Supreme Court Says Employment Bonds Must Balance Public Interest And Fair Terms

Introduction

The relationship between an employer and an employee is vital for the continuous growth and success of any business. Employees are expected to show loyalty, especially since employers invest in shaping them during the initial years through training and exposure to various aspects of the work. Loyalty, however, is a two-way street, employers must also ensure that employees are satisfied with their roles and are fairly compensated. In today's competitive job market, retaining skilled employees is increasingly challenging. To safeguard the time and resources spent on training, employers often incorporate minimum service clauses or employment bonds, requiring employees to serve for a specified period or pay compensation upon early resignation.

In the recent decision of Vijaya Bank & Anr. v. Prashant B. Narnaware, the Hon'ble Supreme Court of India upheld the validity of a minimum service clause requiring an employee of a public sector bank to either serve for a specified period or pay liquidated damages upon early resignation. The Court clarified that such employment bonds or minimum service period conditions, when they operate during the term of employment, do not amount to a restraint of trade under Section 27 of the Indian Contract Act. They are generally enforceable if they are reasonable, proportionate, and not punitive in nature.

While the judgment focused solely on restrictions during employment, it is settled law that any post-employment restrictions, such as non-compete clauses, even if partial and operative after the termination of employment, are strictly void under Section 27 of the Indian Contract Act, even if they appear reasonable, thereby reflecting the consistent and strict interpretation adopted under Indian contract law.

Brief Description of Facts

Prashant B. Narnaware ("Respondent") was employed by Vijaya Bank ("Appellant") and rose to the rank of Middle Management Grade. In 2006, the Appellant issued a recruitment notification for officer-level posts, requiring selected candidates to execute a service bond of ₹2,00,000, enforceable if the employee resigned within 3 (three) years.

The Respondent applied and was selected for the post of Senior Manager (Cost Accountant). He joined on 28 September 2007 and signed the bond in accordance with Clause 11(k) of the appointment letter, agreeing to serve for three years or pay the bond amount upon early resignation.

On 17 July 2009, before completing the three-year term, the Respondent resigned to join IDBI Bank. His resignation was accepted, and he paid the stipulated bond amount.

Subsequently, the Respondent filed a writ petition before the High Court challenging the validity of Clause 11(k) and the recruitment notification. He argued that:

The High Court ruled in the favour of Respondent, quashing Clause 11(k) and ordering a refund of the amount paid. The High Court's decision was primarily based on decision in K.Y. Venkatesh Kumar v. BEML Ltd., which viewed similar clauses as legally unenforceable. This prompted the Appellant to appeal this decision before the Hon'ble Supreme Court of India ("Supreme Court").

Judgment / Ruling of the Court

The Supreme Court reversed the High Court's ruling and upheld the validity of Clause 11(k) in the Respondent's appointment letter. The Court held that Clause 11(k), was not a restraint of trade under Section 27 of the Act. Restrictions during employment are generally valid unless unconscionable or excessively harsh. Since Clause 11(k) applied during the term of employment and imposed no post-employment restriction, it did not infringe upon the employee's right to seek alternative employment.

The Court further held that Clause 11(k) was not opposed to public policy under Section 23 of the Act. Although the term "public policy" is not expressly defined under the Act, the Appellant showed that the clause was reasonable, non-arbitrary, and served a legitimate public interest. Its objective was to ensure continuity and stability in public sector banking, where an untimely resignation would compel the Bank to initiate a lengthy and costly recruitment process. This recruitment process must also involve constitutional mandates enshrined in Articles 14 and 16 of the Constitution.

The stipulated bond amount of ₹2,00,000 was deemed reasonable, considering the seniority of the role. The Respondent had voluntarily paid the amount and moved to another organisation, indicating that the clause did not practically hinder career progression. Furthermore, the issue of financial loss suffered by the public sector undertaking due to time-consuming and costly recruitment by premature resignations had not arisen for consideration in the decision in BEML.

Not All Employment Bonds Are Enforceable Equally

This particular judgment specifically addresses the enforceability of employment bonds within the framework of public sector undertakings ("PSUs"). It does not amount to a blanket approval or rejection of employment bonds across all sectors. Rather, the Court clarified that enforceability of the bond depends on whether the clause is reasonable, proportionate, and aligned with public interest.

In this case, the Court recognised the unique constraints under which PSUs operate. Public sector recruitment is governed by constitutional requirements under Articles 14 and 16, mandating fair, transparent, and competitive hiring processes. Premature resignations disrupt this framework and necessitate costly, time-consuming recruitment drives. Since the liberalisation, PSUs have had to compete with private players, prompting reforms to improve efficiency. In this context, employment bonds help retain experienced staff and serve as legitimate tools to ensure stability, and not as punitive measures

While the judgment arises from a PSU context, it does not imply that employment bonds are unenforceable in other sectors. The validity of such clauses, whether in private or public employment, will depend on their reasonableness, fairness, and alignment with public interest. What is just, fair, and reasonable may vary with time and context, and must be assessed on a case-to-case basis.

Other Judgments Captured / Referred

The Supreme Court, in upholding the validity of Clause 11(k), relied on key precedents such as Niranjan Shankar Golikari v. Century Spinningand Manufacturing Co and Superintendence Company (P) Ltd.. v. Krishan Murgai to reaffirm the distinction between negative covenants operative during and after employment. The Court reiterated that restraints imposed during employment, like exclusivity or minimum service conditions, do not violate Section 27 of the Act, as the doctrine of restraint of trade applies only after termination of employment. Clause 11(k), which required the employee to either serve a minimum term or pay liquidated damages, was deemed to operate during employment and not to restrict future employability, and thus was held not to be in restraint of trade.

It is also important to note that the Supreme Court in Murgai (supra) adopted a strict interpretation of Section 27 of the Act, holding that post-employment restrictions are void, even if they appear reasonable. The Court expressly declined to follow the English law approach, under which all covenants in restraint of trade, whether partial or general, are prima facie void but may be enforced if they satisfy the test of reasonableness, as propounded by Lord Macnaghten in Nordenfelt v. Maxim Nordenfelt Guns & Ammunition Co. Ltd. Under Indian law, the only recognised exception to the prohibition under Section 27 is in cases involving the sale of goodwill, highlighting the strict approach consistently adopted by Indian courts in interpreting Section 27 of the Act

The Court also evaluated the clause under the lens of public policy under Section 23 of the Contract Act, referring to Central Inland Water Transport Corporation Ltd. v. Brojo Nath Ganguly. It acknowledged that standard form employment contracts often reflect unequal bargaining power, where the employee has little or no scope to negotiate terms. In such scenarios, if the employee pleads undue influence or oppression, courts must examine the fairness of the clause, especially when it affects public interest. Any clause found to be unconscionable, unfair, or unreasonable may be void as opposed to public policy, and the burden of proving that a restrictive covenant is justifiable rests on the employer.

The Court clarified that public policy is a dynamic concept shaped by societal and industrial evolution rather than tied to any government's policy. Within employment contracts, reasonable restraints that are essential to protect legitimate business interests may be upheld, provided they are not oppressive or unjust. The Court further distinguished BEML judgement., noting that this judgement involved not only a minimum service term but also post-employment restrictions, and did not address the financial and operational challenges faced by public sector entities due to premature exits, making the High Court's reliance on that decision inappropriate.

Conclusion

The Supreme Court's decision in Vijaya Bank v. Prashant B. Narnaware reaffirms the enforceability of minimum service period clauses in employment contracts, particularly within the context of public sector undertakings. By distinguishing between restrictions during employment and post-employment restraints, the Court has clarified that the former may be valid if they are reasonable, proportionate, and not oppressive. This ruling underscores the importance of balancing employer interests, such as retaining trained talent and ensuring operational continuity, with employee rights and freedoms.

Importantly, while this judgment arises from a public sector scenario, it sets a persuasive precedent for the private sector as well, reinforcing that employment bonds may be upheld if they do not infringe upon public policy or constitutional principles. However, courts will continue to examine such clauses on a case-by-case basis, keeping in mind evolving notions of fairness, equity, and the realities of modern employment.

Disclaimer: LexCounsel provides this e-update on a complimentary basis solely for informational purposes. It is not intended to constitute, and should not be taken as, legal advice, or a communication intended to solicit or establish any attorney-client relationship between LexCounsel and the reader(s). LexCounsel shall not have any obligations or liabilities towards any acts or omission of any reader(s) consequent to any information contained in this e-newsletter. The readers are advised to consult competent professionals in their own judgment before acting on the basis of any information provided hereby.