Employment Bond: Supreme Court Balances Contractual Freedoms And Constitutional Safeguards

In a recent decision in Vijaya Bank v. Prashant B. Narnaware^[1], the Supreme Court examined whether contractual terms stipulating for mandatory minimum employment tenures and related liquidated damages would fall in the constitutional safeguards and the principles under the Indian Contract Act, 1872 ("Contract Act").

The controversy arose from clause 11(k) of the terms of employment contained in the respondent's appointment letter. In terms of the said clause, the respondent was required to serve a minimum employment term of three years, failing which the respondent was bound to pay liquidated damages to the tune of INR 2 Lakhs.

In the earlier round of litigation, the High Court of Karnataka ("High Court") had quashed^[2], inter alia, clause 11(k) of the employment terms. The High Court opined that the mandatory tenure clause infringed Articles 14 and 19(1)(g) of the Constitution and was also violative of Sections 23 and 27 of the Contract Act.

In a decision poised to alter the rules of the game, the Supreme Court has overturned the High Court's ruling and reinstated clause 11(k) of the employment terms.

1. Facts

In 1999, Prashant B. Narnaware, i.e., the respondent, joined the first appellant – Vijaya Bank. Over time, the respondent moved up the hierarchy and assumed new roles. Sometime in 2006, the first appellant bank, seeking to strengthen its managerial cadre, advertised several vacancies across various levels.

The notification pertaining to the recruitment and filling of vacancies contained a provision clause 9(w), which required the selected candidates to complete a minimum employment tenure of three years. In case a candidate failed to complete the minimum employment tenure prescribed, they were required to pay liquidated damages to the tune of INR 2 Lakhs, which the bank took in the form of an indemnity bond at the time of employment.

Being aware of the recruitment drive being conducted by the first appellant bank, the respondent applied for the position of Senior Manager (Cost Accountant). The first appellant selected the respondent and issued him an employment letter containing, inter alia, clause 11(k), the clause in question. The said clause mirrored the terms contained in clause 9(w) of the recruitment notification, stipulating that voluntary resignation before the completion of three years would attract liquidated damages of INR 2 Lakhs.

A little less than two years after joining the position, the respondent opted to move on from the first appellant to another bank, namely IDBI, and tendered his resignation.

Adhering to the employment terms, albeit under strong protest, the respondent remitted the stipulated sum of INR 2 lakhs in liquidated damages. Thereafter, the respondent challenged the legality of the clauses in question (i.e., clause 11(k) of employment terms and clause 9(w) of the recruitment notification).

The respondent contended that the employment terms were unfair, oppressive, and unconscionable. Further, it was argued that the employment terms, requiring the respondent to mandatorily complete a specific period of employment else pay liquidated damages, was violative of the provisions contained in the Indian Contract Act and the Constitution.

Finding merit in the respondent's submissions, the High Court (at both levels, during the writ proceedings^[3] and in the writ appeal^[4]) quashed the clauses in question in the employment terms.

2. Legal Issues

The moot questions before the Supreme Court were as follows:

• Do stipulations providing for a minimum mandatory employment tenure constitute an unlawful restraint of trade under Section 27 of the Contract Act?
• Did the employment terms infringe public policy as outlined in Section 23 of the Contract Act and the constitutional guarantees provided under Articles 14 and 19(1)(g)?

3. Key Legal Issues

The Indian Contract Act and Restraint of Trade

Section 27 of the Contract Act establishes the general principle that agreements restraining one's trade, business, or profession are void ab initio. Similarly, Articles 14 and 19(1)(g) guarantee each person the fundamental right to be treated fairly without arbitrariness and to practise or engage in any profession/ occupation, trade, or business.

The task for the Supreme Court in this matter was to determine whether or not the employment terms governing the employment of the respondent fell under the ambit of Section 27 of the Contract Act.

At the outset, the Supreme Court referred to its decision in Niranjan Shankar Golikari v. Century Spinning and Manufacturing Co.^[5] to distinguish between restrictive covenants operating during the employment versus those extending beyond the period of employment. The Supreme Court held that negative/ restrictive covenants that operate during the period of employment are generally not regarded to be in restraint of trade and therefore do not fall within the scope of Section 27 of the Contract Act. However, the same is not the case for restrictive covenants, which extend beyond the period of employment. Such conditions may be determined to be "unconscionable", "excessively harsh", and "one-sided".

The Apex Court noted that the view taken in Niranjan Shankar Golikari^[6] was also reiterated in the view taken by Justice A. P. Sen in Superintendence Company (P.) Ltd. v. Krishan Murgai^[7]. In Krishan Murgai^[8], Justice Sen opined that service agreements that prevented an employee from taking up other positions elsewhere are not void in terms of Section 27 of the Contract Act. The rationale behind this understanding is that principles pertaining to the restraint of trade do not apply during the mutually agreed-upon employment term. Accordingly, the Apex Court placed significant emphasis on whether or not a restrictive covenant applied to a period following the employment term.

In view of the above-mentioned judgments, the Supreme Court opined that it could be safely concluded that restrictive covenants operating during the subsistence of employment would not put a clog on the freedom of a contracting party to trade or employment.

As per the Apex Court, clause 11(k) of the recruitment notice did not extend beyond the period of employment, which, in this case, was three years.

Upon juxtaposing the clause in question with the established legal threshold, the Supreme Court opined that it was only "in furtherance of" the employment and not in restraint of any future employment. Thus, the Apex Court concluded that it could not be said that clause 11(k) of the recruitment notice was violative of Section 27 of the Contract Act.

4. Public Policy and Constitutional Principles

To address the public policy considerations sought to be raised in terms of Section 23 of the Contract Act and fundamental rights enshrined under Articles 14 and 19 of the Constitution, the Court embarked on a nuanced exploration of the evolving concept of "public policy".

The Apex Court drew extensively from the decision in Central Inland Water Transport Corporation Ltd. v. Brojo Nath Ganguly^[9] wherein the Supreme Court had dealt with the interpretation of standard form employment contracts in the government sector in context of unequal bargaining powers and unconscionability. The Apex Court opined that a majority of contracts were not negotiated individually with the incoming employees, and rather consisted of standard form contracts. Naturally, candidates who wish to be employed ordinarily have lesser bargaining power than employers, leaving them with no viable option but to sign on the dotted line. In such circumstances, the Supreme Court in Central Inland Water^[10] held that if employment contracts affect a large number of people and are unconscionable, unfair, and unreasonable, they are injurious to the public interest.

The legal principles which the Supreme Court culled out upon a careful examination of the judicial precedents are set out below:

• Contracts of employment based on a standard template or form, prima facie, demonstrate unequal bargaining power.
• Whenever the weaker party to such a contract pleads undue influence or coercion, or claims that the contract or any term thereof is contrary to public policy, the Court shall examine such a plea having regard to the unequal status of the parties and the context in which the contractual obligations are created.
• The onus lies with the employer to prove that a restrictive covenant in an employment contract is not in restraint of lawful employment or contrary to public policy.

As regards what constitutes public policy, the Supreme Court once again referred to its decision in Central Inland Water^[11] and opined that public policy connotes some matter which concerns the public good and the public interest. It is not necessarily a government policy and is likely to vary with the changing times. What is just, fair, and reasonable in the eyes of the society is bound to change as the civilisation advances. Thus, the attitude of courts as regards public policy has never been inflexible.

Coming back to employment contracts, the Supreme Court observed that when a contract for employment is tested on the anvil of public policy, it must be viewed through the prism of fast-paced technological advancements, the skilling and re-skilling of employees, and the preservation of an otherwise scarce specialised force in the free market.

The Apex Court observed that in the post-liberalisation Indian economic landscape, the golden days of monopolistic behemoths are long gone. Employers like the first appellant are now required to compete with far-efficient players in the private sector. To survive the de-regulated markets, enterprises, especially public sector undertakings were required to go back to the drawing board and chalk out new strategies. It is in one such attempts at protecting the legitimate interests of the first appellant organisation that it incorporated a clause for minimum service tenure to retain its able and experienced managerial staff.

When viewed from the above perspective, the Supreme Court held that a restrictive covenant prescribing a minimum tenure of employment could not be deemed unconscionable, unfair, or unreasonable, and thereby in contravention of public policy.

As regards the imposition of liquidated damages to the tune of INR 2 Lakhs, the Supreme Court held that the first appellant's stance was neither unjust nor unreasonable. Unlike its private counterparts, the Supreme Court observed that a public bank could not resort to ad-hoc appointments through private contracts. Thus, an untimely resignation would require the bank to go through the entire recruitment process once again.

In view of the above findings, the Supreme Court allowed the appeal and the impugned judgment of the High Court was set aside.

The Supreme Court's reasoning in Vijaya Bank v. Prashant B. Narnaware^[12] carefully balances between the interests of the employer and the employees. The Apex Court's judgment appears to be in tandem with international jurisprudence, especially in the case of common law jurisdictions where restrictive covenants during the currency of the employment have been upheld so long as they are reasonable and proportionate.

This ruling, however, cannot, be considered a sweeping judicial precedent that upholds all employment tenure clauses. The Apex Court has outlined the individual circumstances of the first appellant bank and the context in which the employment terms withstood the test of public policy. Consequently, employers who choose to impose restrictive covenants will still be legally required to ensure that such terms are reasonable and proportionate.

Critics may argue that the Supreme Court could have more robustly addressed the underlying inequities faced by employees who are compelled to accept restrictive conditions without meaningful bargaining opportunities. However, it seems that a deeper analysis of the inequities was not necessary given the facts of the case.

Authors: Vasanth Rajasekaran is the Head and Founder of Trinity Chambers. Harshvardhan Korada is a Counsel at Trinity Chambers. Views are personal.