Appointment letter clause requiring payment of liquidated damages for leaving employment before specified years not restraint of trade or opposed to public policy – SC
In a recent judgment Hon’ble Supreme Court has held that clause in appointment letter requiring payment of liquidated damages by the employee in the event of leaving employment prior to specified years does not amount to restraint of trade nor is it opposed to public policy.
ABCAUS Case Law Citation:
4564 (2025) (05) abcaus.in SC
In the instant case, the appellant employer had challenged the judgment and order passed by the High Court quashing clause of the appointment letter whereby the employee was required to pay liquidated damages of Rs. 2 lakhs in the event of leaving employment of the appellant employer prior to three years. The Hon’ble High Court had directed the employer to refund the said sum to the employee.
The appellant employer was a Nationalised Bank which issued a recruitment notification for appointment of officers in different grades. One of the clause of the recruitment notification stated that the selected candidates were required to execute an indemnity bond of Rs. 2.00 Lakh 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 respondent employee had applied to the posts and was selected for the said post. Subsequently, the said employee was issued an appointment letter. One of the clause of the appointment letter again stated that he was 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 which had to be paid in case he resigned from the services before completion of stipulated minimum period of 3 years.
Accepting the aforesaid condition, respondent employee resigned from his erstwhile post and joined the post applied for. He also executed an indemnity bond in terms of the said clause of the appointment letter.
However, before completion of three years from his date of joining, respondent employee tendered resignation for joining another Bank. His resignation was accepted and the respondent employee in terms of the appointment letter, paid the sum of Rs.2 lakhs to the appellant-bank under protest.
Thereafter, respondent employee filed a writ petition before the High Court praying for quashing the clauses related to payment of liquidated damages in the recruitment notification the appointment letter alleging the same were in violation of Articles 14 and 19(1)(g) of the Constitution of India and Sections 23 and 27 of the Indian Contract Act, 1872.
The Single Judge of the High Court relied on the decision of a Division Bench of the High Court and allowed the writ petition. The order was upheld by the Division Bench.
The Hon’ble Supreme Court observed that Section 27 of the Contract Act provides every agreement which restrains a person from exercising a lawful profession, trade or business of any kind is to that extent void. A sole exception is carved out in the proviso with regard to sale of goodwill of a business.
The Hon’ble Supreme Court observed that the question whether Section 27 operates as a bar to a restrictive covenant during the subsistence of an employment contract fell for consideration by the Hon’ble Supreme Court. The Bench made a distinction between restrictive covenants operating during the subsistence of an employment contract and those operating after its termination. This view was reiterated subsequently in two decisions with regard to validity of restrictive covenants during the subsistence of a contract.
The Hon’ble Supreme Court opined that in view of the authoritative pronouncements, it can be safely concluded law is well settled that a restrictive covenant operating during the subsistence of an employment contract does not put a clog on the freedom of a contracting party to trade or employment.
The Hon’ble Supreme Court observed that a plain reading of the relevant clause of the appointment letter showed that restraint was imposed on the respondent to work for a minimum term and in default to pay liquidated damages. The clause sought to impose a restriction on the respondent’s option to resign and thereby perpetuated the employment contract for a specified term. The object of the restrictive covenant was in furtherance of the employment contract and not to restrain future employment. Hence, it cannot be said to be violative of Section 27 of the Contract Act.
The Hon’ble Supreme Court observed that the legal principles relating to interpretation of standard form employment contracts may be summarized as follows (i) Standard form employment contracts prima facie evidence unequal bargaining power. (ii) Whenever the weaker party to such a contract pleads undue influence/coercion or alleges that the contract or any term thereof is opposed to public policy, the Court shall examine such plea keeping in mind the unequal status of the parties and the context in which the contractual obligations were created. (iii) The onus to prove that a restrictive covenant in an employment contract is not in restraint of lawful employment or is not opposed to public policy, is on the covenantee i.e. the employer and not on the employee.
The Hon’ble Supreme Court further observed that generally speaking, public policy relates to matters involving public good and public interest. What is ‘just, fair and reasonable’ in the eyes of society varies with time. Civilizational advancements, growth of knowledge and evolving standards of human rights and dignity alter the contours of public good and policy. From the prism of employer-employee relationship, technological advancements impacting nature and character of work, re-skilling and preservation of scarce specialized workforce in a free market are emerging heads in the public policy domain which need to be factored when terms of an employment contract is tested on the anvil of public policy.
The Hon’ble Supreme Court observed that Public sector undertakings like the appellant-bank needed to compete with efficient private players operating in the same field. To survive, public sector undertakings were required to review and reset policies which increased efficiency and rationalized 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. This prompted the appellant-bank to incorporate a minimum service tenure for employees, to reduce attrition and improve efficiency. Viewed from this perspective, the restrictive covenant prescribing a minimum term cannot be said to be unconscionable, unfair or unreasonable and thereby in contravention of public policy.
The Hon’ble Supreme Court rejected the argument that the quantum of the liquidated damage was disproportionate and caused unjust enrichment to the employer. It was observed that the liquidated damages were neither unjust nor unreasonable. The appellant-bank was a public sector undertaking 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.
Consequently, it was held that the restrictive covenant in the appointment letter did not amount to restraint of trade nor was it opposed to public policy.
Accordingly, the appeal was allowed and the impugned judgment and order of the High Court was set aside
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