Introduction:
Restrictive covenants in employment contracts have long been a contested subject in Indian contract law. The tension lies between two competing values: the employer’s legitimate interest in protecting its business and investments, and the employee’s constitutional right to freely exercise trade, business or profession. Section 27 of the Indian Contract Act, 1872 (“Contract Act”), read with Article 19(1)(g) of the Constitution of India, 1950 (“Constitution”), provides the legal backdrop against which such clauses are tested.
The Supreme Court judgment in Vijaya Bank & Anr. v. Prashant B. Narnaware[i] (“Vijaya Bank Case”), revisits this delicate balance. The Court upheld the validity of a clause in an employment contract requiring an employee to serve a minimum tenure of three years, failing which he was liable to pay liquidated damages of INR. 2,00,000/-. The case has sharpened the contours of the law on restrictive covenants, particularly in distinguishing between restrictions during the course of employment and those post-termination.
Facts of the Case:
The respondent, an officer of Vijaya Bank, applied for promotion to the post of ‘Senior Manager’ in 2007. Clause 11(k) of his appointment letter required him to serve a minimum of three years and execute an indemnity bond of INR. 2,00,000/-, payable if he resigned before completing the tenure. He resigned within two years to join another bank, paid the amount under protest, and challenged the clause as violative of Articles 14 and 19(1)(g) of the Constitution and Sections 23 and 27 of the Contract Act. The High Court of Karnataka struck down the clause, holding it to be a restraint of trade and opposed to public policy.
Legal Issues:
- Whether Clause 11(k) of the appointment letter amounted to a restraint of trade under Section 27 of the Contract Act.
- Whether it was opposed to public policy under Section 23 of the Contract Act and violative of Articles 14 and 19 of the Constitution.
Restraint of Trade under Section 27
Section 27 reads as follows:
“27. Agreement in restraint of trade, void.—Every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void.”
Indian courts, however, have evolved a nuanced approach. In Niranjan Shankar Golikari v. Century Spinning and Manufacturing Co.,[ii] and Superintendence Company v. Krishan Murgai,[iii] the Supreme Court drew a vital distinction:
- Negative covenants during employment, such as exclusive service requirements, are enforceable and not hit by Section 27 of the Contract Act.
- Post-employment restraints, such as non-compete clauses, are void unless they fall within the narrow exception of the sale of goodwill under Section 27 of the Contract Act.
In the Vijaya Bank Case, the Supreme Court found that Clause 11(k) of the appointment letter did not prohibit future employment but merely required the employee to serve a minimum term or pay damages. This, it held, was in furtherance of the contract and not a restraint on trade. The covenant was therefore valid under Section 27 of the Contract Act.
Public Policy and Standard Form Contracts
The respondent contended that the covenant was unconscionable, imposed through unequal bargaining power, and hence void under Section 23 of the Contract Act as opposed to public policy.
In Central Inland Water Transport Corporation v. Brojo Nath Ganguly[iv], the Supreme Court invalidated oppressive clauses in standard form contracts on the ground of unequal bargaining power and public policy. The Court in the Vijaya Bank Case acknowledged this principle but held that the covenant here was neither unconscionable nor excessive. Public sector banks, competing in a liberalised economy, had legitimate grounds to enforce minimum service tenures to protect against attrition and costly recruitment processes. The clause was thus not injurious to public interest, and its imposition of INR. 2,00,000/- as liquidated damages was considered proportionate given the employee’s seniority and pay scale.
The case highlights the tension between:
- Freedom of Contract: Employers, particularly in sectors requiring stability and trained personnel, must have autonomy to design contractual safeguards.
- Freedom of Trade/Occupation: Employees have a constitutional guarantee under Article 19(1)(g) of the Constitution to pursue professions and mobility of employment.
The Court tilted in favour of freedom of contract, provided the clause was reasonable, limited to the subsistence of the employment, and not designed to stifle future prospects.
Legal Analysis:
- Section 27 of the Contract Act and Judicial Interpretation:
Section 27 of the Contract Act, on its face, declares all restraints on trade void save for the narrow exception of the sale of goodwill. Yet, over decades, the judiciary has read down its rigidity by carving out distinctions between restraints during employment (valid) and restraints post-employment (void). This interpretive device has enabled courts to preserve commercial efficacy without formally diluting the statutory bar. The present judgment is another illustration of this judicial pragmatism. By treating Clause 11(k) of the appointment letter as a measure to “further” the employment contract rather than “restrain” future employment, the Court sidesteps the literal sweep of Section 27 of the Contract Act. While it may be argued that this approach undermines legislative clarity; however, it reflects the Court’s sensitivity to economic realities and the impracticability of applying Section 27 of the Contract Act in its absolute terms.
- Unequal Bargaining Power vs. Informed Consent:
The respondent in the Vijaya Bank Case argued that the clause was a standard form contract, signed under unequal bargaining power. The Court rejected this plea, noting that the clause was justified by the bank’s operational needs. Here lies a deeper tension:
- On one hand, the doctrine of unconscionability recognises that employees often sign “on the dotted line” without meaningful choice.
- On the other hand, in managerial or senior roles, employees enjoy sufficient agency to weigh the costs of minimum service bonds against career advancement.
By refusing to categorically strike down such clauses, the Court implicitly introduced a functional test: the higher the position and pay, the stronger the presumption of informed consent. This nuanced stance avoids overprotecting employees who voluntarily assume contractual risks.
- Public Interest and Attrition Costs
The Court’s reasoning that attrition imposes recruitment costs and operational disruptions is compelling. It situates restrictive covenants within the public interest in organizational efficiency, particularly in public sector undertakings bound by constitutional hiring norms. Unlike private companies that can hire laterally with flexibility, public sector undertakings must undergo open, transparent, and expensive recruitment. Hence, attrition is not merely a private inconvenience but a systemic burden, justifying the imposition of liquidated damages.
- Liquidated Damages as Enforceable Deterrent
The indemnity of INR. 2,00,000/- was upheld as proportionate. This reflects an important doctrinal move: treating such clauses as liquidated damages rather than a penalty under Section 74 of the Contract Act. The Court’s stance implicitly affirms that retention costs and recruitment expenses are quantifiable harms, capable of pre-estimation. If left unchecked, courts striking down such clauses as penalties would discourage employers from investing in the training and professional development of employees.
- Constitutional Dimension
The invocation of Articles 14 and 19 of the Constitution was unconvincing. The Court rightly held that constitutional rights do not automatically override voluntary contractual undertakings unless the clause is arbitrary or oppressive. This demarcation is essential. Extending constitutional scrutiny to every employment covenant risks paralysing contractual autonomy and commercial certainty.
In sum, the Court’s approach reflects a calibrated balance: it preserves employee mobility post-employment while legitimising reasonable service obligations during employment.
Implications For Legal Drafting:
- Drafts must specify pre-estimated losses and justify amounts with reference to training costs, recruitment expenses and operational disruption.
- Clauses should not extend to prohibiting employment elsewhere post-contract. Such terms remain unenforceable.
- Employers should calibrate damages according to employee seniority and investment made. A flat amount across all roles risks being challenged as arbitrary.
Conclusion:
The Supreme Court’s ruling in the Vijaya Bank Case decisively clarifies that minimum service covenants with proportionate liquidated damages are valid contractual safeguards, not unlawful restraints on trade. The decision embraces commercial realism: employers cannot be left vulnerable to attrition costs in a competitive economy, while employees must remain free to chart their future post-employment. By drawing this line, the Court reaffirmed that freedom to contract and freedom of trade are complementary, not conflicting values. Contractual autonomy is preserved during employment, while constitutional liberty is safeguarded after termination.
In an evolving labour market shaped by competition, mobility and specialisation, this judgment stands as a cornerstone: restrictive covenants that are reasonable, proportionate, and time-bound will endure; those that stifle freedom beyond employment will not.
Article by: Garima Bothra, Associate
[1] Vijaya Bank and Ors. vs. Prashant B. Narnaware AIR 2025 SC 2820.
[1] Niranjan Shankar Golikari vs. The Century Spinning and Mfg. Co. Ltd. AIR 1967 SC 1098
[1] Superintendence Company of India (P) Ltd. vs. Krishan Murgai AIR 1980 SC 1717 [1] Central Inland Water Transport Corporation Limited and Ors. vs. Brojo Nath Ganguly and Ors. AIR 1986 SC 1571
