Supreme Court Decsion on Validity of Employment Bonds

Background

Many employers are in the practice of requiring their employees to execute ‘employment bonds’ which require the employee to serve the employer for a fixed period of time failing which the employees are required to pay a certain stipulated amount to the employers for of violation of such bond. Practically it is seen that the reason for executing the employment bonds is that some form of training has been provided to the employee during the course of employment and hence the employee is expected to serve the employer in lieu of the same for a fixed period of time.

It is seen that the employees agree to sign the bond at the time of joining employment, however at the time of prematurely resigning from their employment, they are unwilling to honour the bond and make payment of the stipulated amount.

This has given rise to litigations across courts in India. Validity of employment bonds has long been a contentious issue and the Supreme Court in a recent decision of Vijaya Bank v Prashant Narnaware (Civil Appeal No. 11708 of 2016) has upheld that validity of employment bonds

Supreme Court decision

No restraint of trade

Section 27 of the Indian Contract Act (‘ICA’) provides that any agreement which imposes restraints on a person from exercising a lawful profession, business or employment is void. The Supreme Court has held that employment bonds which require the employee to serve the employer for a fixed period of time is a restraint during the subsistence of the employment and consequently does not violate the section 27 of the ICA The Supreme Court, while agreeing with the settled legal position, has reiterated that only a restraint on the employee with respect to his future employment shall be held void under section 27 of the ICA. Accordingly, this decision may not apply for enforcement of non-compete clauses by employers.

Accordingly, the Supreme Court has held that since the restraint (being the requirement to work for minimum three and in default pay liquidated damages of Rs. 2 lakhs was valid and not in violation of section 27 of the ICA

No contravention of public policy

Section 23 of the ICA provides that any agreement opposed to public policy is void. The Supreme Court has held that public policy relates to matters involving public good and public interest. Supreme Court while examining the term ‘public policy’ in the context of ‘employer-employee’ relationship, has also held that the employment bond under consideration before it cannot be considered to be against public policy as in current times, the public sector undertakings are required to compete with private sector companies and are required to operated efficiently. According to the Supreme Court, ensuring retention of employees which would help to increase the efficiency of the public sector undertaking thereby allowing it to compete with private players and hence the employment bond cannot be considered to be unfair or unreasonable and being in contravention of public policy.

Damages

The Supreme Court in its decision has noted that as the employer-bank was a public sector undertaking it had to incur expenses and costs to undertake an extensive recruitment process which required open advertisement and fair competitive procedure and the employer-bank could not resort to private or ad-hoc appointments through private contracts. Accordingly, the Supreme Court held that damages/losses were suffered by the employer on violation of the employment bond as it would have had to resort to the extensive recruitment process again and hence the employee was required to compensate the employer for the same by paying the stipulated amount.

Our thoughts

It is important to note that while claiming compensation for violation of the employment bond, it is crucial for the employer to prove that it has suffered losses/ damages on account of such violation and that the stipulated amount for violation of bond being claimed by the employer is only a compensation for those losses suffered. It is important to note that the stipulated amount for violation of the bond should not be claimed so as to penalize the employee for leaving the employment.

Where employers in the private sector seek to enforce employment bonds, they should ensure that the amount stipulated in the employment bond should be only to compensate the employer for any expenses incurred in relation to the employee which can be in the form of specialized trainings or imparting any special knowledge or sponsoring further executive education of the employee etc.

Hence, while the decision of the Supreme Court upholding the validity of the employment bond is indeed welcome, however, employers in the private sector need to be mindful of the fact that only a valid employment bond does not entitle the employer to claim damages and that the Courts will award damages only when there is a loss suffered by the employer due to violation of the employment bond by the employee.