In today’s fast-paced business world, an employee is one of the most valuable resources a company can have. To ensure continuity of employment, especially for founders and senior executives, lock-in periods are a common practice. But here’s the main question: Are these lock-in clauses even legal?
If you’ve ever wondered whether these contractual obligations are enforceable or not, you’re not alone. A recent judgement by the High Court of Delhi this year, sheds light on this issue. So, let’s dive into the key-takeaways on lock-in periods and what it means for you and your company’s employment agreements.
Reasonable Lock-In Periods: While the courts have held that lock-in periods in an employment agreement do not violate fundamental rights set out in the Indian Constitution, the same is required to be for a ‘reasonable period.’ There is no express mention of what period is considered reasonable, however, as per industry practice, it typically ranges between 3 to 5 years.
This is considered valid because there is a presumption that the terms of an employment agreement including the applicability of lock-in periods, fixation of pay, and benefits are negotiated and decided voluntarily and the parties consent to enter into the agreement out of their own volition.
Damages in case of breach: At times, employment agreements may require employees to make payment of liquidated damages if the lock- period is breached. Courts in India have limited the validity of employment bonds and damages to cases where the employer has (a) spent significant resources on training or skill enhancement of the employee; or (b) conferred a special benefit to such employee involving a monetary commitment.
Since the validity of liquidated damages for breach of a lock-in period is limited, lawyers have come up with interesting alternative arrangements to ensure enforcement of lock-in periods. For instance, the component of variable pay is increased and often tied to the completion of a time period. For employees who are entitled to equity, the allotment is made in tranches linked to a time or performance based schedule.
Such arrangements encourage employees to work with the company for longer periods. However, it is important for lawyers to be involved in drafting such agreements to ensure they are legally valid, reducing the possibility of employer-employee disputes.
Arbitrability in case of Disputes: Courts have held that disputes arising out of an employment agreement, including those pertaining to lock-in periods are capable of being resolved by arbitration. Hence, it becomes particularly important for all such agreements to have a well-defined arbitration or dispute resolution clause.
LexStart Partners has been providing tailor-made legal services to the startup ecosystem and has roughly a decade of experience in drafting numerous agreements including employment agreements tailor-made to satisfy each company’s unique commercial requirement.
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