The Supreme Court recently outlined the legal principles applicable to interpreting standard form contracts often viewed as weaker contracts from the employee’s perspective typically drafted unilaterally by employers (such as corporations or institutions) and offered to employees on a “take-it-or-leave-it” basis.
The bench comprising Justices PS Narasimha and Joymalya Bagchi laid down legal principles relating to the interpretation of standard form employment contracts were summarized as follows:
“(i) Standard form employment contracts prima facie evidence unequal bargaining power.
(ii) Whenever the weaker party to such a contract pleads undue influence/coercion or alleges that the contract or any term thereof is opposed to public policy, the Court shall examine such plea keeping in mind the unequal status of the parties and the context in which the contractual obligations were created.
(iii) The onus to prove that a restrictive covenant in an employment contract is not in restraint of lawful employment or is not opposed to public policy, is on the covenantee i.e. the employer and not on the employee.”
The Court said that although the standard form of contract creates an unequal bargaining power to the employee, it cannot be invalidated solely on that ground unless it is shown that the contract’s term is oppressive, unconscionable, or against public policy.
If an employee challenges a contract as oppressive, unconscionable, or contrary to public policy, the Court must assess it in light of the inherent power imbalance considering whether the employee was in a vulnerable position, whether the penalty clause is disproportionately harsh compared to the employee’s salary, and whether it far exceeds the actual losses suffered by the employer (such as a bank) in the event of early resignation.
The Court made these observations while hearing a plea by a bank which required its employee to pay ₹2 lakhs, penalty if they resigned before completing the mandatory three-year service period prescribed before joining another bank.
Upon his switch to another bank, the Appellant made the Respondent to pay Rs. 2 lakh penalty, against which the Respondent filed a writ petition before the High Court. Aggrieved by the High Court’s decision declaring the execution of bond as restrictive trade practices under Section 27 of the Contract Act, prompted the Bank to appeal to the Supreme Court.
Setting aside the High Court’s decision, the judgment authored by Justice Bagchi emphasized that exclusivity clauses cannot be termed as restrictive of trade practices under Section 27 of the Contract Act, as such clauses do not restrict future employment but only imposed a financial penalty for early exit.
“A plain reading of clause 11 (k) shows restraint was imposed on the respondent to work for a minimum term i.e. three years and in default to pay liquidated damages of Rs. 2 Lakhs. The clause sought to impose a restriction on the respondent’s option to resign and thereby perpetuated the employment contract for a specified term. The object 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 Contract Act.”
The Court rejected the Respondent’s argument that such exclusivity clauses were unconscionable and part of a standard-form contract with no negotiation scope. Instead, the Court stated such clause to be reasonable given the fact that public sector undertakings need to retain skilled staff, and early exit prompts them to incur high cost of re-recruitment.
“The appellant-bank is a public sector undertaking and cannot resort to private or ad-hoc appointments through private contracts. An untimely resignation would require the Bank to undertake a prolix and expensive recruitment process involving open advertisement, fair competitive procedure lest the appointment falls foul of the constitutional mandate under Articles 14 and 16.”, the court said.
Thus, the Court justified the imposition of Rs. 2 lakhs penalty, stating that it was not excessive for a Respondent, who was a Senior Manager (MMG-III) drawing a lucrative salary.
Also From Judgment: ‘Employment Bond Valid, Doesn’t Violate S.27 Contract Act’ : Supreme Court Upholds Rs 2 Lakh Penalty For Premature Resignation
Case Title: Vijaya Bank & Anr. VERSUS Prashant B Narnaware
Citation : 2025 LiveLaw (SC) 565
