In its decision in Vijaya Bank & Another vs Prashant B. Narnaware (Civil Appeal No. 11708 of 2016), decided on May 14, 2025, the Supreme Court of India upheld the validity of a restrictive covenant placed by the employer upon employee in an employment contract which prohibited the employee from resigning before the lapse of 3 years from date of appointment and to pay liquidated damages of INR 2 lakhs in case of premature resignation and breach of such restrictive covenant.
Background of the Case
Prashant B. Narnaware (Respondent) joined the services of the Vijaya Bank (Appellant), a public sector undertaking, in 1999 as a Probationary Assistant Manager. In 2006, the Appellant issued a recruitment notification for appointments of officers in different grades. In the notification, under a specific clause, i.e., clause 9(w), it was stated that the selected candidates are required to execute an indemnity bond of INR 2 lakhs, indemnifying that they will pay the said amount if they leave the service before the completion of 3 years.
The Respondent applied for the post and was also selected. On August 7, 2007, he was issued an appointment letter by the Appellant. The aforesaid restrictive covenant was incorporated under clause 11(k) of the appointment letter, and the Respondent was hence bound by the restrictive clauses.
The Respondent, before the completion of 3 years, resigned from the services in 2009 to join another bank. His resignation was accepted, and he also paid a sum of INR 2 lakhs, albeit under protest. Consequently, the Respondent filed a writ petition before the High Court of Karnataka challenging the validity of restrictive covenants for being violative of Articles 14 and 19 of the Constitution of India and Sections 23 and 27 of the Indian Contract Act, 1872.
The Single Judge of the High Court of Karnataka, while relying upon a decision of the Division Bench in K.Y. Venkatesh Kumar vs BEML Ltd. (W.A. No. 2736 of 2009), allowed the writ Petition and quashed the restrictive covenants. The judgment of the Single Judge was upheld by the Division Bench of the High Court, against which the Appellant approached the Supreme Court.
Findings and Reasoning of the Supreme Court
The following two issues fell for consideration of the Supreme Court:
- Whether the restrictive covenant is violative of Section 27 of the Indian Contract Act;
- Whether the restrictive covenant is opposed to public policy and hence contrary to Section 23 of the Indian Contract Act and violative of Articles 14 and 19 of the Constitution of India.
Findings on Issue No. 1
While dealing with this issue, the Supreme Court relied upon its previous judgments in Niranjan Shankar Golikari vs Century Spinning and Manufacturing Co. (1967 SCC OnLine SC 72) and Superintendence Company (P) Limited vs Krishan Murgai (1981) 2 SCC 246. It drew a distinction between a restrictive covenant, which operates during the subsistence of employment, and a restrictive covenant, which operates post-termination. These judgments held that the doctrine of restraint of trade never applies during the continuance of a contract of employment. Therefore, the restrictive covenants operating during the subsistence of an employment contract do not clog the freedom of a contracting party to trade or employment and thus would not amount to a restraint of trade under Section 27 of the Indian Contract Act.
In the present case, the Court held that the restrictive covenant does not prohibit the Respondent from pursuing future employment and only sought to impose a condition on the Respondent’s option to resign, thereby perpetuating the employment contract for a specified term, i.e., 3 years. The Court recognised the objective of the Restrictive Clauses, which was held to be in furtherance of the employment contract and not to restrain future employment. Hence, the covenant was held to be not violative of Section 27.
Findings on Issue No. 2
The Court then went into the question of a restrictive covenant being opposed to public policy. While dealing with this question, the Court relied upon its previous decision in Central Inland Water Transport Corporation Ltd. vs Brojo Nath Ganguly (1986) 3 SCC 156, wherein the Court dealt with the interpretation of standard form employment contracts in the backdrop of unequal bargaining power of employees. The legal principles relating to the interpretation of standard-form employment contracts were summarised as follows: –
- Standard form employment contracts prima facie indicate unequal bargaining power;
- Whenever the weaker party pleads undue influence/coercion or alleges that the contract is opposed to public policy, the Court shall examine the plea, keeping in mind the unequal status of the parties and the context in which the contractual obligations were created;
- The onus to prove that a restrictive covenant is not opposed to public policy is on the covenantee, i.e., the employer.
The Court held that public policy relates to matters involving public good and public interest, and with civilizational advancements, growth of knowledge and evolving standards of human rights and dignity, public policy may change over time. In the context of an employer-employee relationship, technological advancements impacting the nature and character of work, re-skilling and preservation of scarce specialised workforce in a free market were held to be emerging heads in the public policy domain, which are required to be factored when terms of an employment contract are tested on the anvil of public policy.
The Supreme Court noted that with the advent of globalisation and privatisation, the Appellant had to compete with private sector banks and ensure retention of an efficient and experienced staff contributing to managerial skills was one of the tools inalienable to the interest of the Appellant, which prompted it to put in place a minimum service tenure to reduce attrition and improve efficiency.
The Court also held that the imposition of liquidated damages of INR 2 Lakhs was just and reasonable since, on account of the untimely resignation by the Respondent, the Appellant had to undertake a prolix and expensive recruitment process to refill the vacant position. The Appellant clarified this financial hardship in their pleadings before the High Court. Therefore, the Supreme Court set aside the judgment of the Division Bench of the Karnataka High Court and held that the Restrictive Covenants did not amount to a restraint of trade and were not against public policy. The Court, therefore, upheld the validity of the Restrictive Clauses and the imposition of liquidated damages.
Conclusions
The judgment has recognised the enforceability of employment bonds in a service contract while noting that such restriction is a restriction during the subsistence of the employment and, hence, is not violative of the doctrine of restraint of trade. However, the Court has not seemed to have conducted a detailed discussion with respect to the enforceability of employment bonds, especially in view of precedents wherein the Courts have held that for enforcing the employment bond against the employee, the employer must show that they have incurred expenses to give special training to the employee.
Moreover, the judgment does not deal with a factual situation where the employee may be bound by an onerous bond condition and consequently restricted from resigning. Having said that, the present judgment has surely paved the way for a broader and expansive interpretation of “public policy” to determine the validity of restrictive covenants in employment agreements, especially in the context of modern employment.
Authors: Manisha Singh and Nisha Sharma
First Published by: Mondaq here