Employment Bonds – Validity & Enforceability

Introduction

The elemental task assigned on my first day of legal internship encircled, what seemed a rather straightforward case, around Section 138 of the Negotiable Instruments Act, 1881. The more I divulged into the more puzzling it became encircling Contract Act, Employee-Employer Relationship and interconnected legislations, and the Indian Constitution.  

The case was that of an employee who was terminated from service on account of its gross negligence and lack of care. The Employer was our client and wanted to encash the post-dated cheque provided by the employee as security, an essential condition of its Employment Bond.

The question which posed before me was of the inherent validity of the Employment Bond and therefore the mechanism for its enforcement.

To understand better, we first analyse the doctrine of restraint of trade. The doctrine of restraint of trade is a strange beast. Its role in contract law is traditionally understood to be that of denying validity to contracts that unduly restrain the freedom of one or both contracting parties. it is not entirely surprising that restraint of trade law has been, as one judge delicately put it, ‘the subject of observations which are by no means easy to reconcile’.[1]

In Esso Petroleum v. Harper’s Garage,[2] Lord Hodson stated that ‘the basis of the doctrine of restraint of trade is the protection of the public interest’. Yet, other judgments barely mention or entirely ignore the public interest and at least one judgment[3] states that the public interest has never been relevant in a restraint of trade decision.

Restraint of trade cases raise three questions. First, is judicial scrutiny of contracts of the sort in dispute generally desirable? Scrutiny is desirable where one or (preferably) more of three features exist: (a) the obligation is onerous; (b) there was a significant risk of cognitive error in the framing of the obligation; (c) the parties’ self-interest was a weak safeguard against unreasonableness. Second, does the restraint protect an investment necessary to the achievement of some positive endeavour? If it does not, that is, if the restraint is an ‘unadorned’ restraint on freedom, then, regardless of its reasonableness, it should be invalidated without further scrutiny. Third, does the restraint provide no more protection than necessary for the protection of the endeavour? Unnecessary restraints are undesirable and should not be supported by the law.

Restraint of trade law appears to be more complicated than it is primarily for two reasons. First, restraint of trade cases commonly raises extremely difficult factual questions, often of a highly technical economic character. Second, unnecessary, or inappropriate considerations and qualifications have been introduced in several restraints of trade cases.

The existence of so many important unresolved issues in restraint of trade law suggests that a re-examination of the doctrine and therefore the various kinds of restrictive covenants is needed and therefore the quest of this research paper.

There are broadly two kinds of restrictive covenants in operation during the term of employment which are non-compete and non- disclosure of confidential information. If the employee is in breach of a non-compete restriction, prohibiting him/her from engaging  in any kind of business or activity which is similar to the company’s business, or making  a mandate to not disclose or misuse confidential information or trade secret passed on to the employee, during the course of his/her employment then such breaches would inevitably lead to a potential dispute.

Therefore, to reduce litigation risk, it is helpful to obtain a representation from the new employee (whether under the employment contract or otherwise) that the employee has not and will not breach any obligations towards his previous employer, as a result of joining the employment under the new employer. This has been adopted as a standard practice in most multinational corporations these days to avoid litigation at a later stage.

When contrasted with the employees’ constitutional and statutory rights to  pursue occupations of their choice and  earn a livelihood, by using the full array of knowledge and skill at their disposal, the diverging interests sought to be advanced by employers (for protection of confidential information to retain the ‘competitive edge’) promise to form a fertile ground for contentious disputes between the employers and employees in the near future.

Incorporation and subsequent enforcement of these ‘restrictive covenants’ such as confidentiality, non-disclosure and non-solicitation in employment contracts, intended to restrict the employees from disseminating confidential and other important information exclusively available with an employer, are often amongst contentious issues in India because such provisions seemingly conflict with Section  27 of the Indian Contract Act. However, Section 27 itself is succinct and does not offer insight as to what kinds of restraints are valid, so the qualification of ‘reasonable’ restraints being valid and enforceable has been read into Section 27 by the courts.

Ultimately, the validity of such restrictive covenants is tested on the standards of reasonability, involving considerations of duration and space of the restriction in question. However, the legislations governing several aspects of the employer-employee relationship and therefore these kinds of agreements existing both at national and state level are so numerous, complex and ambiguous, that they tend to promote litigation rather than providing easy solutions to potential problems.

In view of the Constitution of India and the provisions of the Indian Contract Act, 1872 courts have generally held that the right to livelihood of the employees must prevail over the interest of the employer, in spite of an existing agreement between the employer and the employee.

However, there is profound inconsistency within the judiciary itself when it comes to developing appropriate standards of review for addressing these emerging contentious employment related issues relating to confidentiality and non-solicitation which this paper seeks to shine light upon.

Kinds

As the complexities within the work field increased, the ‘white collar’ employees usually found themselves engaged in varied matters associated with breach of fiduciary responsibilities, company defamation, and company law non-compliance. they are conjointly engaged in problems concerning payment terms, termination of service, breach of confidentiality, non-compete or non-solicitation clauses adding a brand-new domain to the construct of commercial relations. The legal framework addressing the latter remains at an emergent stage in Bharat.

This half discusses the things wherever such disputes could arise between employers and workers at varied stages of their relationship.

A.   Pre-Hire

It is doable that dispute could arise even before someone is employed as an associate degree worker of a corporation. Cases wherever a recruit has joined employment while not punctually terminating his agreement with the previous employer could cause risk of potential disputes, each for the worker and therefore the new employer.

Typically, such disputes would arise between the erstwhile employer and worker. However, there are instances wherever the potential employer has conjointly been dragged into proceeding, by taking the position that the new employer is encouraging and helping the worker to breach his obligations towards the previous employer.

Further, many companies have a pre employment screening policy, but it may raise concerns of violation of the right to privacy of the persons being subjected to such screening, as the mode and manner of gathering such information may violate rights of individuals guaranteed under Article 21 of the Indian Constitution.[4]

The Nine Judge Bench of the Supreme Court in Justice K.S Puttaswamy (Retd.) v. Union of India and Ors.[5] recently held that the right to privacy is protected as an intrinsic part of the right to life and personal liberty under Article 21 and as a part of the freedoms guaranteed by Part III of the Constitution. The judgment has defined nine different kinds of privacy and one of them includes Informational Privacy.

B.    Throughout Employment

During employment, many disputes could arise between the leader and therefore the worker. Misconduct or undisciplined associate degree worker, trading, pampering in criminal activities, under-performance, breach of the terms of the utilization contract or hour policies/code of conduct etc., are few of the contentious problems which can ultimately result in a dispute. Further, if the worker is in breach of a non-compete restriction, prohibiting him/her from partaking in any reasonably business or activity that is analogous to the company’s business, or creating a mandate to not disclose or misuse counsel or secret passed on to the worker, throughout the course of his/her employment then such breaches would inevitably result in a possible dispute.

C.    Termination

Termination of employment by the employer often leads to a stand-off between an employee and employer which has all the ingredients for baking a potential dispute. Termination of employment due to misconduct, breach of the employment agreement including violation of restrictive covenants therein, is often escalated and settled through resort to courts.

The procedure to be followed for termination due to ‘misconduct’ would involve framing of charges, issuance of a charge sheet, conducting an internal (domestic) enquiry by an unbiased inquiry officer, followed by issuance of a show cause notice. The process needs to be in accordance with the principles of natural justice and the employee should be given an opportunity to submit his/her defence and to call upon witnesses. Decisions to terminate employment of an employee should be taken depending upon the gravity of the misconduct done on the part of the employee.

D.   Post-Termination

The covenants restraining employees from joining competitors after the cessation of employment are often found in modern day employment contracts. Restrictions in this category may also prevent a former employee from starting a competing business or advising a family member or relative who is in a similar line of business.

A breach of post termination clauses often forces the employer to seek advice on the legal recourse available to it. Indian courts however prioritize the protection of rights of an employee seeking employment over protecting the interests of the employer seeking to protect itself from competition.

In Affle Holdings Pte Limited v. Saurabh Singh[6], the Delhi High Court held that a negative covenant in the employment contract, which prohibits carrying on a competing business beyond the tenure of the contract is void and not enforceable. This prohibition operates on account of the provisions of Section 27 of the Contract Act.

Status of Restrictive Covenants

While it is a settled position of law that restrictive agreements bind current employees in lawful employment of the employers throughout the duration of the contract, the position of laws regarding validity of such restraints on employees after termination of contract is more contentious and adjudicated before courts.

The Supreme Court in Niranjan Shankar Golikari v. Century Spg & Mfg Co. Ltd[7] enumerated the tests to determine the validity of ‘restrictive’ agreements in terms of Section 27 of the Contract Act. In this case, a foreign producer collaborated with a company manufacturing tyre cord yarn by an agreement which stated that the company would maintain secrecy of all technical information. In pursuance of the agreement, the company signed a non-disclosure agreement with the appellant, at the time of his/her employment. The Supreme Court observed as thus:

“…considerations against restrictive covenants are different in cases where the restriction is to apply during the period after the termination of the contract than those in cases where   it is to operate during the period of the contract. Negative covenants operative during the period of the contract of employment when the employee is bound to serve his employer exclusively are generally not regarded as a restraint of trade and therefore do not fall under section 27 of the Contract Act. A negative covenant that the employee would not engage himself in a trade or business or would not get himself employed by any other master for whom he would perform similar or substantially similar duties is not therefore a restraint of trade unless the contract as aforesaid is unconscionable or excessively harsh or unreasonable or one sided…”

Referring to the above-mentioned Supreme Court case, Delhi High Court in LE Passage to India Tours & Travels Pvt. Ltd vs. Deepak Bhatnagar[8] observed that under Indian law there is a complete embargo to an agreement in restraint of the trade with the sole exception that one who sells goodwill of a business may agree with the buyer to refrain from carrying a similar business “within specified local limits” provided that such limits appear to the Court to be reasonable, regard being had to the nature of the business. However, in the garb of the alleged sale of goodwill of the trade, parties cannot enforce a restraint on the employment even after the employee ceases to be in the employment.

Recently, in the case of Kumar Apurva v. Valuefirst Digital Media Pvt. Ltd.,[9] the court upholding the decision of the Arbitral Tribunal, restrained the appellant from carrying any activity which is competitive to that of company, and also from soliciting, interfering with, disturbing or attempting to disturb the relationship between the company or subsidiary and third party, including any customer or supplier of the company or subsidiary.

In Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr.[10] it was held by the Supreme Court that “… a restrictive covenant extending beyond the term of the contract is void and not enforceable”. The Supreme Court also held that “the doctrine of restraint of trade does not apply during the continuance of the contract of employment and it applies only when the contract comes to end.” The Supreme Court further went on to observe that the doctrine of restraint of trade “is not confined to contracts of employment but is also applicable to all other contracts”.

Further in the case of Ozone Spa Pvt. Ltd. v. Pure Fitness & Ors.,[11] the court restricted the defendants from establishing, running or setting up any competing business in any area that falls within a range of 4 kilometres from the premises of the plaintiff. Section 27 states that all agreements in restraint of any profession are void, so long as an employee does not have the motive to cheat, mistrust or cause irreparable loss to the company, trade, or business. Hence, reasonable restraints are permitted, and they do not render the contract void.

In Kailash Kumar v. Syndicate Bank Ltd.,[12] the employee had entered into a bond with the employer which stipulated that if the employee intends to discontinue or resign from services during the probationary period, the employee will be required to reimburse the bond amount of Rs. 2,00,000 to the employer for the notional training expenses and any other expenses that the employer had incurred on behalf of the employee. The Delhi High Court observed that there was no occasion for the employee to undergo training or the employer to incur any expenses on training The court observed that expenses incurred by the employer towards carrying out the process of appointment including advertisement, or the expenses incurred expenses in future for making an appointment against the vacancy arisen because of the employee’s resignation cannot be treated as amounts reimbursable by the employee. Accordingly, the Delhi High Court held that since there were no training expenses incurred in the present case, the condition containing the employment bond would not be enforceable against the employee at the time of the employee’s resignation.

Furthermore, in Satyam Computer Services Limited v. Ladella Ravichander,[13] the defendant was an employee who had abruptly left the company and as per terms of employment bond, was required to pay liquidated damages of Rs. 2,00,000 along with stipend charges and additional expenses incurred by the company for the defendant. However, the Andhra Pradesh High Court held that such action by the defendant did not cause any damage or loss to the company and it would be unreasonable to acquire such an amount from the defendant.  An amount of Rs. 1,00, 000 was fixed by the court as reasonable damages taking into consideration the period of work and the fact that no actual loss was caused to the Company.

Similarly, in M/s Sicpa India Limited v. Shri Manas Pratim Deb,[14] the employee had to enter two bonds, one which provided that the employee had to work for a period of five years or pay an amount of Rs. 200,000, and another which stated that the expenditure on business trip would be recouped from the services of the employee. The employee resigned from the company towards the end of five years of his/ her bond period. The company instructed the employee to pay certain amounts for medical expenses incurred by the company on behalf of the employee. The employee refused to pay the amount as it was unreasonable, and the matter was taken up to the court where it was held that the five years mentioned in the first bond was almost coming towards the end and Rs. 67,596 was already recouped from the services of the employee for the second bond. Therefore, taking into consideration the period left in the bond, the court awarded reasonable damages to the employer.

Lastly, in Toshnial Brothers (Pvt.) Ltd. v. E. Eswarprasad & Ors.[15] the Madras High Court dealt with a situation where an employee working as a sales engineer in breach of his undertaking left his services within 14 months as against the contractually agreed period of three years. The Madras High Court held that the employer was entitled to recover the stipulated damages, which is a genuine pre-estimate by the parties of the damages incurred. There is no requirement to prove separately any post-breach damages. The employer is required to establish that the employee was the beneficiary of special favour or concession or training at the cost and expense wholly or on the part of the employer and there had been a breach of the undertaking by the beneficiary of the same. In such cases, the breach would per se constitute the required legal injury resulting for the employer due to breach of the contract.  

Conclusion

The discussion above on Section 27 of the Contract Act clearly states that restraints can be enforced only when the employee is in the service of the employer and these restraints cannot be enforced after the employee leaves service of the employer – irrespective of whether the employee leaves voluntarily or as a result of his/her service being terminated.

 However, the only restrictions that would be enforceable in an Indian court after the termination of employment would be non- disclosure of confidential information and non-solicitation of customers and employees.

In Gujarat Bottling v. Coca Cola[16] the Supreme Court observed:

“…In the past, nations often went to war for the protection and advancement of their economic interests. Things have changed now. In the time of cut throat competition and high employee turnover rate, the employers usually try to protect their trade secrets and in order to compete in the market, make their employees sign contracts/agreements which restrain their employees from disclosing the job profile, in future, or from competing with the same establishment or from working with the competitors. These agreements entered between the employer and the employee should not hamper the growth of the employee as well as secure the interests of the employer.”

The approach used by the Supreme Court in Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr.[17] seems to be the most appropriate approach to address concerns arising out of restrictive covenants:

“……Somewhere there must be a line between those contracts which are in restraint of trade and whose reasonableness can, therefore, be considered by the courts, and those contracts which merely regulate the normal commercial relations between the parties and are, therefore, free from doctrine….”

The relevance of inserting restrictive covenants in all kinds of contracts has evolved over a period and gained significant importance specifically due to the growing trend of employer employee disputes. The Law Commission of India in its 13th Report in 1958 had recommended that Section 27 under the Contract Act shall be amended to include only agreements in restraint of trade that are unreasonable or are not in the interests of the public to be void, however till date no such amendment has taken place.[18]

Restrictive covenants need to be analysed on a case-to-case basis. While broad principles emerge from the rulings, whether a condition is violative or not is a question of fact which only a court of law can examine and arrive at an appropriate conclusion based on facts and circumstances.

Recommendations for enforcing Restrictive Covenants

  1. Serving the employee with a legal notice.
  2. Seeking enforcement of undertaking or encashment of cheque based on clauses of the agreement.
  3. Initiating civil suit seeking injunction/specific performance of contract as well as damages.
  4. While damages are a remedy that an employer may seek for breach of employment contract, including breach of confidential agreements, the same requires trial and evidence. Therefore, the employer once again would require only an injunction under Order XXXIX Rule 1 and 2 of the Code of Civil Procedure, 1908 (“CPC”) at the interim stage or initially if they apprehend that premature departure of an employee could cause injury to the employer.
  5. Filing suit for declaration that the acts of the employee amount to tortious interference in the business of the employer and injunction therefrom.[19]  

Frequently Asked Questions

What are Employment Bonds?

Employment Binds are a form of Restrictive Covenants binding the employee to the service of the employer for a stipulated period of time in exchange for training and other such costs to be borne by the employer. The employee provides security in the form of post-dated cheque or other collateral in case of termination due to their negligence or resignation before the stipulated period. 

Are Employment Bonds legal?

Yes. But this highly depends upon the nature of the terms and conditions of the bond agreement, the bargaining power of the employee-employer and therefore is a subjective test.

Which law governs Employment Bonds?

Section 27 of the Indian Contract Act, 1872 along with Article 19 (1) (g) governs the restrictive covenants like Employment Bonds.

Is the entire security encashed in case of termination/resignation before the bond period?

No, courts have usually set the amount of damages suffered by the employer due to early termination/resignation of the employee as per the period served by and the expenses incurred on the employee and not as per the stipulated amount of the security.

What are the terms of the Employment Bond?

Ultimately, Employment Bonds are contracts. Therefore, the terms of the Contract would be set by the parties within the framework of the Indian Contact Act, 1872 but keeping in mind Article 19 (1) (g) and the principles of natural justice.


[1] Texaco Ltd v Mulberry Filling Station Ltd., [1972] 1 WLR 814.

[2] Esso Petroleum v. Harper’s Garage, UKHL 1 AC 269.

[3] AG Australia v Addaxdt Suamskip Co., [1913] AC 724.

[4] Vikram Shroff & Neha Sinha, Background Checks in India, Society for Human Resource Management (2012), http:// www.shrmindia.org/knowledge-center/talent-acquisition/ background-investigations/background-checks-India.

[5] K.S Puttaswamy (Retd.) v. Union of India and Ors., WP (C) 494 of 2012.

[6] Affle Holdings Pte Limited v. Saurabh Singh, OMP 1257/2014.

[7] Niranjan Shankar Golikari v. The Century Spinning & Mfg. Co. Ltd., (1967) 2 SCR 378.

[8] LE Passage to India Tours & Travels Pvt. Ltd vs. Deepak Bhatnagar, CS (OS) 1881/2013.

[9] Kumar Apurva v. Valuefirst Digital Media Pvt. Ltd., 2015 SCC Online Del 8360.

[10] Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr., AIR 2006 SC 3426.

[11] Ozone Spa Pvt. Ltd. v. Pure Fitness & Ors., 2015 222 DLT 372.

[12] Kailash Kumar v. Syndicate Bank Ltd., 8IAD (Delhi) 444.

[13] Satyam Computer Services Limited v. Ladella Ravichander, MANU/AP/0416/2011.

[14] M/s Sicpa India Limited v. Shri Manas Pratim Deb, MANU/DE/6554/2011.

[15] Toshnial Brothers (Pvt.) Ltd. v. E. Eswarprasad & Ors., 1997 LLR 500.

[16] Gujarat Bottling v. Coca Cola, AIR 1995 SC 2372.

[17] Percept D’Mark (India) Pvt. Ltd. v. Zaheer Khan & Anr., AIR 2006 SC 3426.

[18] Law Commission of India Report, 1958 Available at http:// lawcommissionofindia.nic.in/1-50/Report13.pdf, last seen at February 26, 2014.

[19] Embee Software Private Ltd v. Samir Kumar Shaw & Ors., 2012 (3) CHN 250.

2 Replies to “Employment Bonds – Validity & Enforceability”

  1. Very informative. I would like to know can I en-cash the post dated cheque provided by an employee who was terminated without going to court?

    1. You may encash the cheque without going to court provided the procedure of termination has followed the principles of natural justice, i.e. sufficient notice provided for justification, fair and unbiased hearing afforded to the employee, and just cause for termination.

      Though keep in mind the cases discussed in the article wherein the courts in multiple instances have refused to provide full sum to the employer.

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