness of a restraint could not be considered either, since the restraint was post- contractual. The Court rejected the initial term argument, and held that the right of first refusal clearly restricted Zaheer’s future liberty to deal with the persons he chooses for his endorsements, promotions, advertising or other affiliations and such a type of restriction extending beyond the tenure of the contract is clearly hit by section 27 of the Indian Contract Act and is void.

Yuvraj Singh case

This case involved Percept’s attempt to enforce the “right of first refusal” clause in its promotional agreement with cricketer Yuvraj Singh (Yuvraj). The contract entered into in 2003 gave Percept the exclusive rights to manage and market Yuvraj during the four-year contract period which was due to expire on December 11, 2007.

The “right of first refusal” clause gave Percept the right, during the contract period as well as subsequent to that, to match any third party offer received by Yuvraj and to continue the relationship on those commercial terms for the period beyond the original service period. Taking into consideration the Supreme Court of India’s precedent in the Zaheer Khan case and other decisions that had been followed in the Zaheer Khan case, the High Court held the clause to be a “post-termination negative covenant in a personal services contract” and, therefore, void and unenforceable.

In both the afore mentioned cases, the courts drew up a set of principles that will be applicable in any future litigation of a similar nature:

a) The right of first refusal in promotional agreements is in the nature of a negative covenant;

b) The legal position with regard to post-contractual negative covenants or restrictions has been consistent, unchanging and completely settled in India. The legal position clearly crystallised in India is that such post-contractual negative restraints are void and that while construing the provisions of section 27 of the Indian 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 dealing with sale of goodwill;

c) In view of the personal nature of the service and relationship between the contracting parties, a contract of agency/management/promotional agreement is incapable of specific performance and to enforce performance thereof would be inequitable. Similarly, a court cannot grant an injunction restraining an athlete from contracting with a third party as that would have the effect of compelling the athlete to be managed by the agency he was previously contracted to and in substance, effect a decree of specific performance.

Right to Terminate

Usually, contracts may be terminated at any time for any reason, by either party. A party may terminate a contract because it is no longer in its best interests or because the other party has failed to perform its obligations as promised or has breached its representations and warranties.

The key determinative factor is whether the termination was justified. An agreement may contain a provision that allows either party to terminate the contract at any time, with or without cause. Usually, the party seeking to terminate the agreement must give the other advance written notice of his intention to terminate the contract. As long as the party seeking to terminate the contract complies with the notice provisions, termination of the contract is permissible.

Vijender Singh case

Ace Indian boxer, Vijender Singh (Vijender) was managed by Infinity Optimal Solutions Pvt. Ltd (IOS). In 2009, IOS sought an injunction restraining Vijender from entering into any sports management agreement /contract with another agency during the subsistence of his agreement with IOS. IOS also sought that Vijender be directed to honour the agreements IOS has entered into on behalf of Vijender.

Vijender had granted exclusive rights to IOS to represent him in all commercial possibilities that could emanate from such a relationship. In turn, IOS was to pay a monthly retainer with 10% increase in subsequent years. The term of the agreement was for a period of ten years. IOS was to receive percentage of the price and other amount earned by Vijender in Indian and International professional boxing as well as endorsements and other commercial possibilities. The agreement could be terminated by IOS after giving one month notice if Vijender’s performance was below par or below standard. The agreement could also be terminated by IOS without the notice in case Vijender got involved in some controversial issues that detracted him or affected his ability to perform. In 2009, Vijender entered into a similar agreement with a third party.

Though there was no provision in the contract between Vijender and IOS for Vijender to terminate the contract, the Court held that where a contract is entered into for mutual profits and gains and if running of the contract is found disadvantageous by either of the party, it can be terminated by either party irrespective of whether there is a termination clause in the contract or not. The right of termination of contract cannot be restricted only to one of the party’s to the contract.

Further, the Court went on to hold that a contract of representation and services is based on mutual trust and if the trust is lost between the parties, one party cannot be legally compelled to keep the contract alive. In view of section 27 of Indian Contract Act, the court held that Vijender could not be restricted from terminating the contract of an agency of one company and giving it to some other company. Precedent for this reasoning was a Division bench judgment which held that even in absence of specific clause authorizing and enabling either party to terminate an agreement in the event of happening of events specified therein, a commercial transaction could be terminated even without assigning a reason by serving a reasonable notice and ultimately if it is found that the termination was bad in law or contravening any terms or the agreement, the remedy of the appellant would be to seek a compensation for such wrongful termination but not claim for specific performance.

Conclusion

The precedents cited above clearly lay down that, under the Indian Contract Act, any post- termination negative covenant in an agreement for personal services, such as a promotional agreement, is void and unenforceable. Further, even in the event that an existing personal services contract may not specify mutually termination provisions, both parties may have the right to walk away from the deal, with the only remedy being a suit for termination rather than specific performance being an available remedy. The existing law clearly biases towards healthy and evolving relationships within the sports sphere and flexibility and movement. At the same time, it may give sponsors and representatives some cause for concern as the law might limit the incentive of investing in the development of young talent that may, upon achieving professional success, walk away from long term contracts putting paid to all the initial investment by the sponsor or representative. Over time, the law will no doubt find a reasonable compromise between the interests of those who are sponsored and the investors in sport. This healthy balance in contract enforcement is necessary for the continued growth of the Indian sporting ecosystem.

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