Does having a minimum service clause in an employment contact amount to an agreement in restraint of trade?
Responding to this question in the affirmative, the Supreme Court (SC) recently in the matter of Vijaya Bank & Anr. v. Prashant B Narnaware (2025 INSC 691) held that having a minimum service clause in an employment contact does not amount to a restraint of trade under *Section 27 of the Indian Contract Act, 1872 (Act).
The matter involved a dispute over a clause in the employment contract of a Public Sector Bank which mandated employees to serve a minimum tenure of three years from the date of joining and execute an indemnity bond of Rs. 2 lakhs. This amount is payable as liquidated damages if the employee resigns before completing the stipulated service period.
An employee of Vijaya Bank, appointed as Senior Manager (Cost Accountant) under this condition, resigned before completing three years of service with Vijaya Bank to join IDBI Bank. He paid the Rs. 2 lakhs amount under protest and subsequently challenged the validity of the clause before the Karnataka High Court (High Court). The High Court was of the view that the clause constituted a “restraint of trade” and was hence unenforceable under Section 27 of the Act. However, this decision was overturned by the Supreme Court, which upheld the enforceability of the clause.
The SC upheld the validity of a restrictive covenant in the employment contract which required employees of a public sector bank to serve a minimum tenure or pay liquidated damages upon premature resignation. The SC held that the clause requiring Rs. 2 lakhs as liquidated damages were neither arbitrary nor excessive given the managerial grade and pay of the employee and the potential operational costs incurred by the bank due to sudden resignations. Further, it was held that the objective of the restrictive covenant was in furtherance of the employment contract and not to restrain future employment hence, it cannot be said to be violative of Section 27 of the Act. Accordingly, the SC found that the clause did not amount to a restraint of trade nor was it contrary to public policy. The appeal by the bank was allowed, and the High Court’s order was set aside.
Source: Supreme Court
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*Section 27 of the Indian Contract Act,1872
- 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. Exception 1.—Saving of agreement not to carry on business of which good-will is sold.—One who sells the good-will of a business may agree with the buyer to refrain from carrying on a similar business, within specified local limits, so long as the buyer, or any person deriving title to the good-will from him, carries on a like business therein, provided that such limits appear to the Court reasonable, regard being had to the nature of the business.
