'Employment Bond Valid, Doesn't Violate S.27 Contract Act' : Supreme Court Upholds Rs 2 Lakh Penalty For Premature Resignation

The Supreme Court upheld the validity of a bond clause in an employment contract, allowing a Public Sector Bank to recover ₹2 lakhs from an employee who resigned before completing the mandatory three-year service period. The Court held that exclusivity clauses in employment contracts (requiring minimum service period) are legally permissible and do not fall within the scope of Section 27 of the Indian Contract Act, which prohibits agreements in restraint of trade. Since these clauses operate during the term of employment rather than post-termination, they are not considered restrictive under the law, the court said. The Court emphasized that in today's competitive environment, public sector undertakings must continuously revise their policies to enhance operational efficiency and streamline administrative costs. One critical aspect of this strategy is retaining skilled and experienced staff who contribute to the development of managerial capacity, an interest that the Court deemed essential to such organizations. “Since the last decade of 20th century, India witnessed an era of liberalization. Golden days of monopolistic public sector behemoths were gone. Public sector undertakings like the appellant-bank needed to compete with efficient private players operating in the same field. To survive in an atmosphere of deregulated free-market, public sector undertakings were required to review and reset policies which increased efficiency and rationalized administrative overheads. Ensuring retention of an efficient and experienced staff contributing to managerial skills was one of the tools inalienable to the interest of such undertakings including the appellant-bank.”, the court said “This prompted the appellant-bank to incorporate a minimum service tenure for employees, to reduce attrition and improve efficiency. Viewed from this perspective, the restrictive covenant prescribing a minimum term cannot be said to be unconscionable, unfair or unreasonable and thereby in contravention of public policy.”, the court added Consequently, the Court found that requiring a minimum service period in employment contracts is a legitimate and reasonable means of reducing attrition and maintaining efficiency. Such provisions cannot be considered oppressive, unconscionable, or contrary to public policy. Allowing employees to resign prematurely would compel the Bank to initiate a lengthy and costly recruitment process, including open advertising, which the Court viewed as an unnecessary burden on the institution. Background The bench comprising Justice PS Narasimha and Justice Joymalya Bagchi was hearing the case in which the appellant, Vijaya Bank, issued a recruitment notification requiring selected officers to execute a ₹2 lakh indemnity bond if they resigned within 3 years. The Respondent, who joined as Senior Manager-Cost Accountant, accepting the condition, had resigned before 3 years to join IDBI Bank, and paid ₹2 lakhs under protest, challenging the clause in court. The Karnataka High Court quashed the clause, calling it a "restraint of trade" under Section 27, Contract Act, prompting the Appellant-Bank to approach the Supreme Court. Decision Setting aside the High Court's decision, the judgment authored by Justice Bagchi emphasized that exclusivity clauses cannot be termed as restrictive of trade practices under Section 27 of the Contract Act, as such clauses do not restrict future employment but only imposed a financial penalty for early exit."A plain reading of clause 11 (k) shows restraint was imposed on the respondent to work for a minimum term i.e. three years and in default to pay liquidated damages of Rs. 2 Lakhs. The clause sought to impose a restriction on the respondent's option to resign and thereby perpetuated the employment contract for a specified term. The object of the restrictive covenant was in furtherance of the employment contract and not to restrain future employment. Hence, it cannot be said to be violative of Section 27 of the Contract Act."The Court rejected the Respondent's argument that such exclusivity clauses were unconscionable and part of a standard-form contract with no negotiation scope. Instead, the Court stated such clause to be reasonable given the fact that public sector undertakings need to retain skilled staff, and early exit prompts them to incur high cost of re-recruitment. “The appellant-bank is a public sector undertaking and cannot resort to private or ad-hoc appointments through private contracts. 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.”, the court said. Thus, the Court justified the imposition of Rs. 2 lakhs penalty, stating that it was not excessive for a Respondent, who was a Senior Manager (MMG-III) drawing a lucrative salary. Accordingly, the Court...

'Employment Bond Valid, Doesn't Violate S.27 Contract Act' : Supreme Court Upholds Rs 2 Lakh Penalty For Premature Resignation

Yash Mittal

The restrictive covenant prescribing a minimum term cannot be said to be unconscionable, unfair or unreasonable, the Court held.

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