Enforcement of Employment Indemnity Bonds in India: Judicial Shift in Interpretation

An article titled “𝐄𝐧𝐟𝐨𝐫𝐜𝐞𝐦𝐞𝐧𝐭 𝐨𝐟 𝐄𝐦𝐩𝐥𝐨𝐲𝐦𝐞𝐧𝐭 𝐈𝐧𝐝𝐞𝐦𝐧𝐢𝐭𝐲 𝐁𝐨𝐧𝐝𝐬 𝐢𝐧 𝐈𝐧𝐝𝐢𝐚: 𝐉𝐮𝐝𝐢𝐜𝐢𝐚𝐥 𝐒𝐡𝐢𝐟𝐭 𝐢𝐧 𝐈𝐧𝐭𝐞𝐫𝐩𝐫𝐞𝐭𝐚𝐭𝐢𝐨𝐧” co-authored by our Partner, Akshay Jain and Associate, Anuj Vakharia, has been published by BW Legal.

The Supreme Court of India in a recent judgement (Vijaya Bank & Anr. v. Prashant B. Narnaware), upheld the enforcement of an employment indemnity bond which required an employee to pay ₹2,00,000 to their employer, a public sector undertaking (PSU). The sum was payable as the employee had resigned prior to an agreed three-year minimum service tenure.

While a large part of the jurisprudence regarding enforcement of such bonds consists of cases where payment obligations have not been enforced in full, this judgment forms part of the few exceptions where employment bonds have been enforced as intended, i.e. payment of the amount specified under the bond has been enforced as liquidated damages under Section 74 of Indian Contract Act, 1872 (“Contract Act”). More than just a ruling on damages, the Court’s reasoning in this case offers a fresh perspective on restrictive covenants in the modern Indian economy, signaling a potential shift in judicial thinking.

Supreme Court’s Modern Take on Core Issues

In addition to the primary focus of this judgment, i.e. enforcement of payment obligations under employment indemnity bonds, the Supreme Court’s perspective on the legality of the bond itself is interesting. The three key aspects discussed in this case and court’s take on each, is listed below:

a) Whether employment bonds are in restraint of trade: Reaffirming (once again) the long-standing principle from Niranjan Shankar Golikari v. Century Spinning & Mfg. Co. Ltd., the Supreme Court held that negative covenants binding an employee to serve exclusively for a stipulated term are not a restraint of trade, as they operate during the period of employment. The bond’s objective was to ensure the fulfillment of the existing contract, not restrain future employment. The obligation to pay was a consequence that crystallised upon premature resignation, not a restriction under Section 27 of the Contract Act.

b) Whether employment bonds are opposed to public policy: The employee contended that the bond, part of a ‘standard-form contract’, was void for being opposed to “public policy” under Section 23 of the Contract Act, alleging he was compelled to “sign on the dotted line” due to unequal bargaining power. While acknowledging the principle from Central Inland Water Transport Corporation Ltd. v. Brojo Nath Ganguly allowing courts to strike down unconscionable terms, the Supreme Court emphasized that “public policy” must be interpreted in light of evolving economic realities.

Rooting its analysis firmly in India’s post-liberalization economy, the SC noted that the “golden days of monopolistic public sector behemoths” are over. For employers like PSU banks operating in a competitive free market, minimum service conditions were deemed a reasonable policy to ensure staff retention and protect its investment against attrition. In balancing the employee’s interests against the employer’s commercial imperatives in a “deregulated free-market”, the court found the clause was not unconscionable.

c) Payment of bond amount as liquidated damages: The Court accepted the bank’s justification that a premature managerial resignation would cause significant prejudice to the employer. Being a PSU which is compelled to undertake a “prolix and expensive recruitment process”, the Court found the sum of ₹2,00,000 to be a reasonable and genuine pre-estimate of damages, not an arbitrary penalty under Section 74 of the Contract Act. The Court also observed that the employee was a senior manager with a lucrative salary, and the stipulated amount was not so disproportionate as to render the option of resignation illusory.

This decision adds to a niche but significant line of cases, including Ashwani Bahl v. Air India Limited and Captain Bindu Kelunni v. Blue Dart Aviation Limited. While these were not referred to in the Vijaya Bank judgment, given these previous cases dealt with resignations by pilots in a highly specialized industry, application of similar principles to resignation by a bank manager is particularly noteworthy.

Key Takeaways: Bonds and Beyond

The implications of this judgment potentially extend beyond the immediate issue of indemnity bonds:

• Bonds are Viable Tools: The jurisprudence from Vijaya Bank, Ashwani Bahl, and Captain Bindu Kelunni confirms that employees can be required to honour payment obligations under indemnity bonds where the amount is a reasonable pre-estimate of damages that are difficult to quantify, provided the employer articulates a legitimate business rationale.
• Commercial Rationale vs. Unconscionability: This judgment signals a potential weakening of traditional challenges to in-service covenants. Courts may be less receptive to arguments of ‘restraint of trade’ or ‘unequal bargaining power’ when an employer presents a clear commercial justification rooted in modern market dynamics. The validation of such terms as a necessary business protection tool is significant.
• The Evolving Nature of “Public Policy”: By expressly recognizing “public policy” as an evolving concept that adapts to economic realities, the Supreme Court has seemingly opened the door for greater judicial acceptance of other restrictive covenants that have historically faced enforcement hurdles. In an information age where human capital is a key asset and India strives to improve its contract enforcement landscape, this judgment suggests the boundaries around such covenants may be shifting.

While applicability of these principles may be subject to commercial realities unique to each sector and each employment relationship, evaluation of enforceability of restrictive covenants including minimum service periods is likely to be a more nuanced affair going forward.