Employment Bond Is It A Restrictive Covenant In An Appointment Letter?
Organizations should weigh carefully, while incorporating such clauses in their appointment letter or policy documents, the need to have such a clause and if they decide to have such a clause, they should restrict it to certain set of employees who are critical and vital resources as against a generic condition of employment, which if not done might create an atmosphere where potential employees may find it hard to join the organization leading to vital gap in hiring quality talent.
Very often we see a clause in the appointment letter wherein the employer seeks indemnity from the employee in case he leaves the services of the company / employer before a stipulated period of time. Does it make the employee a slave of the employer? Does it mean that the employee can’t leave the services of the company / employer before the stipulated time frame? Does such clause violate the public policy doctrine? Is the employee in an unequal bargaining position at the time of accepting the appointment letter? These issues came up recently before the Supreme Court of India in the case titled Vijaya Bank & Anr Vs Prashant B. Narnaware (Civil Appeal no. 11708 of 2016) and vide a judgement dated 14th May, 2025, the court clarified the legal position vis-à-vis above issues.
The court tested the above issues against Section 27 of the Indian Contract Act,1872 to decide whether the appointment letter (an agreement / contract between the employer and employee) containing such restrictive clause would make the agreement void. Before analyzing what the court said, let us look at Section 27 which says –
27. Agreement in restraint of trade, void.
Every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.
Exception 1. Saving of agreement not to carry on business of which good-will is sold. One who sells the good-will of a business may agree with the buyer to refrain from carrying on a similar business, within specified local limits, so long as the buyer, or any person deriving title to the good-will from him, carries on a like business therein, provided that such limits appear to the Court reasonable, regard being had to the nature of the business.
A perusal of section 27 of the Indian Contract Act, 1872 reflects that an agreement which restrains a person from exercising a lawful profession, trade, or business is void. However, section 27 also carves out an exception which provides that when the goodwill of a business is sold, the seller can agree with the buyer to refrain from carrying on a similar business within specified local limits.
In India, Section 27 has often been invoked to decide whether the “non-compete” and “non-solicitation” clauses contained in the appointment letter of an employee are valid. With the increase in cross-border trade and an enhanced competitive climate in India, confidentiality, non-compete, and non-solicitation agreements are becoming increasingly popular, especially in the IT and technology sectors. An increasing number of outsourcing and IT companies are including confidentiality, non-compete, and non-solicitation clauses in agreements with their employees, with terms ranging from a few months to several years after the employment relationship is terminated. The companies claim that such restrictions are necessary to protect their proprietary rights and their confidential information.
Indian courts have consistently refused to enforce post-termination non-compete clauses in employment contracts, viewing them as “restraint of trade” impermissible under Section 27 of the Indian Contract Act, 1872, and as void and against public policy because of their potential to deprive an individual of his or her fundamental right to earn a livelihood. The Supreme Court of India in Percept D’ Mark (India) Pvt. Ltd Vs. Zaheer Khan – AIR 2006 SUPREME COURT 3426 observed that under Section 27 of the Act, a restrictive covenant extending beyond the term of the contract is void and not enforceable. The court also noted that the doctrine of “restraint of trade” is not confined to contracts of employment only but is also applicable to all other contracts with respect to obligations after the contractual relationship is terminated. Section 27 does not distinguish between partial or total restraint of trade and makes all contracts falling within the terms of this section as void, unless it falls within the exception mentioned therein. Sir Richard Couch C.J., in the celebrated judgment in Madhub Chunder Vs. Rajcoomar Doss (1874) 14 Beng LR 76 held that whether the restraint was general or partial, unqualified or qualified, if it was in the nature of a restraint of trade, it was void. This principle laid down in 1874 has been followed by the Supreme Court of India in a catena of judgements, thereafter.
In Superintendence Company of India vs Krishan Murgai [AIR 1980 SUPREME COURT 1717], the Supreme Court held that a contract, which had for its object a restraint of trade, was prima facie void. The company, with its head office at Kolkata and branch office at New Delhi, carried on business as valuers and surveyors. It had established a reputation and goodwill in its business by developing its own techniques for quality testing and control and possessed trade secrets in the form of these techniques and clientele. Mr Murgai was employed as branch manager of the New Delhi office. One of the clauses of the terms and conditions of employment placed him under a post-service restraint that he would neither serve any other competitive firm nor carry on business on his own in a similar line for two years at the place of his last posting; and the restriction would come into operation after he left the company. When he was terminated from service, the employee started a business on similar lines. When the matter came for appeal, the Supreme Court held that under Section 27 of the Indian Contract Act, 1872, the service covenant extended beyond the termination of the service and hence was void. The Court held that there is a clear distinction between a restriction in a contract of employment which is operative during the period of employment and one which is to operate after the termination of employment. Mere existence of negative covenant in a service agreement does not make it void on the ground that it was in restraint of trade and contrary to the Contract Act. The restriction contained in clause 10 of the agreement in this case is clearly in restraint of trade and therefore illegal under section 27 of the Contract Act as it is not seeking to enforce the negative covenant during the term of employment of the respondent but after the termination of his services. The Court also held that the restraint may not be greater than necessary to protect the employer nor unduly harsh and oppressive to the employee. However, the court while reaching this conclusion also took strong note of the use of the word “leave” in clause 10 of the agreement and the fact that the employee did not leave the services on his own but was terminated.
There is a landmark judgement of the Supreme Court in M/S Gujarat Bottling Co.Ltd. & Ors vs The Coca Cola Co. & Ors (1995) 5 SCC 545 where the negative covenant was upheld falling under exception to section 27. On September 20th, 1993, Gujarat Bottling Company (GBC) entered into an agreement with Coca Cola Co to bottle and distribute “Thumbs Up”, “Maaza”, “Limca”, “Rim Zim” and “Gold Spot”, whose trademarks were acquired by Coca Cola from Parle. Paragraph 14 of the above contract posed a negative covenant on GBC wherein they were forbidden from bottling, distributing or simply dealing with any other company or trademarks during the subsistence of the contract. It was to remain in effect till 1998 and could be terminated at the option of either party by sending a 1-year prior notice or by mutual consent. The above contract also bound GBC from the supply of syrup in case of subsequent transfer of control without the consent of Coca Cola. The Court held that paragraph 14 of 1993 agreement was not in restraint of trade as its application is confined to the subsistence of the agreement and not thereafter (i.e the restraint was only for the period of the contract.). It was also mutually entered into by the parties for the promotion of Coca Cola products for their mutual benefit and therefore doesn’t fall under the ambit of restraining trade.
Another landmark judgement from the Supreme Court is Niranjan Shankar Golikari v. The Century Spinning and Manufacturing Company Ltd 1967 SCC OnLine SC 72. The Appellant Mr. Golikari was employed by Century Rayon, a division of Century Spinning and Manufacturing Co. Ltd., under an agreement that included stringent restrictive covenants. These covenants mandated exclusivity in employment, confidentiality of proprietary information, and imposed penalties for breach. After resigning abruptly and joining a competitor, Mr. Golikari faced legal action from Century Rayon seeking injunctions and damages. The appellant challenged the validity of such clauses imposed by Century Spinning and Manufacturing Co. Ltd., alleging that they were oppressive and contrary to public policy. The trial and High Court upheld the enforceability of the restrictive clauses, leading Mr. Golikari to appeal to the Supreme Court. The Supreme Court affirmed the lower courts’ decisions, ruling that the restrictive covenants were reasonable, necessary for protecting the company’s legitimate business interests, and not against public policy. The Court observed that restraints or negative covenants in the appointment or contract may be valid if they are reasonable. A restraint upon freedom of contract must be shown to be reasonably necessary for the purpose of freedom of trade. The court held that a person may be restrained from carrying on his trade by reason of an agreement voluntarily entered into by him with that object. In such a case, the general principle of freedom of trade must be applied with due regard to the principle that public policy requires the utmost freedom to the competent parties to enter into a contract and that it is public policy to allow a trader to dispose of his business and to afford to an employer an unrestricted choice of able assistance and the opportunity to instruct them in his trade and its secrets without fear of them becoming his competitors. Where an agreement is challenged on the ground of its being in restraint of trade, the onus is upon the party supporting the contract to show that the restraint is reasonably necessary to protect his interests. Once, this onus is discharged by him, the onus of showing that the restraint is nevertheless injurious to the public is upon the party attacking the contract.
Hence the non-compete covenants used in agreements can be categorized into in-term and post-term covenants. In an employment contract, the basic interests of the employer which are required to be protected include trade secrets and business connections and other such confidential information. In case of restraints in contracts of employment, the nature of business and employment is relevant in assessing the reasonableness of restraints. An employee owes a duty to the employer to not disclose to others or use to his own advantage the trade secrets or confidential information which he had access to during the course of employment, and he could be restrained from or sued for divulging or utilizing any such information in his new employment. But once again, he cannot be prevented from taking up the employment. Also, the employer cannot prevent the use of the employee’s knowledge, skill or experience even if the same is acquired during the course of employment.
Restrictive covenants are different in cases where the restriction is to apply during the period after termination of the contract than in those cases where it is to operate during the period of the contract. Negative covenants operative during the period of contract of employment when the employee is bound to serve the employer exclusively are generally not regarded as restraint of trade and do not fall under Section 27 of the Indian Contract Act, 1872. A negative covenant, one that the employee would not engage himself in a trade or business or would not get employment under any other employer for whom he/she would perform similar or substantially similar duties, is not a restraint of trade unless the contract is unconscionable or excessively harsh or unreasonable or one sided.
The above principles were applied and reiterated by the Supreme Court recently in the case of Vijaya Bank & Anr Vs Prashant B. Narnaware. In this case, the respondent had joined the appellant bank as a probationary Assistant Manager in 1999. His service was confirmed in 2001. Thereafter, he was promoted to middle management scale-II. In 2006, appellant bank issued a recruitment notification for appointment of 349 officers in different grades. Clause 9 (w) of the recruitment notification reads as follows:-
“Selected candidates are required to execute an indemnity bond of Rs, 2.00 lakh (Rupees Two Lakh only) 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”.
Cognizant of the said condition, the respondent applied for the post of Senior Manager-Cost Accountant and was selected for the said post. Subsequently, the respondent was issued an appointment letter on 7.8.2007 which had clause 11(k) which read as under:-
“You are 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. The said amount has to be paid by you in case you resign from the services of the bank before completion of stipulated minimum period of 3 years…………”
On 17.7.2009 i.e before completion of three years from his date of joining, the respondent tendered resignation for joining another Bank (IDBI). His resignation was accepted and on 16.10.2009 respondent, under protest in terms of the aforesaid condition, paid Rs. 2 lakhs to the appellant bank.
The Supreme Court of India tested clause 11(K) of the appointment letter against Section 27 of the Indian Contract Act, 1872 and held clearly that – “……..it can be safely concluded that the 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”. While upholding clause 11 (K) as valid, the court further held – “A plain reading of clause 11(K) shows restraint was imposed on the respondent to work for a minimum term i.e three years and in default to pay liquidated damages of Rs. 2 lakhs. 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.”
Another aspect which was raised in the present case of Vijaya Bank was whether the said clause 11 (K) was opposed to the public policy. The counsel for the respondent argued that the clause is a part of a standard form contract and his client was compelled to sign on the dotted line. If he did not do so, he would have to forsake career advancement. The terms of the contract were imposed on him through an unequal bargaining mechanism. It was argued that the said clause is unreasonable, onerous and ex-proportionate resulting in unjust enrichment for the appellant bank and thus is opposed to public policy.
The court looked into the above arguments and summarized the legal principles relating to interpretation of standard form employment contracts as follows:-
1. Standard form employment contracts prima facie evidence unequal bargaining power.
2. 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 Courts shall examine such plea keeping in mind the unequal status of the parties and the context in which the contractual obligations were created.
3. 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.
Earlier, the Supreme Court had an occasion to deal with interpretation of standard form employment contracts in the backdrop of unequal bargaining power of employees in the famous case of Central Inland Water Transport Corporation Ltd Vs Brojo Nath Ganguly – AIR 1986 SC 1571. The court held that contracts which affect a large number of persons or a group or groups of persons, if they are unconscionable, unfair and unreasonable, are injurious to the public interest. Thus, public policy should concern public good and the public interest.
Supreme Court in the Vijaya Bank case held – “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 are tested on the anvil of public policy. Since the last decade of the 20th century, India witnessed an era of liberalization. Golden days of monopolistic public sector behemoths were gone. Public sector undertakings like the appellant-bank needed to compete with efficient private players operating in the same field. To survive in an atmosphere of deregulated free-market, 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.” Thus, the Court concluded that clause 11(K) was not against public policy.
The Supreme Court in the Vijaya bank case gave a lot of weightage and emphasis to the fact that an untimely resignation would require the Bank to undertake a prolix and expensive recruitment process involving open advertisement, fair competitive procedure test, checking the attrition by preventing pre-matured resignation and the financial hardship flowing therefrom. Accordingly, the court also upheld that Rs. 2 lakhs imposed as liquidated damage was not excessive and noted that the appellant had paid the said amount and resigned from the post. While many organizations would jump to this judgement and attempt to incorporate a similar restrictive employment bond clause in their appointment letters or may even go to the extent of issuing a policy to this effect; a word of caution here is important. The court did draw a minute distinction between the entire recruitment process deployed in a public sector undertaking which it felt is time consuming and expensive unlike the appointment process in a private sector undertaking. organizations should weigh carefully, while incorporating such clauses in their appointment letter or policy documents, the need to have such a clause and if they decide to have such a clause, they should restrict it to certain set of employees that are critical and vital resources as against a generic condition of employment which if not done might create an atmosphere where potential employees may find it hard to join the organization leading to vital gap in hiring quality talent. Such employment bonds are never a substitute to well curated employee welfare and career development programs, trainings, open culture, collaboration etc as a means to retain talent. Organizations should also be careful, in the event they choose to have such restrictive clause, that the amount of liquidated damages are reasonable, fair and justifiable as such amount will always be tested before the court, in case of employer-employee dispute. Equally important for organizations is to take note that in this case, the employee had resigned and hence organizations should not use such employee bonds to terminate the services of the employee and at the same time seek liquidated damages if the employee could not serve the entire stipulated period of minimum employment due to such termination. Drafting of such restrictive clauses in the appointment letter is therefore critical so as to be on the right side of the law.
Disclaimer – This article is written by Amar Sundram (BA (Hons); LL. B & LL.M – Delhi University), Sr. Vice President (Legal) – General Counsel & Chief Compliance Officer – NEC Corporation India Pvt Ltd. The views expressed herein are absolutely personal and has no bearing or relation with the organization he serves.