Know The Law | Whether Employment Bonds Are Legally Enforceable In India? Supreme Court Explains

The Supreme Court recently resolved the contentious issue of whether employment bonds are valid and legally enforceable in India.It held that employment bond agreements mandating a minimum service period or imposing a financial penalty for early resignation are legally valid. The Court ruled that such clauses do not violate Section 27 of the Indian Contract Act, 1872, which prohibits restraints on trade, provided the restrictions operate only during the period of employment and do not prevent the employee's right to seek other job opportunities post resignation.The case heard by a bench of Justices PS Narasimha and Joymalya Bagchi centered around a contentious clause in the Appellant-Vijaya Bank's employment contract with a Respondent-employee, which required him to serve a minimum of three years or pay a hefty penalty of ₹2 lakh for premature resignation. The Respondent, a Senior Manager-Cost Accountant, had resigned before completing his tenure to join IDBI Bank, triggering the penalty clause. Challenging the bond's validity, he argued that it violated Section 27 of the Indian Contract Act, 1872, as the imposition of a Rs. 2 lacs penalty for early exit prohibited him from joining new employment. Further, the Respondent argued that the penalty clause was opposed to public policy as, at the time, he was compelled to comply with the illegal condition of depositing Rs. 2 lacs, which he had done under protest. Rejecting the Respondent's argument, the judgment authored by Justice Bagchi emphasized that public sector undertakings (PSUs) have a legitimate interest in retaining skilled employees and avoiding costly recruitment processes, making such bonds reasonable and not opposed to public policy if the penalties are proportionate and the terms are transparent. “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. “Respondent was serving in a senior middle managerial grade having a lucrative pay package. Judged from that perspective, the quantum of liquidated damages was not so high as to render the possibility of resignation illusory. In fact, the appellant had paid the said quantum and resigned from the post.”, the court said. Restrictive Covenants Are Valid If Imposes Restrictions During Employment, Not Post-Termination However, the Court cautioned against oppressive or unconscionable clauses, particularly in standard-form contracts where employees may have little bargaining power. This ruling aligns with precedents like Niranjan Shankar Golikari v. Century Spinning Co. 1967 SCC OnLine SC 72, which upheld reasonable restrictions during employment but struck down post-termination bans. A fruitful reference was also made to the case of Superintendence Company (P) Ltd. v. Krishan Murgai, (1981) 2 SCC 246, where the court, speaking through Justice AP Sen, upheld the validity of restrictive covenants during the subsistence of a contract. “In view of these authoritative pronouncements, it can be safely concluded law is well settled that a restrictive covenant operating during the subsistence of an employment contract does not put a clog on the freedom of a contracting party to trade or employment.”, the court said. Incorporating Minimum Service Tenure For Employees To Reduce Attrition And Improve Efficiency Is Not Opposed To Public Policy Further, the Court stated that re-skilling and preservation of scarce specialized workforce in a free market are emerging heads in the public policy domain which need to be factored when terms of an employment contract is tested on the anvil of public policy. The Court supported the minimum service tenure in employment stating that “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.” “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. Conclusion Ultimately, the Court allowed the Bank's appeal, holding that employment bonds are legal and ...

Know The Law | Whether Employment Bonds Are Legally Enforceable In India? Supreme Court Explains

Yash Mittal

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