Disputes Related To Lock-In Periods In Employment Contracts Are Arbitrable: Delhi High Court

The High Court held that the three-year lock-in period did not constitute an unreasonable curtailment of the employees' right to employment and did not violate any fundamental rights. It noted that such clauses are typically negotiated voluntarily and entered into with mutual consent.

Brief Facts:

Lily Packers Pvt. Ltd. (Petitioner) is engaged in the business of manufacturing and trading corrugated packaging, as well as sourcing and outsourcing materials. On 16th April 2022, the Petitioner employed Ms. Vaishnavi Vijay Umak (Respondent) as a fashion designer in its division called 'De Belle', and an agreement was executed defining the scope of her services.

The agreement included various conditions, such as salary, benefits, working hours, employment conditions, a lock-in period, confidentiality, and data protection. Clause 5 of the agreement specified a lock-in period of three years, during which the employee could not terminate her employment. Clause 9 contained a negative covenant requiring the employee to devote her full time and energy to the company, and Clause 10 emphasized compliance with company rules and the protection of confidential information. The agreement also included clauses on intellectual property, data protection, and termination, with Clause 17 providing for arbitration in case of disputes.

The Petitioner alleged that despite the lock-in period specified in Clause 5, the Respondent went on leave on 14th June 2023, and never returned. Additionally, the Petitioner was concerned about potential breaches of the confidentiality, intellectual property, and data protection clauses. Following the Respondent's departure, the Petitioner issued a notice of demand and invocation of arbitration. However, the Respondent's reply denied the allegations claimed harassment and humiliation, and refused to submit to arbitration. Consequently, the Petitioner approached the Delhi High Court for appointment of an Arbitral Tribunal under Section 11 of the Arbitration and Conciliation Act, 1996.

The Respondent argued that the disputes raised in the petition were not arbitrable.

Observations by the High Court:

The High Court referred to the 1885 case of The Brahmaputra Tea Co. Ltd. v. Scarthwhere the Calcutta Civil Appellate Court examined whether it was lawful to bind an employee to exclusive employment for a specified term. The court held that a covenant restricting an employee from engaging in tea cultivation for five years post-employment was void under Section 27 of the Indian Contract Act. However, it upheld the validity of a covenant requiring exclusive service during the employment term and awarded damages accordingly.

The Supreme Court further clarified this position in Niranjan Shankar Golikari v. Century Spinning And Manufacturing Co., where it distinguished between negative covenants during the term of employment and those post-termination. The Supreme Court held that negative covenants during the employment period, which require exclusive service, are generally not contrary to law. The Supreme Court even granted an injunction against the employee to prevent the disclosure of confidential information.

This principle was reiterated in Percept D' Mark (India) (P) Ltd. v. Zaheer Khan & Anr., where the Supreme Court distinguished between covenants active during the contract period and those post-termination. The Supreme Court held that restrictive covenants during employment are valid whereas those extending beyond the employment term are void.

In Affle Holdings Pte Limited Vs. Saurabh Singh, the Delhi High Court held that covenants prohibiting competition beyond the employment term are unenforceable but valid during the contract period.

The High Court noted that the Respondent entered into Service Employment Agreements with the Petitioner company, which included a lock-in period clause requiring them to serve the employer for three years from the date of joining. The High Court held that this clause doesn't violate the fundamental rights enshrined in the Constitution of India. It noted that such clauses are typically negotiated voluntarily and entered with mutual consent.

The High Court noted that these lock-in periods are prevalent at executive levels in various industries and are essential for reducing employee attrition and ensuring organizational continuity.

Therefore, the High Court held that the three-year lock-in period did not constitute an unreasonable curtailment of the employees' right to employment and did not violate any fundamental rights as claimed by the respondents.

The High Court noted:

“However, the law with regard to covenants in employment contracts is settled. The lawful and reasonable covenants which are operative during the term of employment are valid and enforceable. Such covenants are not in violation of the fundamental rights as provided in the Constitution of India.”

In considering the question of whether the disputes were arbitrable under the Arbitration Act, the High Court referred to the Supreme Court's decision in Lombardi Engineering Limited v. Uttarakhand Jal Vidyut Nigam Limited. In this case, the Supreme Court examined the validity of Clause 55 which included an arbitration clause requiring a pre-deposit of a certain percentage of the arbitral claim as a condition for invoking arbitration.

The Supreme Court held that an agreement requiring a pre-deposit for arbitration violated Article 14 of the Constitution of India, as it prevents a party from availing legal remedies according to law. The Supreme Court held that such a clause which mandates the deposit of a part of the claimed amount to access arbitration is illegal and unenforceable.

The High Court held that disputes related to lock-in periods during the subsistence of employment contracts are arbitrable. It referred to a similar factual situation in BLB Institute of Financial Markets Ltd. v. Ramakar Jha, where the disputes were referred to arbitration. In this case, the employment contract included a clause binding the employee to serve the employer for three years. The employee breached this contract by leaving employment after one year. The court held that the negative covenant in the contract, operating during the subsistence of the service agreement, was not in restraint of trade and, therefore, the disputes were arbitrable.

The High Court held that:

“In the present cases, this Court holds that reasonable lock-in periods in employment contracts that apply during the term of employment are valid in law and do not violate Fundamental Rights as enshrined in the Constitution of India. Hence, in the opinion of this Court, disputes relating to lock-in periods that apply during the subsistence of employment contracts, are arbitrable in terms of the Act, 1996.”

The High Court also considered its decision in Desiccant Rotors International Pvt. Ltd. v. Bappaditya Sarkar and Ors. In this case, the employee signed an obligation agreement restraining him from seeking employment with a competing business post-termination. The High Court found this clause invalid. However, the Court upheld an injunction preventing the employee from soliciting business from the employer's suppliers and customers in competition with the employer.

But the High Court noted that:

“In the present cases, the employer is not seeking to restrain the employees from seeking employment with any competitor of the employer, post termination of the employment agreements. Covenants in the present employment agreements are only operative during the subsistence of the employment agreements.”

The High Court reviewed the letters invoking arbitration under Section 21 sent by the Petitioner to the Respondent. It noted that the Petitioner aimed to protect its confidential information and seek damages from the Respondent.

Consequently, the High Court held that the disputes raised were arbitrable under the Arbitration Act. Mr. Akshay Makhija, Senior Advocate, was appointed as the Sole Arbitrator to adjudicate the disputes under the employment contracts.

Case Title: Lily Packers Private Limited Vs Vaishnavi Vijay Umak and connected matters

Citation: 2024 LiveLaw (Del) 777

Case Number: ARB.P. 1210/2023

Advocate for the Petitioner: Mr. Anand Mishra, Mr. Sachin Midha & Mr. Aditya Vikram Bajpai

Advocate for the Respondent: Mr. Pravin Salunkhe and Mr. Ashish

Date of Judgment: 11th July, 2024

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