Contractual Validity Of Restrictive Covenants For Premature Resignation Legal Analysis

Update: 2025-08-30 03:30 GMT
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In a significant judgment delivered on 14 May 2025, the Supreme Court of India in Vijaya Bank & Anr. v. Prashant B. Narnaware, 2025 LiveLaw (SC) 565 (“Vijaya Bank Case”) clarified the enforceability of liquidated damages clauses in employment contracts, particularly in cases of premature resignation. The court held that a clause requiring an employee to pay a pre-determined sum...

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In a significant judgment delivered on 14 May 2025, the Supreme Court of India in Vijaya Bank & Anr. v. Prashant B. Narnaware, 2025 LiveLaw (SC) 565 (“Vijaya Bank Case”) clarified the enforceability of liquidated damages clauses in employment contracts, particularly in cases of premature resignation. The court held that a clause requiring an employee to pay a pre-determined sum for leaving employment before completing a minimum tenure does not amount to a restraint of trade under Section 27 of the Indian Contract Act, 1872 (“ICA”), nor is it opposed to public policy under Section 23 of the ICA.

The Facts and the Clause in Question

The Respondent, an officer in Appellant's Bank, i.e. Vijaya Bank, applied for a promotion and was appointed to a higher post in 2007, with a condition in Clause 11(k) of the appointment letter that required him to serve a minimum of 3 (three) years in the Appellant's Bank. If he resigned before that period, he was liable to pay INR 2,00,000 (Rupees Two Lakhs) as liquidated damages.

The Respondent accepted the terms, joined the post, and executed the required indemnity bond. In 2009, before completing the stipulated mandatory 3 (three) years period in the Appellant's Bank, he resigned to join IDBI Bank and paid the damages under protest. He later challenged the validity of the clause before the High Court, which held the requirement to be invalid and struck it down, calling it violative of Articles 14 and 19(1)(g) of the Constitution of India and Sections 23 and 27 of ICA.

Legal Issues

  1. The central legal issues before the Supreme Court in the instant case were:
  2. Whether the condition in the appointment letter requiring an employee to serve a minimum period of time in a public sector organisation or pay liquidated damages in lieu of it, constituted a restraint of trade under Section 27 of ICA?
  3. Whether the above condition was opposed to public policy under Section 23, and therefore unenforceable?
  4. Additionally, the Supreme Court also determined if the clause was disproportionate, unconscionable, or excessive, especially in a standard form contract where unequal bargaining power was alleged.

Judicial Reasoning and Precedents – for Standard Form Contracts

To understand the standard form contracts, we may refer to Central Inland Water Transport Corporation Ltd. v. Brojo Nath Ganguly, 1986 INSC 66, wherein it was explained that standard form contracts are standard or in a prescribed form or consist of a set of rules as part of the contract. They are not contracts between individuals containing terms meant for those individuals alone. Such contracts are entered into by the party with superior bargaining power with a large number of persons who have far less bargaining power or no bargaining power at all. The Supreme Court observed that such contracts which impact a large number of individuals or group, and are unconscionable, unfair, or unreasonable, would be detrimental to public interest. Therefore, such a contract or clause ought to be declared void as it is contrary to public policy.

Interpreting the principle of restraint of trade, the Supreme Court in Superintendence Co. v. Krishan Murgai (1981), 1980 INSC 124 (“Krishna Murgai Case”), opined that “the doctrine of restraint of trade never applies during a continuance of a contract of employment; it applies only when the contract comes to an end.” The Apex Court further referred to an observation in Niranjan Shankar Golikari v. Century Spinning and Mfg. Co. Ltd, 1967 INSC 10 (“Niranjan Shankar Case”), wherein it was stated that – “a restraint by which a person binds himself during the term of his agreement directly or indirectly not to take service with any other employer or be engaged by a third party has been held not to be void and not against Section 27 of the Contract Act.

Therefore, with the help of above observations, it is clear that the question of restraint of trade under Section 27 of ICA can only be analysed if the restraint has been imposed post the termination of employment and not during the employment. Secondly, that if a person himself/herself agrees to get bound by the restrictive or negative covenants, then the terms cannot be held to be violative of Section 27 of ICA. However, the above conclusions are qualified by the observations made in Niranjan Shankar Case and Krishna Murgai Case, wherein it was held that a contract imposing restrictive covenants will not be violative of restraint of trade if the contract—

  1. is not unconscionable or excessively harsh;
  2. is not unreasonable, unfair or one-sided; and
  3. involves equal bargaining of both parties.

Decision in Vijaya Bank Case

In this case, the Supreme Court found that the clause did not bar future employment, nor did it impose a post-exit restriction. It merely sought to secure a minimum tenure through a pre-agreed financial consequence (which the Respondent paid implying he had the capacity to pay), especially to mitigate costs arising from recruitment and training. Therefore, the clause was held to be:

  1. not a restraint of trade under Section 27 of ICA.
  2. not unconscionable or opposed to public policy under Section 23 of ICA.
  3. reasonable and proportionate in light of the employer's operational needs.

The judgment emphasized that public sector banks, bound by constitutional mandates (Articles 14 and 16 of the Constitution of India), cannot engage in ad-hoc appointments and have to follow a time-consuming and cost-intensive recruitment process. Hence, protecting against early attrition is a legitimate business interest.

Evolution of Law on Restrictive Covenants

The rules around enforcing employment agreements and liquidated damages have changed over time through court decisions. Indian courts have tried to strike a fair balance between contractual terms and what is reasonable and fair for both employers and employees.

In case of the Brahmaputra Tea Co. Ltd v. E. Scarth, (1885) ILR 11 CAL 545, the Calcutta High Court observed any restraint imposed post-employment is void. Further, the court while referring to an earlier case Madhub Chunder Poramanick v. Raj Coomar Dass, (1874) 14 Bengal Law Reporter 76, noted that Section 27 of ICA applies not only to total restraints but also to partial restrictions such as those limited by time or geography. The court, however, while upholding the restriction imposed during employment observed – “An agreement to serve a person exclusively for a definite term is a lawful agreement, and it is difficult to see how that can be unlawful which is essential to its fulfilment, and to the due protection of the interests of the employer, while the agreement is in force.” Moreover, with respect to liquidated damages, it was observed that if a contract mentions a specific amount to be paid in case for breach, the Court has the power to award reasonable compensation, up to that amount, even if no actual loss is proven. Furthermore, while the Court does have discretion to decide what is reasonable, it should not completely ignore the amount agreed upon by the parties, unless that amount is clearly unfair or excessive, based on the nature of the breach and the parties' circumstances.

In Sicpa India Ltd. v. Manas Pratim Deb, 2011 DHC 5791 the Delhi High Court traced the evolution of law on liquidated damages and employment covenants, particularly in the context of training bonds. Basis Supreme Court's verdict in the cases of Fateh Chand v. Balkishan Dass, 1963 INSC 1, Maula Bux v. Union of India, 1969 INSC 189 and Union of India v. Raman Iron Foundry, 1974 INSC 51, it stated that “clauses of liquidated damages which are in the nature of penalty are void and the liquidated damages are only the upper limit of damages which are awarded once actual damages are proved.” It means that liquidated damages clauses, when in the nature of a penalty, are subject to Section 74 of ICA, and not automatically enforceable. It held that unless actual losses are unquantifiable, employers cannot recover fixed sums without proof of loss. It further held that “when losses cannot be proved, then, of course the liquidated damages specified can always be recovered.” Regarding employment covenants, the Court found that requiring 5 (five) years of service or INR 2,00,000 (Rupees Two Lakhs) in lieu of it, along with claiming an amount for not serving notice period, for minimal training (28 (twenty-eight) days approximately) was excessive and unconscionable, and the bond terms were executed under undue pressure, rendering them unreasonable. The decision reaffirmed the principle that employment bonds must be proportionate, freely agreed upon, and not oppressive in nature.

Applicability to Private Sector Employers

The Supreme Court's ruling in Vijaya Bank Case, though it arises from a public sector context, carries potential significant implications for private companies. This judgement does not address private sector, but if it were to be construed in a broader perspective, it may open the door for private employers to include minimum service periods in appointment letters, provided that such employment agreements are backed by a liquidated damages clause provided: (i) the clause is not arbitrary or excessive; (ii) the damages are pre-estimated and reasonable, and (iii) the clause does not bar an employee from seeking alternate employment.

In the interest of legal propriety and effective risk mitigation, private employers should refrain from incorporating clauses that restrains post-exit employment (which may be hit by Section 27 of ICA unless they fall under its narrow exception) and imposes penalties rather than genuine pre-estimates of loss, which may render the clause void under Section 74 of ICA.

Private employers must also be aware that courts will scrutinize standard form employment contracts, especially where there is evidence of unequal bargaining power, to ensure that clauses are just, fair, and reasonable. For instance, in the recent case of Varun Tyagi vs. Daffodil Software Pvt. Ltd., 2025 LiveLaw (Del) 707, the Delhi High Court struck down a post-employment restraint that prohibited the employee from working with the employer's business associate, holding it to be a restraint of trade under Section 27 of ICA. The court emphasized that after termination of employment, any restriction on seeking lawful employment, even with a client of the previous employer, is void unless it protects legitimate proprietary interests like trade secrets or confidential data. But in the garb of protecting those interests, employer cannot be forced to perpetuate forced employment. In case, the employer is able to prove the breach of the terms of employment, it can be compensated by way of damages. The ruling underscores that post-employment restrictions must be narrowly tailored and cannot operate as blanket prohibitions on professional freedom.

The evolving judicial interpretation of restrictive covenants and liquidated damages in employment contracts reflects a balanced approach that protects both employer interests and employee rights. Courts have upheld minimum service clauses and corresponding liquidated damages provisions where they are reasonable, proportionate, and not in the nature of penalties. At the same time, post-employment restrictions continue to be scrutinized strictly under Sections 27 and 74 of ICA, particularly when they affect an individual's right to livelihood.

The Supreme Court's validation of minimum tenure clauses in Vijaya Bank marks a shift toward recognising legitimate employer expectations, even in standard form contracts, provided there is no overreach. Private sector employers must therefore draft such clauses with precision, ensuring fairness, clarity, and enforceability, while avoiding blanket restrictions on post-employment conduct that courts are likely to strike down.

Preena Salgia Sethi is Advocate on Record, and Payal Dubey is practicing advocate, Supreme Court of India. Views Are Personal. 

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