Source:  Supreme Court  

Why in News? 

Recently, the bench of Justice PS Narasimha and Justice Joymalya Bagchi upheld the validity of a bond clause in employment contracts, ruling that a mandatory minimum service period is legally permissible and not violative of Section 27 of the Indian Contract Act(ICA) . 

• The Supreme Court held this in the matter of Vijaya Bank & Anr. v. Prashant B Narnaware (2025). 

What was the Background of Vijaya Bank & Anr. v. Prashant B Narnaware (2025) Case? 

• In 1999, Mr. Prashant B Narnaware joined Vijaya Bank as a Probationary Assistant Manager, was confirmed in 2001, and later promoted to Middle Management Scale II. 
• In 2006, Vijaya Bank issued a recruitment notification for 349 officers across different grades, stipulating that selected candidates must execute an indemnity bond of ₹2 lakhs payable if they left service before completing 3 years. 
• Mr. Narnaware applied for the post of Senior Manager-Cost Accountant with a basic pay of ₹18,240/-, was selected, and received an appointment letter containing clause 11(k) requiring minimum service of 3 years with execution of the ₹2 lakh indemnity bond. 
• Accepting these conditions, Mr. Narnaware voluntarily resigned from his previous post as Manager (MMG-II), joined as Senior Manager (MMG-III) on 28th September 2007, and executed the required indemnity bond. 
• On 17th July 2009, before completing the stipulated three-year period, Mr. Narnaware tendered his resignation to join IDBI Bank. 
• Upon acceptance of his resignation, Mr. Narnaware paid ₹2 lakhs to Vijaya Bank under protest on 16.10.2009, in accordance with the indemnity bond. 
• Subsequently, Mr. Narnaware filed a writ petition before the High Court challenging clause 9(w) of the recruitment notification and clause 11(k) of the appointment letter as violations of Articles 14 and 19(1)(g) of the Constitution and Sections 23 and 27 of  ICA 1872. 
• The High Court allowed Mr. Narnaware's petition, which was subsequently upheld by its Division Bench, leading Vijaya Bank to appeal to the Supreme Court. 

What were the Court’s Observations? 

• The Supreme Court observed that restrictive covenants operating during the subsistence of an employment contract do not amount to a restraint of trade under Section 27 of ICA as they are in furtherance of the employment relationship rather than restricting future employment. 
• The Court noted that public policy considerations in employment contracts must be viewed through the lens of technological advancements affecting work nature, re-skilling requirements, and preservation of specialized workforce in a free market economy. 
• The Court observed that following liberalization, public sector undertakings like Vijaya Bank needed to compete with efficient private players, necessitating review and recalibration of policies to enhance efficiency and rationalize administrative costs. 
• The Court held that ensuring retention of efficient and experienced staff contributing to managerial skills was inalienable to the interest of such undertakings, and a covenant prescribing minimum service tenure to reduce attrition was neither unconscionable nor contrary to public policy. 
• The Court remarked that as a public sector undertaking, Vijaya Bank could not resort to private or ad-hoc appointments and an untimely resignation would necessitate a prolix and expensive recruitment process involving open advertisement and fair competitive procedure to satisfy the constitutional mandate under Articles 14 and 16. 
• The Court determined that the quantum of liquidated damages (₹2 lakhs) was not disproportionate considering the respondent's senior managerial position with a lucrative pay package, and did not render the possibility of resignation illusory, as evidenced by the respondent's actual resignation after paying the stipulated amount. 
• The Court concluded that the High Court erred in mechanically applying precedent without considering the restrictive covenant in its proper perspective within the specific factual matrix of the case. 

What is Section 27 of ICA ? 

• Section 27 declares that any agreement which restrains a person from exercising a lawful profession, trade or business of any kind is void to that extent. 
• The fundamental principle embodied in this section is that freedom to trade and conduct business is essential to public welfare, and contractual clauses restricting such freedom are prima facie void. 
• The section establishes a general prohibition against all restraints of trade, adopting a stricter approach than English common law which permits reasonable restraints. 
• The sole statutory exception to this prohibition concerns agreements related to the sale of goodwill, wherein the seller may be restrained from carrying on similar business within specified local limits. 
• For the goodwill exception to apply, three conditions must be satisfied: the restraint must be confined to specified local limits, it must be operative only so long as the buyer or his successor in title carries on like business within those limits, and the limits must appear reasonable to the Court considering the nature of the business. 
• The reasonableness of local limits under the exception is a question of fact to be determined judicially with regard to the particular nature and circumstances of each business. 
• The section adopts an absolute approach toward post-contractual restraints on employment, rendering covenants that prevent an employee from working elsewhere after termination void, regardless of their reasonableness. 
• The prohibition extends to both direct and indirect restraints, encompassing not only express prohibitions but also any contractual mechanism that effectively prevents a person from exercising their profession or trade.