NEW DELHI: The Supreme Court ruling that companies can include minimum service requirements or job lock-in periods in employment contracts if these conditions are reasonable, fair and protect business interests could significantly influence how employment contracts are drafted and enforced in India, particularly in the public sector, said experts.
This means that employers can now ask for compensation from employees who leave early, if the clause is not unfair or too harsh.
Some of the principles, however, may not apply to the private sector straight up, said Sowmya Kumar, partner at law firm Cyril Amarchand Mangaldas.
“It is useful to see how courts are looking at indemnity bonds in India’s changing formal work environment. For instance, whether the indemnity bond restricts future employment, quantum of indemnity sought, replacement costs incurred by employer and duration of service required, will all have to be looked into while understanding whether or not an indemnity bond can be upheld,” she said.
She further added that employers will have to take the above principles into account while drafting their standard form employment contracts or standalone indemnity bonds.
“They would have to look at these clauses in greater detail, and include them only where there is a strong business case to do so (for instance, where specialised training is required, for senior management contracts, etc.),” Kumar said.
Earlier principles laid down on the reasonableness of liquidated damages, however, will continue to apply, she said, adding that the quantum of damages cannot be so high as to force the employee to remain with the employer.
“Employees cannot be penalised if they choose to move to another employer,” she added.
The apex court gave the ruling in a dispute over a clause in an appointment letter requiring an employee to serve at least three years or pay ₹2 lakh as liquidated damages upon premature resignation from a public sector bank. The employee resigned early and paid the amount under protest, then filed a plea challenging the clause as unconstitutional and against public policy.
The high court sided with him and quashed the clause but the bank appealed to the Supreme Court, which upheld the clause, stating it was not a restraint of trade or unfair, and served a legitimate business interest.
“The stance of the appellant-bank is neither unjust nor unreasonable. The appellant-bank is a public sector undertaking (PSU) and cannot resort to private or ad-hoc appointments through private contracts. An untimely resignation would require the bank to undertake a prolix and expensive recruitment process involving open advertisement, fair competitive procedure lest the appointment falls foul of the constitutional mandate under Articles 14 and 16,” the Bench of Justices PS Narasimha and Joymalya Bagchi said.
The court also said PSUs like the appellant-bank needed to compete with efficient private players operating in the same field and to survive in an atmosphere of deregulated free-market, PSUs were required to review and reset policies which increased efficiency and rationalised administrative overheads.
“Ensuring retention of an efficient and experienced staff contributing to managerial skills was one of the tools inalienable to the interest of such undertakings including the appellant-bank,” the court said.
Shiv Sapra, partner at law firm Kochhar & Co, said every case will depend upon its own set of facts and circumstances and not all lock-in clauses may be enforceable or constitutional. “Principles of fair play and reasonableness will be crucial factors in every such case,” he said.
Previously, courts often viewed restrictive covenants in employment contracts, particularly those post-termination, with scepticism under Section 27 of the Indian Contract Act, said Suhael Buttan, partner at SKV Law Offices.
Section 27 of the Indian Contract Act, 1872, states that any agreement that restricts a person from exercising a lawful profession, trade, or business is void to that extent.
There is, however, an exception: an agreement not to carry on a business when the goodwill of that business is sold is valid if it’s reasonable and within specified local limits.
“This judgment distinguishes between post-employment restraints (typically void) and restrictions operative during employment (generally valid). The court clarified that a clause requiring a minimum service period with financial consequences for breach is not a restraint on trade if it operates during the employment term and serves a legitimate business interest,” Buttan said.
Going forward, a reasonable clause will always be interpreted positively by the courts. On the other hand, any unreasonable restriction on the employee or a condition which is unreasonable and is beyond the damages contemplated by the parties or punitive in nature will be struck down by the courts, said Soayib Qureshi, partner at law firm PSL Advocates & Solicitors.
He added that even in cases which relate to consultants where no employer and employee relationships are defined, the parameters are the same.
“Where there is no clear employer–employee relationship —such as with freelancers, gig workers, volunteers, or informal hires — lock-in clauses are generally not enforceable as there is no formal contract establishing duties, consideration, or a service relationship. Courts require well-defined legal obligations to enforce any claim of breach or compensation for early termination.
Any attempt to impose a lock-in without a defined legal relationship could be seen as arbitrary, one-sided, or even violative of the worker’s freedom to trade or work,” he added.
Source: Business Standard
