Introduction
In today’s employment landscape, employers increasingly incorporate restrictive covenants—such as clawback clauses, minimum service clauses, repayment undertaking or training bonds—that require employees to reimburse training costs if they leave prematurely or are terminated. These provisions are intended to protect the employer’s investment and prevent employees from gaining an unfair advantage after receiving specialised training. Although there is no bar on including such clauses in employment agreements, courts consistently examined their validity and enforceability, emphasising that any restrictive covenant must comply with established legal principles to remain reasonable, proportionate, and legally sustainable.
Restrictive Covenant in Employment Agreement.
Restrictive covenants are incorporated in most employment agreements and operate to secure specific obligations from the employee. One such less examined category within these covenants is the use of indemnity bonds or employment lock-in periods. These provisions require the employee to remain in employment for a defined tenure, during which or prior to the permanent employment, the employer invests in training and role-specific skill development.
If the employee resigns or is discharged before completing the minimum mentioned period, the covenant enables the employer to recover the predetermined bond amount or seek reimbursement for the costs incurred in training. The rationale is straightforward: to protect the employer’s investment and ensure continuity of service. While the enforceability of such clauses ultimately depends on the facts of each case, the inclusion of an indemnity bond or lock-in requirement in an employment agreement, by itself, does not render the covenant invalid.
Damages / Compensation for breach of the Agreement
As per the Indian Contract Act, 1872, compensation for breach of contract is determined within the framework of Sections 73 and 74. The Former allows compensation for loss or damage that naturally arises in the usual course of events or which the parties could reasonably foresee at the time of contract formation (unliquidated damages). Whereas, Section 74 comes into play where the contract specifies a penalty or a fixed sum payable upon breach (genuine pre-estimate loss/ liquidated damages). In later cases, the court may award only reasonable compensation, and not necessarily the amount named in the contract.
It is common for contracting parties to provide security or indemnity amounts at the time of entering into an agreement (including employment agreement). In the event of breach, the aggrieved party often seeks to forfeit this amount by invoking Section 74.
Courts across India, including the Hon’ble Supreme Court and several High Courts, have repeatedly examined whether an aggrieved party can forfeit the entire security or indemnity amount by invoking Section 74 of the Act.
The Constitution Bench in “Fateh Chand vs Balkrishan Dass” [1] held that Section 74 of the Act applies not only to cases where compensation is claimed but also to stipulations for forfeiture of earnest or advance money, if the forfeiture or advance money constitutes a penalty or is in the nature of a penalty. The amount named in the contract operates only as the maximum limit of compensation and the court must determine what reasonable compensation is justified. Although proof of actual loss is not an absolute requirement, the court cannot award compensation when it is evident that no loss at all has occurred. In such cases, no amount—whether styled as liquidated damages or forfeiture—can be retained.
In “Maula Bux v. Union of India”[2], the Hon’ble Supreme Court, following the principles laid down in Fateh Chand, held that Section 74 of the Act applies to cases where the aggrieved party seeks compensation pursuant to a contractual stipulation for a sum payable on breach, whether described as a penalty or arising from forfeiture. The Court observed that earnest money or security deposits do not automatically amount to penalty; however, even if treated as such, only reasonable compensation—as the amount named in the contract—may be awarded. The Court also clarified that the expression “whether or not actual damage or loss is proved to have been caused thereby” in section 74 of the Act, does not permit compensation where no legal injury has occurred; it merely dispenses with strict proof of the precise quantum of loss in contracts involving a genuine pre-estimate of damages. Accordingly, if the stipulated amount represents a true pre-estimate of loss, proof of actual damage is unnecessary; but where the contract contains no genuine pre- estimate and there is no evidence of loss at all, no compensation can be granted.
In “ONGC v. SAW Pipes” [3], the Supreme Court held that a stipulated sum under
Section 74 of the Act, can be enforced as a genuine pre-estimate of loss, even if actual damages are difficult to prove. The contract must reflect the parties’ intention and be compensatory, not punitive. In “Kailash Nath v. DDA” [4], the Court clarified that some legal basis or foreseeability of loss is required, and the sum must be reasonable and proportionate. Courts may moderate excessive or unconscionable amounts. These cases show that Section 74 balances contractual freedom with fairness, preventing unjust enrichment.
That the Hon’ble High Court of Delhi in “Vivek Khanna vs OYO Apartments Investments LLP” [5] while adjudicating the appeal under Section 34 of the Arbitration Act 1996, challenging the Arbitral Award held that
• “The AT rightly applied the judgements to reach the conclusion that the sum agreed by the parties as liquidated damages would not dispense with the requirement of proof by the party, claiming liquidated damages that actually suffered a loss”.
• “Liquidated Damages are not payable, merely as a penalty for breach of contract, if no loss suffered.”
Thus, liquidated damages are recoverable only upon proof of actual loss and cannot be claimed merely as a penalty for breach of contract, ensuring that compensation is confined to the genuine loss suffered.
In “Vijaya Bank & Anr. v. Prashant B. Narnaware” [6], the Supreme Court upheld a minimum service clause requiring an employee to serve three years or pay Rs. 2,00,000 as liquidated damages for early resignation. The Court clarified that such in- service covenants do not constitute a restraint of trade under Section 27 of the Indian Contract Act, since they operate during employment and not post-exit. It held that the employer bears the burden of proving the covenant is reasonable and is aligned with public policy. The Court affirmed the clause’s validity, noting that it protects institutional interests of public sector banks, particularly in the context of costly and protracted recruitment processes.
In Vijaya Bank & Anr. v. Prashant B. Narnaware, did the Hon’ble Supreme Court depart from or disregard the principles established in Fateh Chand v. Balkrishan Dass and subsequent judgments?
Although the Supreme Court in Vijaya Bank (Supra) did not expressly refer to Fateh Chand or subsequent authorities but the reasoning remains consistent with the principles laid down therein. The Court reaffirmed that where a contract provides for liquidated damages, the aggrieved party is entitled to reasonable compensation, subject to showing that loss occurred or was likely to occur—strict proof of exact loss not being an inflexible requirement under the jurisprudence starting from Fateh
Chand and later expanded in ONGC and Kailash Nath. Accordingly, the Vijaya Bank decision does not depart from the settled position of law; it is substantively aligned with the established framework governing liquidated damages.
Common Law Approach to Restrictive Covenants and Penalty Clauses
Under common law, restrictive covenants under the contracts are enforceable only if they protect a legitimate business interest and are reasonable. In relation to liquidated
damages, Makdessi[7] and ParkingEye[8] cases clarified that the older ‘genuine pre-
estimate of loss’ test is no longer applicable. A stipulated sum will be struck down only if it amounts to a penalty—that is, if it imposes a detriment out of proportion to any legitimate interest the innocent party has in enforcing the contractual obligation. If the clause is penal, it is unenforceable; if it protects a legitimate interest in a proportionate manner, it will be upheld even if it is not a genuine pre-estimate of loss.
Conclusion
Under Indian law, in-service restrictive covenants are generally enforceable, whereas post-employment restraints face strict scrutiny under Section 27 and are upheld only when they protect a legitimate proprietary interest and are reasonable. Claims arising from minimum-service clauses or training bonds are assessed under Sections 73 and 74, where courts award only reasonable compensation—capped by the sum named in the contract—and only when loss is shown to have occurred or is likely. In contrast, common-law jurisdictions after Makdessi (Supra) uphold stipulated sums so long as they protect a legitimate interest and are not penal. Indian law therefore adopts a more cautious, compensatory approach that restrains punitive clauses while still protecting genuine employer interests.
[1] 1963 SCC OnLine SC 49
[2] 1969 SCC OnLine SC 291
[3] 2003 SCC OnLine SC 545
[4] 2015 SCC OnLine SC 19
[5] 2023 SCC OnLine Del 5792
[6] 2025 SCC OnLine SC 1107
[7] [2015] UKSC 67
[8] [2015] UKSC 67