Validity of Employment Bonds in India

[Apoorv Madan is a 4th year law student at Jindal Global Law School in Sonipat]

Background

Corporations often invest huge amounts of time and money in imparting training to their employees so as to gain competitive advantage. Regardless, the attrition rate continues to be significant. Several employees, after acquiring valuable skills, leave the organization for diverse reasons. Therefore, the employer may incur significant losses in terms of competitive advantage and incur costs in terms of time, money and human capital. It is in this context that the employers often require their future or existing employees to sign an employment bond. By the virtue of these contracts or undertakings, the employee agrees to serve the employer for a certain minimum period stipulated by the bond, failing which the employee promises to pay the amount stipulated therein. This post attempts to answer two main questions concerning employment bonds: (i) under what circumstances, can employment bonds be enforced, if at all? (ii) whether employment bonds may be enforced against persons other than employees (say, against private contractors or interns)?

Validity of Restrictive Covenants in General

Courts have generally held that employees’ rights to livelihood must prevail over employers’ interests, notwithstanding a pre-existing agreement between the two. For instance, in the 2009 case of Desiccant Rotors International (P) Ltd v Bappaditya Sarkar, the Delhi High Court observed that in instances of conflict between employers’ attempts to protect themselves from competition and the right of employees to seek employment wherever they choose,“it is clear that the right of livelihood of the latter must prevail”. Some authors claim (and reasonably so) that the rationale behind invalidation of the restrictive covenants is that their enforcement would entail that, paradoxically, the employee would be restrained “because of his increased expertise, from advancing further in the industry in which he is most productive”.

However, the Supreme Court in Niranjan Shankar Golikari v The Century Spinning And Mfg Co cited a Calcutta High Court judgment with approval. It provides in clear terms that: “An agreement to serve a person exclusively for a definite term is a lawful agreement, and it is difficult to see how that can be unlawful which is essential to its fulfilment, and to the due protection of the interests of the employer, while the agreement is in force.” [emphasis supplied] Thus, it implies that the restrictive covenants are valid for the duration of employment and not violative of section 27 of the Indian Contract Act, 1872. The validity of the restrictive covenants comes into question if they extend to post-termination scenarios.

Employment Bonds Imposing Post-Termination Obligations

Section 27 of the Contract Act prohibits, inter alia, a contract that debars an employee from carrying on an employment with a competitor after serving an employer (who requires the signing of a bond). Various case laws includingHigh Polymer Labs Pvt Ltd v RK Mutreja and the more recent case of Le Passage to India Tours v Deepak Bhatnagar have affirmed the same.

Further, in Pepsi Foods Ltd v Bharat Coca-Cola Holdings (P) Ltd, the Delhi High Court held that a negative covenant that restrained employees from undertaking employment for 12 months after they left the plaintiff’s service amounted to a violation of Section 27. It held that such contracts are unenforceable, void and against public policy, and that what the law prohibits cannot be permitted by an injunction.

Employment Bonds in the Cases of Specialized Training Provided by the Company – Conditions for Their Validity

Indian courts, however, have unequivocally held contracts containing restrictive covenants to be valid if the organization has spent significant resources on personnel training or skills enhancement of the employee. This proposition, however, comes with various caveats.

After the perusal of various Supreme Court judgments, the Madras High Court in Toshnial Brothers (Pvt) Ltd v E Eswarprasad & Ors held that the existence of a legal injury accruing as a consequence of breach is a pre-requisite for claiming liquidated damages in accordance with section 74 of the Indian Contract Act, 1872.  In other words, the employer must show a legal injury automatically resulting from the breach of the commitment to serve for a minimum period.According to the Court, a presumption of legal injury arises incases“where the employer or the management concerned was shown to have either incurred any expenditure or involved itself into financial commitments to either give any special training either within the country or abroad or in having conferred any special benefit or favour to the detriment of the claimant in favour of the violator involving monetary commitments.” The inevitable conclusion from the foregoing decision is that the employer must prove that the employee was the beneficiary of special favour or training or concession at the expense of the employer. Otherwise, actual injury accruing as a result of the breach would have to be proved.

However, just because a legal injury is proved, that does not per se entail that the court would grant the employer the whole of the damages stipulated by the contract. For example, in Sicpa India Limited vs Shri Manas Pratim Deb, the Court considered the actual loss suffered by the employer. As against the stipulated compensation of Rs 2,00,000, the Court granted damages of Rs 22,532. In this case, the employee resigned from employment after serving two years instead of three years as mandated by the bond.

Based on these cases, it becomes clear that employment bonds are unequivocally enforceable if following requirements are satisfied:

  1. The employer has actually spent money on the employee,
  2. The said expenditure is in lieu of a promise from the employee that he or she would not leave the employment for duration specified in the contract,
  3. The employee has breached the contract and left the employment before the stipulated period,
  4. On account of the breach, the employer has suffered loss.

In addition, Liquidated Damages must not be in the nature of penalty. The Supreme Court in Fateh Chand vs Balkishan Das held that such stipulations are void. If the actual loss (incurred by the employer on account of breach of the bond) can be computed, the same should be awarded and the stipulated damages should be kept as the upper cap. While courts may be willing to award liquidated damages (in accordance with section 74 of the Indian Contract Act), they have mostly been reluctant to grant specific performance of the covenant.

Further, the contract must not be too heavily one-sided such that it loses the character of a contract promoting trade and attains the character of a contract in restraint of trade. The cases of Jet Airways (I) Ltd v Jan Peter Ravi Karnik and Lalbhai Dalpatbhai & Co v Chittaranjan Chandulal Pandya expound this well-recognized legal principle.In the former case, the defendant resigned within six months of completion of the training, in violation of the employment bond. However, the Bombay High Court refused to grant injunction in favour of the company on the ground that the negative covenant was one-sided and unreasonable. The Court observed that there was no proprietary interest of the employer in need of protection. Similarly, a covenant that mandated the employee to serve for a period of 20 years was held to be oppressive and one-sided in Shree Gopal Paper Mills Ltd v Surendra K Ganeshdas Malhotra.

Are Employment Bonds Enforceable Against People Other than Employees?

Courts have recognized that a reasonable and balanced bond entered into between a company and a trainee is valid. An example is the case of Subhir Ghosh v Indian Iron and Steel Company in which a contract imposing an obligation on the trainee to mandatorily accept an employment offer, if made by the company upon completion of his training, was held to be valid.

However, employment bonds in relation to private contractors may be considered to be too far-fetched, lopsided and unreasonable, and thereby, violating section 27 of the Act.

Conclusion    

From the above analysis, it is clear that the restrictions that operate during the period for which the employee has agreed to serve would usually not amount to a restraint of trade. This comes with caveat that the covenants are not one-sided, do not impose unreasonable fetters and are not oppressive. However, restrictions operating subsequent to termination would be considered invalid and in breach of section 27 of Indian Contracts Act, 1872. Further, for computation of liquidation damages to be awarded in case of breach of employment bond, the court would pay due regard to the guidelines mentioned above and would be unlikely to grant specific performance of the contract. In addition, the bonds would also be valid with respect to trainees if the employer proves that it has suffered a legal injury resulting from the trainee’s breach of the bond.

– Apoorv Madan

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