Supreme Court decides on Enforceability of Employment Bonds

Employment agreements have always sought to maintain a fine balance between furthering the interests of the employer and safeguarding the rights of the employee. A perceived imbalance in the protection of both sets of interests has often brought employment contracts under judicial scrutiny. In a recent Supreme Court ruling, the Court examined and determined the validity of an employment bond clause, requiring a bank employee to serve a minimum of 3 (three) years or pay liquidated damages upon premature resignation.

The appellant-bank ("Bank") is a public sector undertaking. The Bank issued a recruitment notification which stated that employees appointed at certain posts would be required to execute an indemnity bond of Rs. 2,00,000/- (Rupees Two Lakhs only), indemnifying that the employee will pay an amount of Rs. 2,00,000/- (Rupees Two Lakhs only), if the employee leaves service prior to completion of 3 (three) years. The respondent ("Employee") applied for one of the posts, on which this condition was applicable and was subsequently selected for the same. Clause 11(k) of the appointment letter issued to the Employee stated that the Employee was required to serve the Bank for a minimum period of 3 (three) years from the date of joining the Bank and the Employee was required to execute an indemnity bond of Rs. 2,00,000/- (Rupees Two Lakhs only). The said amount was to be paid by the Employee in case the Employee resigned from the services of the Bank before the completion of the stipulated minimum period of 3 (three) years.

Prior to completing the stipulated minimum period, the Employee tendered his resignation. The resignation was accepted by the Bank and the Employee paid the required sum to the Bank. Thereafter, the Employee filed a writ petition before the High Court praying for quashing of the said clause of the recruitment notification and Clause 11(k) of his appointment letter. The following issues were addressed by the Supreme Court:

(i) whether Clause 11(k) amounts to restraint of trade under Section 27 of the Indian Contract Act, 1872 ("Contract Act"); and

(ii) whether Clause 11(k) is opposed to public policy and thereby violative of Section 23 of the Contract Act and Articles 14 and 19 of the Constitution of India.

The Supreme Court primarily evaluated the application of Section 27 of the Contract Act to determine whether it imposed a bar on the inclusion of restrictive covenants in an employment contract. Section 27 provides that every agreement which restrains a person from pursuing a lawful profession, trade or business of any kind is void to the extent of such restriction. The Supreme Court evaluated the validity of restrictive covenants operative during the subsistence of an employment contract by relying on the judgment made in Niranjan Shankar Golikari v. Century Spinning and Manufacturing Co. This judgment drew a clear distinction between restrictive covenants that were operative during the subsistence of an employment contract and those operating after its termination. It was held that the factors taken into account while considering the validity of the restrictions imposed on the employee during the period of his employment are different from those taken into account where the restrictions are imposed subsequent to the termination of employment. Accordingly, it was held that negative covenants that require the employee to serve his employer exclusively or refrain the employee from engaging in similar business or trade for the period of employment would not be regarded as restraint of trade and therefore do not fall under Section 27 of the Contract Act, unless the contract in question is unconscionable or excessively harsh or unreasonable or one-sided.

Further, the judgment in the case of Superintendence Company (P) Ltd. v. Krishan Murgai emphasised that the doctrine of restraint of trade never applies during the continuance of a contract of employment; it applies only once the contract is terminated. Any restraint imposed on an employee to bind the employee during the term of his agreement to directly or indirectly refrain from engaging with any third party promotes exclusivity of service and is not oppressive per se and therefore, has been held to be valid. Such a restriction would not be considered void under Section 27 of the Contract Act.

In view of the above, the Supreme Court opined that since Clause 11(k) merely sought to impose a restriction on the Employee’s option to resign, the object of the restrictive covenant was in furtherance of the employment contract. The restrictive covenant did not, in any form or manner, impact the future employment of the Employee. The Court, therefore, held that Clause 11(k) could not be considered to be contrary to Section 27.

It was argued by the Employee that Clause 11 (k) was part of a standard form contract and he was compelled to sign on dotted lines. It was also argued that the terms of the appointment letter were imposed on him through an unequal bargaining mechanism and Clause 11 (k), being an unreasonable, onerous and ex-proportionate measure resulting in unjust enrichment for the Bank, was opposed to public policy. The Supreme Court evaluated whether the restrictive covenant was opposed to public policy by referring to judgment made in Central Inland Water Transport Corporation Ltd. v. Brojo Nath Ganguly, wherein, it was opined that if contracts are unconscionable, unfair, unreasonable and injurious to public interest, they would be deemed void in law, being opposed to public policy. The Contract Act does not define the expression 'public policy'. This judgment stated that the expression 'public policy' is incapable of a precise definition. It simply refers to matters that concern the public good and public interest. Keeping this in mind, it is important to note that the definition of 'public policy' will evolve with the times, along with advancements in the knowledge of society and the ever-developing standards of human rights and dignity. The Court held that from the prism of employer-employee relationship, technological advancements impacting the nature and character of work, re-skilling and preservation of scarce specialised workforce in a free market need to be factored in when the terms of an employment contract are tested on the anvil of public policy. The Supreme Court observed that in order for public sector undertakings to compete with efficient private entities in an economy that caters to the free market, such public sector undertakings were forced to update and modify the pre-existing employment policies, with the goal of increasing employee efficiency. It was held that the requirement imposed by the Bank along with the provision of liquidated damages, with the objective of ensuring employee retention, is neither unjust nor unreasonable, and does not fall foul of the constitutional mandate under Articles 14 and 16.

The judgment leans heavily in favor of upholding reasonable restrictions imposed on the employee during the period of employment. In the context of the dispute, the Supreme Court emphasized that the purpose of an employment bond is to protect the interests of such employers, ensuring that they do not face any undue loss while diligently carrying out the process of hiring, training, and adequately equipping the employee who will replace the resigned employee. This measure was held to be 'valid', 'reasonable' and 'necessary'. Further, the obiter dicta of the judgment clearly states that restrictive covenants which require the employee to continue his/ her employment for a minimum period of time do not amount to restraint of trade under Section 27 of the Contract Act. This landmark ruling would certainly lead to a change in the terms and conditions of employment contracts, ensuring that the validity of such contracts is not challenged under Section 27. Additionally, employers must maintain records of training and recruitment expenses to justify seeking enforcement of such employment bonds.

About the authors: Akanksha Dua is a Partner and Natasha Matange is an Associate at Obhan & Associates.

Disclaimer: The opinions expressed in this article are those of the author(s). The opinions presented do not necessarily reflect the views of Bar & Bench.

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