A recent study found that nearly 33% of new joiners in India seek new employment within six to twelve months of starting a job.[1] This inevitably impacts the health and functionality of an organisation.

In this post, we explore how enforceable these lock-in clauses really are by examining relevant laws and case precedents that have helped shape the legal landscape.

The Fine Print: Are Lock-In Clauses on Solid Legal Ground?

The enforceability of lock-in clauses hinges on foundational contract law principles – the kind most lawyers encounter early in their legal education. But of course, it’s not always that straightforward.

Under Section 27 of the Indian Contract Act, 1872, any agreement that restrains a person from exercising a lawful profession, trade or business of any kind is void to that extent. While in the present case, there’s an important distinction between restrictions that apply during the term of employment and those that apply after it ends. Clauses preventing employees from working elsewhere during the term covered by the agreement cannot be said to be in restraint of trade.[2] Meaning prohibiting concurrent employment or engagement in competing business activities during the time of employment is seen as a reasonable measure to ensure that the employee remains focused on their primary obligations, including but not limited to their duties of loyalty, fidelity, and confidentiality. On the other hand, restrictive covenants that apply post-termination of employment agreements violate the said Section; such covenants are held to be void and unenforceable.[3] The doctrine of restraint of trade applies only after termination of the contract.

As a result, agreements that include a minimum service period and a liquidated damages clause in case of early exit are usually enforceable, unless they are found to be unconscionable, excessively harsh, unreasonable, or one-sided.

Section 23 of the Act also states that an agreement is void if its consideration or object is opposed to public policy. What falls under ‘public policy’ has evolved over time, meaning what’s considered opposed to public policy today may not be so few years down the line.

When it comes to standard form employment contracts, they are entered into by a party with superior bargaining power with a large number of persons who have far less bargaining power or no bargaining power at all. If such contracts are found to be unconscionable, unfair, unreasonable and injurious to the public interest, they will be deemed void, being opposed to public policy.[4]

Employees might also argue that such clauses violate their fundamental rights under Articles 14 and 19(1)(g) of the Constitution – the rights to equality and to practice any profession or carry on any occupation, trade or business.

Vijaya Bank Case

A recent Supreme Court decision in Vijaya Bank & Anr. v. Prashant B. Narnaware[5] sheds some light on this issue. In this case, Narnaware joined Vijaya Bank in 1999 and was promoted to Senior Manager in 2007. His appointment letter and the recruitment notification included a clause requiring him to serve at least three years or pay INR 2,00,000 in liquidated damages for early resignation.

Narnaware tendered his resignation in July 2009, before completing the three-year term. He paid the amount under protest and later approached the Karnataka High Court, seeking quashing of the impugned clause.

The High Court ruled in his favour and ordered a refund, prompting Vijaya Bank to appeal to the Supreme Court.

The Apex Court held that the clause neither amounted to a restraint of trade nor was it opposed to public policy. Its key observations included:

• No Clog on Freedom to Trade or Employment:

The impugned clause was not violative of Section 27 as it sought to perpetuate the employment contract for a specified term, and its object was in furtherance of the employment contract to ensure employee retention, not to restrain future employment.

• Interpreting Standard Form Employment Contracts:

After perusing the observations made by the Supreme Court in previous cases,[6] the following legal principles were summarised relating to the interpretation of standard form employment contracts:

• • Such contracts prima facie evidence unequal bargaining power.
  • If a weaker party alleges undue influence/coercion or that a clause is against public policy, the court has to examine such a plea, keeping in mind the unequal status of the parties and the context in which the contractual obligations were created.
  • The onus is on the employer to prove that the restrictive covenant is not in restraint of lawful employment or is not opposed to public policy.

• Clause Not Opposed to Public Policy:

The Court acknowledged emerging heads in the public policy domain, such as technological advancements impacting the nature and character of work and preservation of specialised workforce in a free market. In the case of PSUs, where retention of a skilled workforce was an inalienable tool to their interest, the Court found the clause neither unfair nor unreasonable.

• Quantum of Liquidated Damages:

The Court rejected the argument that the quantum of damages was disproportionate, noting the financial hardships resulting from time-consuming and expensive recruitment drives due to premature resignations. It considered the employer’s stance to be neither unjust nor unreasonable.

Thoughts on the Decision and Broader Legal Position

This ruling is significant but should be read in the context of its facts. The Court’s reasoning leaned heavily on PSU’s unique limitations. Unlike private companies, PSUs cannot hire on an ad-hoc basis and must follow rigorous procedures.

While this decision supports lock-in clauses by PSUs, it doesn’t automatically apply to private employers. Having said that, reasonable lock-in periods in employment contracts that apply during the term of employment are valid in law, as affirmed by the Delhi High Court in July 2024 in Lily Packers Private Limited v. Vaishnavi Vijay Umak.[7] In this case, the Court upheld a three-year lock-in period, ruling that it didn’t amount to an unreasonable restriction. It was observed that such terms are often the subject of negotiation and agreed upon voluntarily.

A few more cases help clarify how courts view the reasonableness of liquidated damages:

• In Toshniwal Brothers (Private) Limited v. Eswarprasad[8], the Madras High Court upheld an INR 25,000 damages clause after the employer showed it spent a similar amount to send the employee abroad for training. The Court held that such a breach per se constituted legal injury.
• In Ladella Ravichander. v. Satyam Computer Services Limited[9], the Andhra Pradesh High Court held the liquidated damages to be excessive, noting that the two-year lock-in period imposed on an engineering graduate was unreasonable and that no substantial loss or damage was proved by the employer. As a result, the Court reduced the damages from INR 2,00,000 to INR 1,00,000.

What Makes Employment Bonds Enforceable?

As mentioned, lock-in clauses are valid as they operate during the term of employment, as long as they are not unconscionable, unfair or unreasonable. An employee cannot be compelled to stay indefinitely or made to pay damages that are disproportionate to their pay package, training costs, or other relevant factors. These clauses need to strike a balance between protecting business interests and respecting employee rights.

Therefore, the courts assess such clauses on a case-to-case basis, weighing the nature of employment, the circumstances under which the clause was introduced, and whether enforcing it would be contrary to public policy. Employers, therefore, can be advised to draft lock-in clauses with care, ensuring they are clearly worded and grounded in legitimate commercial justification.

Concluding Thoughts

The existing legal framework in India governing lock-in clauses in employment contracts conveys a relentless commitment to protecting the fundamental right to practice any trade, profession, etc. under Article 19(1)(g) of the Constitution, and is shaped by the statutory bar on restraint of trade under Section 27 of the Indian Contract Act, 1872. Judicial decisions have laid down that while in-service restrictions may be conditionally enforceable, post-employment restrictions are unenforceable.

From the employers’ perspective, lock-in clauses add certainty and continuity in business transactions and ensure beneficial returns on investment while effectively deterring short-term opportunism. On the other hand, from the employees’ perspective, these clauses restrain job mobility and introduce coercion in an existing structure that is characterised by an imbalance in power. While both sides can be logically expanded, a sustainable middle ground can be sought wherein reasonable, narrowly tailored compensatory lock-in clauses are incorporated. In addition, greater attention should be given to incentive-based retention rather than coercive retention by exploring alternative strategies like career growth plans, performance-linked incentives, staggered bonus structure, educational and skill sponsorship, etc. This will foster loyalty rather than legal compulsion.