The Supreme Court of India delivered a significant judgment in Vijaya Bank & Anr. v. Prashant B Narnaware (Civil Appeal No. 11499 of 2016), overruling a High Court decision that had quashed a clause in an appointment letter requiring an employee to pay liquidated damages for leaving employment prematurely. The Supreme Court upheld the validity of Clause 11(k) of the Appointment Letter, concluding that it neither amounted to a restraint of trade under Section 27, nor was it opposed to public policy under Section 23, of the Indian Contract Act, 1872 (hereinafter referred to as the "Act"). The judgment clarifies the enforceability of restrictive covenants in employment contracts, particularly in the context of public sector undertakings.
Background
The Respondent, Prashant B Narnaware, joined Vijaya Bank (the Appellant) in 1999 as a Probationary Assistant Manager, and his service was confirmed in 2001. He was subsequently promoted to Middle Management Scale-II. In 2006, Vijaya Bank issued a recruitment notification which included a condition under Clause 9(w) stating that selected candidates were required to execute an indemnity bond of rupees 2 lakhs, indemnifying the bank if they left service before completing three years.
Cognizant of this condition, the Respondent applied for the post of Senior Manager-Cost Accountant. He was selected and was issued an appointment letter on August 7, 2007. Clause 11(k) of the concerned Appointment Letter stipulated that the employee was required to serve the bank for a minimum period of three years and execute an indemnity bond for rupees 2 lakhs, payable if he resigned before completing the stipulated period.
Accepting these terms, the Respondent resigned from his existing post as Manager, MMG-II, and joined the new position of Senior Manager, MMG-III, on September 28, 2007. He also executed the required indemnity bond.
However, on July 17, 2009, prior to completing the three-year minimum service period, the Respondent tendered his resignation to join another bank. His resignation was accepted, and on October 16, 2009, he paid rupees 2 lakhs under protest, as per the condition.
Subsequently, the Respondent filed a writ petition before the High Court, seeking to quash Clause 9(w) of the recruitment notification and Clause 11(k) of the Appointment Letter. The Respondent argued that these clauses violated Articles 14 (equality before the law) and 19(1)(g) (right to practice any profession) of the Constitution of India, as well as Sections 23 (unlawful agreements) and 27 (restraint of trade) of the Act of 1872.
The High Court's Single Judge, relying on a Division Bench decision in K.Y. Venkatesh Kumar v. BEML Ltd.1, allowed the writ petition, and this order was subsequently upheld by the Division Bench. The High Court had directed the Appellant Bank to refund the rupees 2 Lakhs to the Respondent. Vijaya Bank challenged this judgment before the Supreme Court.
Key Issues Before the Supreme Court
The Supreme Court identified two primary issues for consideration:
- Whether clause 11(k) of the Appointment Letter amounted to a restraint of trade under Section 27 of the Act of 1872.
- Whether the clause was opposed to public policy and thereby contrary to Section 23 of the Act of 1872 and violative of Articles 14 and 19 of the Constitution of India.
Restraint of Trade
Section 27 of the Act states that every agreement that restrains a person from exercising a lawful profession, trade, or business is void, with the sole exception being in the sale of goodwill. The Supreme Court affirmed that the Contract Act, while not a complete code, is exhaustive regarding the subject matter it covers, meaning thereby, that the validity of restrictive covenants in agreements, including employment agreements, must be tested against Section 27.
The Court delved into the distinction between restrictive covenants operating during the subsistence of an employment contract and those operating after its termination. It relied heavily on its prior pronouncements in Niranjan Shankar Golikari v. Century Spinning and Manufacturing Co.2 and Superintendence Company (P) Ltd. v. Krishan Murgai3.
In Niranjan Shankar Golikari (supra), the Court had held that restrictive covenants operating during the period of an employment contract, where the employee is exclusively bound to their employer, are generally not considered a restraint of trade and thus do not fall under Section 27. Such negative covenants, preventing an employee from engaging in similar trade or business or being employed by another master for similar duties, are not a restraint of trade unless the contract is unconscionable, excessively harsh, unreasonable, or one-sided.
This view was reiterated by A.P. Sen, J. in his concurrent opinion in Superintendence Company (P) Ltd. (supra), wherein it was stated that service agreements containing negative covenants, preventing employees from working elsewhere during the contract term are not void under Section 27. The rationale is that the doctrine of restraint of trade does not apply during the continuance of employment; it applies only after the contract ends.
Based on these authoritative pronouncements, the Supreme Court concluded that the law is well-settled: a restrictive covenant operating during the subsistence of an employment contract does not restrict a party's freedom to trade or employment.
Applying this principle to the instant case, the Court observed that Clause 11(k) of the Appointment Letter imposed a restriction on the Respondent to work for a minimum term of three years and, in default, to pay liquidated damages of rupees 2 Lakhs. This clause aimed to impose a restriction on the Respondent's option to resign, thereby perpetuating the employment contract for a specified term. The Court emphasized that the object of this restrictive covenant was in furtherance of the employment contract, not to restrain future employment. Therefore, it could not be deemed violative of Section 27 of the Act.
Public Policy
The Respondent argued that Clause 11(k) of the Appointment Letter was part of a standard form contract, compelling him to accept it due to unequal bargaining power, and that it was an unreasonable, onerous, and disproportionate measure leading to unjust enrichment for the Appellant Bank. The Respondent contended that such a clause was opposed to public policy.
The Supreme Court examined the interpretation of standard form employment contracts, particularly in the context of unequal bargaining power, drawing on its decision in Central Inland Water Transport Corporation Ltd. v. Brojo Nath Ganguly4. In that case, the Court had opined that if such contracts are unconscionable, unfair, unreasonable, and injurious to public interest, they should be deemed void under Section 23 of the Act, for being opposed to public policy. The Court in Central Inland Water Transport Corporation Ltd. (supra) had highlighted that contracts in standard forms, entered into by parties with superior bargaining power with numerous individuals having less or no bargaining power, if unconscionable, unfair, and unreasonable, are injurious to public interest and should be adjudged as void. A.P. Sen, J., in Superintendence Company (P) Ltd.(supra), had also noted the need to scrutinize employee covenants carefully due to the inequality of bargaining power, as employees are often presented with standard form contracts on a 'take it or leave it' basis.
Summarizing the legal principles for interpreting standard form employment contracts, the Supreme Court stated:
- Standard form employment contracts prima facie evidence unequal bargaining power.
- When the weaker party alleges undue influence/coercion or that a term is opposed to public policy, the Court must consider the unequal status of the parties and the context of the contractual obligations.
- The onus to prove, that a restrictive covenant is not in restraint of lawful employment or not opposed to public policy, lies on the employer (covenantee).
The Court then turned to the definition and evolving nature of 'public policy'. It reiterated that 'public policy' is not precisely definable and concerns the public good and public interest, evolving with time and societal changes. The Supreme Court, from the perspective of employer-employee relationships, acknowledged that technological advancements, re-skilling, and the preservation of scarce specialized workforce in a free market are emerging considerations in the public policy domain. The Court specifically highlighted the context of liberalization in India since the late 20th century, which necessitated public sector undertakings like Vijaya Bank to compete with private players. To survive and improve efficiency, these undertakings needed tools to retain efficient and experienced staff, including managerial skills.
From this perspective, the Court reasoned that the Appellant Bank's incorporation of a minimum service tenure was aimed at reducing attrition and improving efficiency. Thus, the restrictive covenant prescribing a minimum term could not be deemed unconscionable, unfair, or unreasonable, and thereby not in contravention of public policy.
Regarding the liquidated damages of rupees 2 lakhs, the Respondent argued that it was disproportionate and led to unjust enrichment for the employer. However, the Appellant Bank had clarified in its pleadings the financial hardship caused by untimely recruitment drives due to premature resignations. The bank emphasized that premature resignations would render the recruitment process redundant, lead to losses in continuity of the post, necessitate alternative arrangements, and require a fresh, time-consuming, and expensive recruitment process, which for a public sector undertaking involves open advertisement and competitive procedures to adhere to constitutional mandates under Articles 14 and 16.
The Supreme Court found the Appellant Bank's stance to be neither unjust nor unreasonable. It noted that the Respondent was a senior middle managerial grade employee with a lucrative pay package. From that viewpoint, the quantum of liquidated damages was not so high as to prevent resignation.
The Court criticized the High Court for failing to consider the restrictive covenant in its proper factual context and for mechanically relying on BEML (supra). The Supreme Court distinguished BEML(supra) by pointing out that it involved a restrictive covenant that also imposed a bar on future employability, a factor not present in the instant case. Furthermore, in BEML (supra), the issue of financial loss suffered by a public sector undertaking due to time-consuming and expensive recruitment drives had not been considered. The Court emphasized that judgments should not be read as statutes and must be applied considering the specific factual matrix of each case.
In light of its detailed discussion, the Supreme Court concluded that the restrictive covenant in clause 11(k) of the Appointment Letter neither amounted to a restraint of trade nor was it opposed to public policy. Consequently, the Court allowed the appeal, setting aside the impugned judgment and order of the High Court.
Our Analysis
This judgment provides clarity on the validity and enforceability of clauses in employment contracts that require a minimum service period and impose liquidated damages for premature resignation, particularly in the context of public sector undertakings. It reinforces the principle that such clauses, when reasonably framed to protect the employer's legitimate interests (like recouping recruitment and training costs, and ensuring continuity of service), are not necessarily a restraint of trade or against public policy, especially when the restriction operates during the subsistence of the employment contract. From a corporate and commercial perspective, the judgment affirms the enforceability of minimum service clauses and liquidated damages in managerial appointments, recognizing them as legitimate safeguards against attrition and operational disruption. This decision provides much-needed legal certainty for employers, especially in regulated sectors where recruitment is resource-intensive and time-bound. By distinguishing such in-service covenants from post-employment restraints, the Court has balanced employee mobility with the commercial imperative of workforce continuity.
Footnotes
1 Karnataka HC DB in W.A. No. 2736/2009
2 1967 SCC OnLine SC 72
3 (1981) 2 SCC 246
4 (1986) 3 SCC 156
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