The Price Of Walking Away — New Era Of Enforcement For Employment Bonds

Employment bonds have been a common contractual mechanism used by employers in India to retain talent and protect their investments made in the training, relocation and onboarding of employees. Especially prevalent in skill-intensive sectors such as information technology, aviation, banking and healthcare, these bonds typically require an employee to serve the organisation for a specified minimum period or pay a fixed compensation if they leave their employment earlier.

Employers often justify employment bonds by emphasising the significant time and resources invested in training employees, arguing that these agreements help prevent sudden resignations. However, the argument against such bonds is that they may operate to the detriment of employees, particularly when they are incorporated into standard form contracts without any room for negotiation.

Judicial interpretation of restrictive covenants traces its origin to the 1960s when the Supreme Court in Fateh Chand v. Balkishan Das held that courts have a statutory duty under the Contract Act "not to enforce the penalty clauses but only to award reasonable compensation". For the next two decades, courts focused on the temporal application of restraints, distinguishing between those operative during employment and those taking effect thereafter.

From the late 1980s, judicial scrutiny evolved to examine the fairness of contractual arrangements and the relative bargaining power between the parties to determine whether such a contract violated public policy. Since the 2000s, courts have maintained their established position that post-employment restrictions are void; however, public policy exceptions have been recognised where circumstances warrant.

In that backdrop, the SC's verdict in the recent case of Vijaya Bank & Anr. v. Prashant B. Narnaware upholding an employment bond imposed by a public sector undertaking, needs to be analysed.

In the Vijaya Bank case, based on a recruitment notification that granted a promotion to the respondent, Prashant B Narnaware, he resigned from his previous role as a manager (middle management scale-II), to join Vijaya Bank at a higher designation of senior manager (middle scale management scale-III). Both the recruitment notification and his appointment letter contained a clause requiring him to serve the bank for a minimum of three years or pay Rs 2 lakh as liquidated damages in the event he resigned earlier.

Upon his appointment as the senior manager, the respondent executed an indemnity bond for the same amount of Rs 2 lakh. However, the respondent resigned from his new post within two years from the date of his appointment to join another bank and paid such liquidated damages but did so under protest. He subsequently challenged the validity of this covenant in the Karnataka High Court, which ruled in his favour by holding the covenant as unconscionable, unsustainable and unenforceable in law.

Upon appeal by the bank, the SC ruled that the covenant in the appointment letter of the respondent does not amount to a restraint of trade, nor is it opposed to public policy (and thereby contrary to Sections 27 and 23 of the Contract Art or violative of Articles 14 and 19 of the Constitution of India).

The legal debate centres on the validity of employment bonds under Sections 23 and 27 of the Indian Contract Act, 1872. Section 23 specifies that the consideration or object of an agreement is invalid if it is unlawful. This includes circumstances where the agreement violates any legal statute, conflicts with public policy or involves acts that are fraudulent, immoral or harmful to others. Section 27 states that any agreement which restrains a person from exercising a lawful profession, trade or business of any kind is void.

While tackling the issue under Section 27, the SC referred to the judgement of a division bench in the case of Niranjan Shankar Golikari v. Century Spinning and Manufacturing Co. to emphasise the distinction between restrictive covenants operating during the subsistence of an employment contract and those operating after its termination. In the Golikari case, the SC held that negative covenants in an employment contract which apply during the period of employment are typically not considered a restraint of trade and therefore, do not violate Section 27 of the Contract Act. This includes conditions that prevent an employee from working for another employer or engaging in a similar business, while still under their current contract. Such negative covenants are generally valid and enforceable, unless they are unconscionable, excessively harsh, unreasonable, or one-sided.

The SC also referred to a ruling by a three-judge bench in the case of Superintendence Company (P) Limited v. Krishan Murgai, which clarified that while specific performance of an employment contract cannot be enforced by courts, Section 57 of the Specific Relief Act, 1963, allows courts to issue an injunction to uphold a negative covenant tied to an employment agreement. This means that granting an injunction to prevent the violation of a negative covenant is not considered a restriction on an individual's right to pursue alternate trade but rather a means of reinforcing their current trade or profession.

Applying this rationale to the facts of the Vijaya Bank case, the SC noted that the covenant merely aimed to enforce the terms of the existing employment agreement by limiting the respondent's ability to resign within a specified timeframe and did not inhibit future job opportunities. Accordingly, the SC deemed the Covenant to not be violative of Section 27 of the Contract Act.

The respondent in the Vijaya Bank case also argued that the covenant was part of a standard form contract, and he was compelled to sign it for the sake of his continued employment. He further argued that it was imposed on him by virtue of an unequal bargaining power of the bank and hence, it was an unreasonable, onerous and ex-proportionate measure that resulted in unjust enrichment to the bank, thereby being opposed to public policy under Section 23 of the Contract Act.

In this regard, the SC referred to the decision of a division bench in the case of Central Inland Water Transport Corporation Limited v. Brojo Nath Ganguly in which the SC observed that standard form contracts are entered into by the party with superior bargaining power with a large number of persons who has far less bargaining power or no bargaining power at all, and they would be injurious to the public interest if they are “unconscionable, unfair and unreasonable”.

While elaborating on the meaning of 'public policy', the SC in the Vijaya Bank case stated that public policy relates to matters involving public good and public interest, and what is opposed to public policy varies from time to time based on what is considered just, fair and reasonable in the eyes of society at a given time. In the context of employer-employee relationships, the SC observed that technological advancements impacting the nature and character of work, re-skilling and preservation of scarce specialised workforce in a free market are the factors to be considered in the domain of public policy. The SC thus held that to survive in a de-regulated free-market, PSUs are required to increase efficiency by retaining experienced staff contributing to managerial skills.

Therefore, the SC's rationale for upholding the covenant warrants closer judicial scrutiny and invites further deliberation on its broader implications. It argues that PSUs, such as the bank in this case, now face competition from efficient private players. Since the private players inter alia have simpler and cost-effective recruitment processes, such premature resignations, in violation of the covenant would decrease the competitiveness of the bank. This reasoning seems to imply that employees may be required to accept these outcomes, including higher indemnities compared to those imposed by private sector employers, as a consequence of contractual enforcement premised on public policy.

The SC's interpretation of the Golikari case seems to have ignored important safeguards about what is considered reasonable and fair. It could effectively mean that employers could require employees to do any and all actions during the course of their employment, by imposing severe financial penalties, without any legal consequence. This interpretation may represent a departure from the established jurisprudence that has historically emphasised the inherent unfairness of standardised employment contracts.

The division bench of the Karnataka High Court in the Vijaya Bank case observed that the respondent had served the bank for more than 10 years in different capacities and held that this aspect ought to have been taken into consideration by the bank while directing the respondent to pay Rs 2 lakh as per the conditions of his appointment letter. Regardless of the same, the SC upheld an indemnity bond roughly 10 times the amount of monthly salary earned by the respondent, without the bank having to prove any actual loss or any additional costs incurred for training the respondent for his role as a senior manager.

The judgement of the Madras High Court in Toshniwal Brothers (Private) Ltd. v. E. Eswarprasad and Ors. and of Delhi High Court in Sicpa India Limited v Manas Pratim Deb are relevant in this context. The Madras High Court held that as a prerequisite for claiming liquidated damages under the Contract Act, employers should show a legal injury automatically resulting from the breach of the commitment to serve for a minimum period.

Legal injury can be proved where the employer has incurred any expenditure in giving any special training or in conferring any special benefit or favour on the employee to the detriment of the employer. Else, actual injury accruing as a result of the breach would have to be proved. Further, as held by Delhi High Court, merely because an injury has occurred, it does not mean that the court should grant the exact amount of damages stipulated in the contract without assessing the actual loss to the employer.

Based on the above, although the SC in the Vijaya Bank case acknowledged that liquidated damages were built into the appointment agreement to account for the bank's expensive and time-consuming recruitment process, the SC failed to examine whether such damages were reasonable and proportionate in a contract of this nature. More importantly, the SC did not require the bank to prove the quantum of the actual costs involved in such recruitment process. This lack of scrutiny raises substantive concerns.

The decision in the Vijaya Bank case undeniably alters the customary perception that employment bonds are inherently unfair or unenforceable. Moreover, placing the burden of recruitment challenges on employees raises significant concerns — both in terms of ensuring the continued appeal of public employment and in shaping broader standards across sectors.

This is concerning given that PSUs in India have traditionally been held to a higher benchmark for employee welfare compared to their private counterparts. In this regard, however, while quashing the decision of the Karnataka High Court, the SC laid emphasis on evaluating restrictive covenants within their proper perspective on case-to-case basis and for courts to not mechanically rely on precedents to set aside a covenant as being barred by law.

Consequently, given that the SC's reasoning upheld the covenant (for being a restraint of trade and opposed to public policy) specifically in relation to PSUs, the applicability of this decision to private sector employers remains to be seen. Nevertheless, the judgement provides private employers a persuasive precedent to push for enforcing employment bonds, especially in industries which have high recruitment and training costs. It remains to be seen whether this decision will face further legal challenge and withstand review.

Ankita Ray is a partner and Jay Bhaskar Sharma is an associate at Cyril Amarchand Mangaldas.

Disclaimer: The views expressed here are those of the authors and do not necessarily represent the views of NDTV Profit or its editorial team.