The Supreme Court of India's interpretation of the validity of an employment bond between the employer and the employee has faced some obstacles, especially regarding public policy and the duration of the employment contract. The bond between an employer and an employee does not always end when the employee resigns or leaves the employment. There are instances where employment contracts contain clauses that prevent an employee from joining a competitor, soliciting clients, or leaving before completing a minimum period of service. The enforceability of such negative covenants is primarily determined under Section 27 of the Contract Act, 1872. As per Section 27 of the Act:
“Every agreement by which any one is restraint from exercising a lawful profession, trade, or business of any kind is, to that extent void”.
Though the provision seems to invalidate every restraint on trade, profession, or business, the courts have noted a vital distinction between restraints operating during the employment and those taking effect after its termination. For example, in the case of Niranjan Shank Golikari v. Century Spinning & Manufacturing Co. Ltd, the Supreme Court upheld the validity of the contract which required the employee to work exclusively for the employer for a period of five years. The Supreme Court held that a negative covenant requiring an employee to serve only one employer during the agreed contractual period is not restraint of trade and does not fall within the scope of Section 27. The court observed that the contract is valid because it is essential to protect the employer's interests while the agreement is in force.
The case of Vijaya Bank v. Prashant B. Narnaware
In the contemporary case of Vijaya Bank v. Prashant B. Narnaware, required the respondent (employee) to serve the bank for a minimum period of three years, failing which he would be liable to pay liquidated damages of Rs. 2 lakhs.
To delve more into the background of this case, in 1999, the employee had joined the bank as a Probationary Assistant Manager. His service was confined in 2001. And thereafter, he was promoted to Middle Management Scale-II. In 2006, the bank issued a recruitment notification for appointment of 349 officers. However, according to the Clause 9 (w) of the recruitment notification stated that:
“Selected candidates are required to execute an indemnity bond of Rs. 2.00 Lakh (Rupees Two Lakh only) indemnifying that they will pay an amount of Rs. 2.00 lakh to the Bank if they leave the service before completion of 3 years”
The respondent cognizant of the said condition, applied to the post of Senior Manage-Cost Accountant at the basic pay of Rs. 18,240, in which thereafter being selected. On 7th August 2007, the employee was issued an appointment letter along with Clause 11(k), stated:
“You are now required to serve the Bank for a minimum period of 3 years from the date of joining the bank and should execute an indemnity bond of Rs.2.00 lakhs. The said amount has to be paid by you in case you resign from the services of the bank before completion of stipulated minim period of 3 years. For this purpose, you have to bring a blank non-judicial stamp of Rs.100/-procured in the State of your posting”.
By accepting the aforesaid condition, the respondent voluntarily resigned from his erstwhile post of Manager, MMG-II and joined the post of Senior Manager, MMG-II on 28th September 2007, executing an indemnity bond as well. On 17th July 2009, before completion of three years from his date of joining, the respondent resigned for joining another Bank. On 16th October 2009, the respondent under protest in terms of the afrosaid condition paid the sum of Rs. 2 lakhs to the bank.
The respondent challenged this as being restraint of trade in the High Court. The respondent alleged that the clause 9 (w) of the recruitment notification and clause 11(k) of the appointment letter in violation of Articles 14 and 19(1) (g) of the Constitution of India and Section 23 and 27 of the Indian Contract Act, 1872.
The Supreme court, however held that the contract merely prevented the respondent from taking any other job which required him to give the similar capacity of work. The Court noted as follows:
“The Indemnity Bond obtained by the Bank was done so with a view to secure the interests of the Bank and to place adequate safeguards against premature resignations-tendered by employees. In usual course, appointments are into service of the Bank after a detailed and elaborate process of recruitment and the Banks interest would be seriously prejudiced in the event premature resignations are tendered which would render the entire recruitment process redundant. That apart the Bank would also suffer the consequences of the loss in continuance of the said post which would necessitate alternative arrangements and restricting to ensure smooth functioning of day-to-day business activities. That apart, the bank would have to initiate a fresh process of recruitment which would be time consuming and also expensive.”
The Supreme Court held that an untimely resignation would require the Bank to undertake a prolix and expensive recruitment process involving open advertisement, fair competitive procedure lest the appointment falls foul of the constitutional mandate under Articles 14 and 16. Since the restriction was valid only during the subsistence of the contract and was intended to serve the best interest of the bank by, preventing the bank from facing any further economic loss, it did not violate Section 27.
Employment contract bonds in nursing which requires staff to work for a minimum period or pay a financial penalty to resign early are one of the highly debated topics in the employment bond jurisprudence. While courts recognize bonds to prevent abrupt staffing shortages and recoup training costs, they frequently strike down ones that impose severe penalties that not reasonable. The court cautions that such contracts would not be enforceable, if they were unconscionable and unreasonable.
Public Policy in Employment Contracts
In the case of Superintendence company of India (P) Ltd v. Krishan Murgai, the Supreme Court held that the post-employment restraint was void under Section 27. The court held that once the employment bond comes to an end, or has been terminated by the employer, the future obligations of the employee come to an end and the employee must remain free to pursue any lawful profession, trade or business.
Also, the courts have noted that when a restrictive clause in the contract does not violate Section 27, there is possibility that it may be declared void under Section 23. Under Section 23 of the Indian Contract Act, an agreement is invalid if the agreement is opposed to public policy. For instance, in the case of Central Inland Water Transport Corporation Ltd. V. Brojo Nath Ganguly, the court held that contractual terms which are unfair, unreasonable, or injurious to the public interest are void. The court recognized that employment contracts involve unequal bargaining power because employees are presented with standard form contracts on a “take-it-or-leave-it” basis. In these cases, the employee has no such opportunity to negotiate the term of an employment bond. In most cases, the only choice available is to accept the contract as it is or decline the job offer. In these scenarios, the court had observed that an employee, may accept burdensome restrictions when they are in desperate to secure a job which serves their livelihood.
The unequal bargaining power between an employer and an employee is an important factor in determining the validity of the negative covenants. Employment contracts are agreements drafted solely by the employer, leaving the employee with little or no opportunity to negotiate their terms. Though negative convents operating during the term of employment are enforceable, courts do scrutinize the clauses to ensure that they are not entirely arbitrary or one-sided in total favor of the employer. A contract that imposes an unreasonable burden on the employee may be declared void under Section 23, as being opposed to public policy, even if it does not come under the scope of Section 27. However, it should be noted that decisions on public policy have been subject to change. With the change in trade and free-markets the general principle once applicable to agreements in restraints of trade have been molded in accordance with the country's economic conditions or economic policy.
Arbitration of Employment Contract Disputes
Another clause, apart from restrictive clauses found in the employment contract is the arbitration clause. In an employment contract, one should very carefully note, that it is very likely to have an arbitration clause in an employment contract. An arbitration clause in an employment contract requires employers and employees to resolve workplace disputes outside the court. On the positive side, it ensures that workplace disputes are resolved quickly. However, it also has some drawbacks, as employees often face unequal bargaining power when signing it, often initially give up their right to a jury trial or appeal.
But, there are some exceptions as well. For example, in the case of Dushyant Janbandhu v. M/s Hyundai AutoEver India Pvt.Ltd the Supreme Court ruled that the dispute related to wages and termination of an employee were non-arbitrable and would be exclusively dealt with by the statutory established under the Payment of Wages Act, 1936 (“PW Act”) and the Industrial Dispute Act, 1947 (“ID Act”).
Therefore, one must be aware of what exactly it is written in the arbitration clause. Both the employers and employees should be aware that the scope of arbitration in employment contracts is not absolute and is limited by statutory protections give to the employees.
Final Takeaway
The enforceability of the negative covenants in employment contracts depends on their nature, duration, and purpose. While restraints operating during the term of employment are generally upheld as legitimate means of protecting the employer's interests, post-employment restraints are ordinarily void under Section 27, except in limited situations recognized by law. And at the same time, valid contracts may be struck down under Section 23 if they are against public polices or not reasonable. Indian courts seek to maintain a balance between safeguarding an employer's legitimate business interests and preserving an employee's constitutional and contractual freedom to pursue a lawful profession.
The author is a student of the Shiv Nadar School of Law.