Summary
A public sector bank's appointment letter required a senior manager to serve a minimum of three years or pay Rs. 2 lakhs as liquidated damages; the High Court quashed the clause. The Supreme Court held that a restrictive covenant operating during the subsistence of employment is not a restraint of trade under Section 27 of the Contract Act and that, tested against the unequal bargaining power inherent in standard form employment contracts, a minimum service term with reasonable liquidated damages is not opposed to public policy under Section 23.
Issues
- Whether clause 11(k) of the appointment letter, requiring a minimum of three years' service and payment of Rs. 2 lakhs on earlier resignation, amounts to a restraint of trade under Section 27 of the Indian Contract Act, 1872.
- Whether the clause, as part of a standard form employment contract, is opposed to public policy and thus void under Section 23 of the Contract Act and violative of Articles 14 and 19(1)(g) of the Constitution.
- Whether the quantum of liquidated damages of Rs. 2 lakhs was disproportionate and resulted in unjust enrichment of the employer.
Provisions considered
- Section 27, Indian Contract Act, 1872Section 27 renders void every agreement restraining a person from exercising a lawful profession, trade or business, with a sole exception for sale of goodwill. Following Golikari and Murgai, the Court held that restrictive covenants operating during the subsistence of an employment contract do not fall under Section 27; clause 11(k) only restricted the employee's option to resign for a fixed term and did not restrain future employment. (¶¶ 11, 12, 13, 14, 15, 16)
- Section 23, Indian Contract Act, 1872An agreement is void if its object is opposed to public policy. Applying Brojo Nath, the Court examined whether the clause in a standard form contract was unconscionable, unfair or unreasonable, and held that a minimum service tenure adopted by a public sector bank to reduce attrition and avoid repeated costly recruitment was not opposed to public policy. (¶¶ 17, 19, 21, 22, 24, 25, 26, 27, 28, 29, 30, 31)
- Articles 14, 16 and 19(1)(g), Constitution of IndiaThe employee alleged violation of Articles 14 and 19(1)(g). The Court noted that a public sector bank cannot make ad hoc private appointments and that an untimely resignation forces it into a fresh open and competitive recruitment process to satisfy Articles 14 and 16, which justified the liquidated damages clause. (¶¶ 7, 10, 29)
Held
- The Contract Act is exhaustive on the subjects it covers; the validity of a restrictive covenant in an employment agreement must be tested on the touchstone of Section 27. It is settled that a restrictive covenant operating during the subsistence of an employment contract does not clog the freedom of a contracting party to trade or employment. (¶¶ 12, 13, 14, 15)
- A clause requiring an employee to serve a minimum term and to pay liquidated damages in default restricts the option to resign and perpetuates the employment contract for a specified term; its object is in furtherance of the employment contract, not restraint of future employment, so it is not violative of Section 27. (¶ 16)
- Principles for standard form employment contracts: (i) they prima facie evidence unequal bargaining power; (ii) when the weaker party pleads undue influence, coercion or public policy, the court must examine the plea keeping in mind the unequal status of the parties and the context; (iii) the onus to prove that a restrictive covenant is not in restraint of lawful employment or not opposed to public policy lies on the employer, not the employee. (¶¶ 19, 20, 21)
- Public policy is not static; what is just, fair and reasonable varies with time. In employer-employee relations, technological change, re-skilling and retention of a scarce specialised workforce in a free market are emerging heads of public policy to be factored in when testing an employment term. (¶¶ 22, 23, 24, 25)
- A public sector undertaking competing in a liberalised market may legitimately prescribe a minimum service tenure to reduce attrition and improve efficiency; such a covenant is not unconscionable, unfair or unreasonable and does not contravene public policy. (¶¶ 26, 27)
- Liquidated damages of Rs. 2 lakhs were not disproportionate: the bank had pleaded the financial hardship of repeated recruitment drives, a public sector bank must follow an open competitive process under Articles 14 and 16, and the employee was in a senior managerial grade with a lucrative pay package, so the sum did not render resignation illusory (he in fact paid and resigned). (¶¶ 28, 29, 30, 31)
- The High Court erred in mechanically applying its earlier decision in BEML, which concerned a covenant that also clogged future employability and did not consider the financial loss to a public sector undertaking from premature resignations; judgments cannot be read as statutes and must be applied to the factual matrix of each case. (¶¶ 32, 33, 34)
Result
Civil Appeal No. 11708 of 2016 (by the bank) allowed; High Court judgment quashing clause 11(k) and directing refund set aside. Civil Appeal No. 11499 of 2016 (by an employee challenging a similar clause) dismissed.