A) ABSTRACT / HEADNOTE

The Supreme Court of India in Vijaya Bank & Anr. v. Prashant B Narnaware addressed the validity of Clause 11(k) of an employment contract requiring an employee to serve a minimum tenure of three years, failing which Rs. 2 lakhs would be payable as liquidated damages. The respondent resigned before completing the mandated period, paid the amount under protest, and sought refund through a writ petition. The High Court struck down the clause as violative of Articles 14, 19(1)(g) of the Constitution and Sections 23 and 27 of the Indian Contract Act, 1872.

The Supreme Court reversed this finding, holding that restrictive covenants operative during the subsistence of an employment contract do not constitute a restraint of trade under Section 27 of the Contract Act. Relying on precedents like Niranjan Shankar Golikari v. Century Spinning (1967) and Superintendence Co. v. Krishan Murgai (1981), the Court clarified that restrictions meant to further the employment relationship, such as requiring minimum tenure, are not invalid.

The Court further analyzed whether such a clause was opposed to public policy under Section 23 of the Contract Act. Drawing from Central Inland Water Transport v. Brojo Nath Ganguly (1986), the Court acknowledged concerns about unequal bargaining power in standard form contracts. However, it emphasized the changed realities of a deregulated economy, the need for public sector banks to retain skilled workforce, and the legitimacy of liquidated damages to cover the high costs of recruitment.

The Court concluded that the clause was reasonable, not unconscionable, and not against public policy. Accordingly, it upheld the employer’s right to enforce the clause, set aside the High Court’s ruling, and allowed the appeal.

Keywords: Restrictive covenant, Liquidated damages, Restraint of trade, Public policy, Standard form contract, Section 27 Contract Act, Employment law, Constitutional rights, Public sector undertakings, Minimum service tenure.

B) CASE DETAILS

C) INTRODUCTION AND BACKGROUND OF JUDGMENT

The controversy revolved around the enforceability of a restrictive covenant in an employment contract of a public sector bank officer. The respondent, originally serving as a Manager in MMG-II, applied for promotion as Senior Manager (MMG-III) pursuant to a recruitment notification mandating execution of an indemnity bond of Rs. 2 lakhs if the employee resigned before serving a minimum tenure of three years. Upon promotion and acceptance of the appointment letter dated 07.08.2007, the respondent executed the indemnity bond and joined his new role.

However, within two years, he resigned to join another bank and was compelled to pay Rs. 2 lakhs under protest. Subsequently, he filed a writ petition before the Karnataka High Court, challenging the legality of the restrictive covenant as violating Articles 14 and 19(1)(g) of the Constitution and Sections 23 and 27 of the Contract Act, 1872. The High Court quashed the clause and directed refund.

The bank appealed, arguing that the clause was a reasonable measure to reduce attrition, protect institutional efficiency, and compensate for costly recruitment processes. The matter reached the Supreme Court, which was tasked with interpreting the enforceability of such clauses under contractual and constitutional law, as well as assessing their alignment with public policy.

This judgment carries significant implications for employment contracts, particularly in public sector undertakings where attrition threatens efficiency and the cost of recruitment is substantial. It also provides clarity on the delicate balance between contractual freedom, employee rights, and organizational interests within India’s evolving economic framework.

D) FACTS OF THE CASE

The respondent, Prashant B Narnaware, initially joined Vijaya Bank as a Probationary Assistant Manager in 1999. His services were confirmed in 2001, and he was subsequently promoted to Middle Management Scale-II. In 2006, Vijaya Bank issued a recruitment notification for 349 officer posts across various grades. Clause 9(w) of the notification specifically required selected candidates to execute an indemnity bond of Rs. 2 lakhs to ensure a minimum service of three years.

Pursuant to this notification, the respondent applied for the post of Senior Manager (Cost Accountant) with a basic pay of Rs. 18,240/-. On selection, he was issued an appointment letter dated 07.08.2007, wherein Clause 11(k) reiterated the mandatory service tenure of three years, with liquidated damages of Rs. 2 lakhs applicable for premature resignation. The respondent voluntarily accepted this condition, resigned from his earlier post, joined as Senior Manager (MMG-III) on 28.09.2007, and executed the indemnity bond.

However, on 17.07.2009, before completing three years, the respondent resigned to join IDBI Bank. His resignation was accepted, but he was required to pay Rs. 2 lakhs, which he did under protest. Aggrieved, he approached the Karnataka High Court, contending that the clause was violative of his fundamental rights under Article 19(1)(g) and opposed to public policy under Section 23 of the Contract Act. He also argued that it amounted to a restraint of trade under Section 27 of the Contract Act.

The High Court, relying on K.Y. Venkatesh Kumar v. BEML Ltd. (2009), struck down the clause and directed the refund. Vijaya Bank challenged this decision before the Supreme Court, asserting that the clause was reasonable, necessary for reducing attrition, and justified given the substantial costs of recruitment.

E) LEGAL ISSUES RAISED

i. Whether Clause 11(k) of the appointment letter requiring an employee to serve a minimum tenure of three years or pay Rs. 2 lakhs amounts to restraint of trade under Section 27 of the Contract Act, 1872?

ii. Whether Clause 11(k) is opposed to public policy and thereby void under Section 23 of the Contract Act?

iii. Whether such a clause violates the employee’s fundamental rights under Articles 14 and 19(1)(g) of the Constitution of India?

iv. Whether the High Court was justified in quashing the clause and directing refund of Rs. 2 lakhs?

F) PETITIONER / APPELLANT’S ARGUMENTS

The counsels for Vijaya Bank argued that the restrictive covenant was a valid and reasonable contractual condition aimed at reducing attrition and ensuring organizational efficiency. They contended that the recruitment process in a public sector bank is costly, time-consuming, and constitutionally mandated through transparent procedures. Premature resignations undermine this process and impose financial and administrative burdens.

Relying on Niranjan Shankar Golikari v. Century Spinning (1967), it was argued that restrictive covenants operative during the subsistence of employment contracts do not amount to restraint of trade under Section 27 of the Contract Act. The clause was in furtherance of the employment relationship and not a bar on future employment.

The appellants further emphasized that the liquidated damages of Rs. 2 lakhs were neither excessive nor disproportionate, considering the senior managerial grade and lucrative pay package of the respondent. They argued that the clause was not unconscionable, but a reasonable safeguard against premature attrition.

They also distinguished the BEML case, arguing that unlike there, the present clause did not impose a bar on future employability but only ensured completion of a minimum service tenure. They relied on Haryana Financial Corporation v. Jagdamba Oil Mills (2002) to assert that precedents must be applied in context, not mechanically.

G) RESPONDENT’S ARGUMENTS

The respondent, represented through counsel, argued that the clause was part of a standard form contract imposed by the bank, leaving no room for negotiation. Such contracts, they submitted, are inherently characterized by unequal bargaining power, compelling employees to accept onerous terms for career advancement.

Invoking Central Inland Water Transport v. Brojo Nath Ganguly (1986), they argued that unconscionable or unreasonable terms in standard form contracts are void as opposed to public policy. The liquidated damages clause was characterized as disproportionate, unjust enrichment, and an unfair restraint on the employee’s right to resign and pursue better opportunities.

They further contended that the clause infringed upon the fundamental right under Article 19(1)(g) of the Constitution, which guarantees the freedom to practice any profession or occupation. By mandating a compulsory service tenure under threat of financial penalty, the clause effectively restricted the respondent’s liberty to change employment.

Finally, reliance was placed on the BEML case to support the argument that clauses imposing minimum tenure and penalties are barred under Section 27 of the Contract Act.

H) JUDGMENT

The Supreme Court, speaking through Justice Joymalya Bagchi, overturned the decision of the Karnataka High Court. The Court held that Clause 11(k) of the appointment letter did not amount to restraint of trade under Section 27 of the Contract Act, 1872 and was not opposed to public policy under Section 23.

The Court reasoned that restrictive covenants during the subsistence of employment, unlike post-termination restrictions, are generally valid and enforceable. Such clauses further the employment contract rather than restraining future opportunities. The Court observed that the respondent had voluntarily resigned from his earlier position, accepted the promotion with higher pay and benefits, and executed the indemnity bond with full knowledge of the terms.

On the question of public policy, the Court acknowledged concerns about unequal bargaining power in standard form contracts but emphasized the evolving nature of public interest in the context of liberalization and competition. Public sector undertakings, unlike in earlier decades, operate in a deregulated market and must retain skilled workforce to compete with private players. The Court found that prescribing a minimum service tenure was neither unconscionable nor oppressive but served legitimate institutional interests.

Regarding liquidated damages, the Court upheld the reasonableness of Rs. 2 lakhs, noting that the cost of recruitment in public sector banks is high and involves adherence to constitutional mandates under Articles 14 and 16. The quantum was proportionate given the senior managerial position of the respondent and his lucrative package. The Court distinguished BEML on the ground that it dealt with restrictions extending to future employability, which was not the case here.

Accordingly, the appeal was allowed, and the High Court’s judgment was set aside. The clause was upheld as valid and enforceable.

a. RATIO DECIDENDI

The ratio decidendi of this case rests on two principal legal foundations:

First, the Court reaffirmed the doctrine established in Niranjan Shankar Golikari v. Century Spinning (1967) and Superintendence Co. v. Krishan Murgai (1981) that restrictive covenants operative during the tenure of employment are not hit by Section 27 of the Contract Act. The object of such covenants is to secure continuity of service and protect employer’s legitimate interests, not to restrain the employee’s freedom of trade or profession.

Second, the Court expanded the interpretation of public policy under Section 23 of the Contract Act, observing that concepts of fairness and reasonableness evolve with economic realities. In the deregulated market environment, public sector undertakings must compete with private players and require mechanisms to ensure stability of their workforce. Imposing a minimum service tenure with a proportionate penalty is not unconscionable but aligned with institutional efficiency and public interest.

Thus, the ratio is that a clause requiring minimum service tenure with a reasonable stipulation of liquidated damages for premature resignation is valid, does not amount to restraint of trade, and is not opposed to public policy.

b. OBITER DICTA

In its broader observations, the Court reflected on the dynamic nature of public policy and its adaptability to socio-economic changes. It emphasized that public policy cannot be frozen in time; instead, it must evolve with technological advancements, economic liberalization, and changes in employer-employee relationships.

The Court noted that reskilling, technological change, and preservation of specialized workforce are emerging dimensions of public policy. In this light, retention strategies such as minimum tenure clauses contribute to stability and efficiency in public sector undertakings.

The Court also observed that while standard form contracts generally indicate unequal bargaining power, not every such clause is unfair. The test is whether the clause is unconscionable, one-sided, or oppressive. Where the clause serves legitimate business interests and is proportionate, courts must respect freedom of contract.

These obiter dicta extend the jurisprudence on Sections 23 and 27 of the Contract Act by aligning public policy with contemporary economic needs and reinforcing the principle of reasonableness as a measure of validity.

c. GUIDELINES

From this case, the Supreme Court laid down significant guidelines for interpreting restrictive covenants in employment contracts:

i. Distinction between subsistence and post-termination restrictions – Negative covenants operative during employment contracts are valid; only post-termination restraints are generally void under Section 27.

ii. Legitimate business interests – Restrictive covenants designed to protect organizational efficiency, reduce attrition, or safeguard investment in recruitment and training are enforceable if proportionate.

iii. Public sector considerations – In public undertakings, restrictions ensuring workforce stability serve public interest, given the high cost of recruitment and constitutional mandates of fairness in hiring.

iv. Standard form contracts – Though indicative of unequal bargaining power, such contracts are not per se invalid. Clauses must be tested for fairness, proportionality, and reasonableness rather than struck down mechanically.

v. Evolving public policy – Public policy is dynamic and must reflect contemporary realities such as liberalization, competition, and technological change. What was once considered unreasonable may now be justified in changed economic contexts.

vi. Quantum of damages – Courts must examine whether liquidated damages stipulated are excessive, disproportionate, or illusory. Reasonable compensation, aligned with actual business needs, is enforceable.

I) CONCLUSION & COMMENTS

This judgment marks a significant development in Indian employment and contract law. The Supreme Court has reaffirmed the validity of restrictive covenants that operate during employment, bringing much-needed clarity to employers and employees alike. The decision carefully balances individual rights under Article 19(1)(g) with institutional interests, recognizing that absolute freedom without responsibility undermines organizational stability.

The ruling is particularly important in the context of public sector undertakings, which face challenges of attrition and competition from private entities. By upholding the legitimacy of minimum tenure clauses, the Court has acknowledged the operational realities of PSUs in a deregulated economy. This ensures that investments in recruitment and training are not wasted and that organizational continuity is preserved.

At the same time, the Court has cautiously reiterated that restrictions must not be unconscionable or excessive. This serves as a safeguard against arbitrary employer practices. The obiter dicta expand the understanding of public policy, making it responsive to economic liberalization and workforce mobility.

From a jurisprudential standpoint, the case harmonizes Section 27 of the Contract Act with evolving notions of fairness, aligning Indian law with modern trends in comparative employment law. It also signals that courts will adopt a contextual approach, considering the specific nature of restrictions, the grade of employment, and the proportionality of damages.

This judgment will likely influence drafting of employment contracts across industries, as it legitimizes reasonable retention clauses while cautioning against exploitative practices. It strengthens the principle that freedom of contract, tempered by fairness and proportionality, is essential for both employee rights and institutional efficiency.

J) REFERENCES

a. Important Cases Referred

i. Niranjan Shankar Golikari v. Century Spinning & Manufacturing Co., [1967] 2 SCR 378 : 1967 SCC OnLine SC 72.
ii. Superintendence Company (P) Ltd. v. Krishan Murgai, [1980] 3 SCR 1278 : (1981) 2 SCC 246.
iii. Central Inland Water Transport Corporation Ltd. v. Brojo Nath Ganguly, [1986] 2 SCR 278 : (1986) 3 SCC 156.
iv. Haryana Financial Corporation v. Jagdamba Oil Mills, [2002] 1 SCR 621 : (2002) 3 SCC 496.
v. K.Y. Venkatesh Kumar v. BEML Ltd., Karnataka HC, W.A. No. 2736/2009, decided on 09.12.2009.

b. Important Statutes Referred

i. Constitution of India – Articles 14, 16, and 19(1)(g).
ii. Indian Contract Act, 1872 – Sections 23 and 27.
iii. Specific Relief Act, 1963 – Section 57.