Abstract
In a recent judgement in Vijaya Bank and Ors. v. Prashant B. Narnaware (Civil Appeal Nos. 11708 of 2016 and 11499 of 2016) decided on May 14, 2025, the Supreme Court of India considered the legal position relating to employment bonds in India. The Supreme Court re-affirmed the tests for restrictive covenants in employment contracts and opined on how the public policy exception could come into play in India’s employment law paradigm.
Background
The respondent-employee was originally employed by Vijaya Bank in 1999. In 2006, the appellant-employer (i.e., the bank) issued a recruitment notification for officer positions in different grades, with the recruitment notification stipulating 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 employee applied for the post of Senior Manager-Cost Accountant and was selected for the post, and was issued a fresh appointment letter which required the employee to execute an indemnity bond, indemnifying the employer in the event the employee resigns from the services of the bank prior to the completion of a minimum period of three years. The relevant clause of the appointment letter stated:
“You are 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 for 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 minimum period of 3 years. For this purpose, you have to bring a blank non-judicial stamp paper of Rs. 100/- procured in the State of your posting.”
The employee accepted this condition, voluntarily resigned from his existing position with the employer-bank, and joined the new position, as a Senior Manager-Cost Accountant. He also executed the required indemnity bond. However, prior to the completion of three years from his date of joining the new position, he resigned to join another bank. His resignation was duly accepted by the employer-bank, and under protest, he paid the amount of INR 0.2 million as indemnity, in accordance with the terms of his appointment letter.
The employee subsequently filed a writ petition before the Karnataka High Court, seeking to quash the requirement for the employment bond in the recruitment notification and his appointment letter, arguing inter alia that it violated Sections 23 and 27 of the Indian Contract Act, 1872.
The Karnataka High Court held in favor of the employee, with a single judge bench allowing the writ petition, holding the requirement for the employment bond to be unconscionable, unsustainable and unenforceable in law. A division bench of the same court dismissed a writ appeal by the employer-bank. On appeal to the Supreme Court, the following two questions pertaining to the relevant employment bond provision were identified:
- whether such provision constitutes a restraint of trade under Section 27 of the Contract Act, and /or
- whether such provision is opposed to public policy, thus violating Section 23 of the Contract Act?
Analysis
Public policy
Every agreement of which the object or consideration is unlawful, is void. The object or consideration of an agreement is not considered to be lawful if it is inter alia “opposed to public policy”. The Contract Act does not define the expression “public policy” or “opposed to public policy”, and it has consistently been reiterated by the courts that such terms are incapable of precise definition. In Central Inland Water Transport Corporation Limited v. Brojo Nath Ganguly (AIR (1986) SC 1571), the Supreme Court recognized public policy to be a dynamic concept that has varied from time to time. Generally, public policy connotes some matter which concerns the “public good” and “public interest”, and not the policy of any particular government.
In light of the above, contracts which would affect a large number of people, if they are unconscionable, unfair and unreasonable, have been found to be injurious to the public interest. An unconscionable contract would be one which is irreconcilable with what is right or reasonable. Another legal principle is the test of reasonableness or fairness of a clause in a contract; where there is an inequality of bargaining power between the parties, courts are likely to strike down an unfair or unreasonable provision.
The Supreme Court summarized the legal principles relating to interpretation of standard form employment contracts, recognizing that such contracts prima facie evidence unequal bargaining power between employers and employees. This unequal status of the parties must be kept in mind by courts when a party alleges that an employment contract, or any part thereof, is opposed to public policy. In such a scenario, the onus is on the employer to prove that such contract, or part thereof, is not opposed to public policy.
In the case at hand, since the appellant-bank had incorporated a minimum service tenure to reduce attrition and improve efficiency, the Supreme Court held that such a clause in the employment contract cannot be said to be unconscionable, unfair or unreasonable and thereby would not be in contravention of public policy. The Supreme Court noted that an untimely resignation would require the employer-bank, as a public sector company, to undertake an expensive recruitment process involving open advertisement and fair procedure lest the procedure falls foul of the constitutional mandate.
Restraint of trade
An agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind is, to that extent, void. This principle extends to restraints on the right of being employed, and a literal interpretation may suggest that every agreement creating any restrictive covenant on an employee’s right to employment is void. However, jurisprudence has evolved to provide that restraints, where reasonable, may be permitted, whether general or partial. Indeed, the leading Supreme Court judgement in Niranjan Shankar Golikari v. The Century Spinning (AIR (1967) SC 1098) found that restrictive covenants applicable during the term of a contract of employment must be distinguished from those that apply after its cessation, and negative covenants operating during the term of a contract of employment are generally not regarded as a restraint of trade, and therefore do not fall foul of Section 27 of the Contract Act. In fact, an employer would expect its employee to be bound to serve the employer exclusively – such a restriction cannot be said to be unconscionable, excessively harsh, unreasonable or one-sided.
On the other hand, an employer generally should not have any legitimate interest in preventing an employee from entering the service of a competitor, after the termination of their existing employment relationship.
In the case at hand, the Supreme Court recognized that while the employment bond amounted to a restraint on the employee, effectively requiring him to complete a minimum period of three years of employment, such a restraint was in furtherance of the employment contract, during its course, and was not to restrain future employment. The Supreme Court considered that based on the pay package of the employee, the quantum of the bond amount was not so high as to render the possibility of resignation as illusionary. It thus considered such a restriction reasonable and not violative of Section 27 of the Contract Act.
Conclusion
As regards restraint of trade, the Supreme Court in Vijaya Bank re-affirmed a long-standing precedent while navigating employer-employee relationships. It reiterated the distinction between restrictions in a contract of employment which are operative during the period of employment and those which operate after the termination of employment. It concluded that a restrictive covenant during the subsistence of an employment contract does not put a clog on the freedom of a contracting party to trade or employment.
This decision also assesses the debate on unequal bargaining power between employers and employees. While it upheld the specific employment bond under consideration based on the factual context, employers need to carefully weigh the pros and cons of inserting restrictive bonds in employment agreements. Although such employment bonds add certainty to the employer’s supply of personnel, the tenure and amount linked to employment bonds need to be reviewed with due regard to specific facts and situations to enhance the likelihood of their being upheld upon judicial scrutiny.
This insight has been authored by Rajat Sethi, Riyan Vatcha and Shashankaa Tewari from S&R Associates. They can be reached at [email protected], [email protected] and [email protected], respectively, for any questions. This insight is intended only as a general discussion of issues and is not intended for any solicitation of work. It should not be regarded as legal advice and no legal or business decision should be based on its content.