Are Employment Bonds Enforceable?

  • Employment
Are Employment Bonds Enforceable?

In a relationship between employer and employee, both parties primarily depend on the terms and conditions stipulated in their employment contract.

There are times, however, when an employer wants to take control over the employee’s ability to leave the company. This is particularly true when the employer invests a great deal of time and money in training and equipping the employee with the skill set necessary to perform their job well. As a result, the employer usually wants the employee to stay with the company for a minimum number of years so that they can make the most of their investment.

In most cases, parties may customise the terms of the employment contract to meet their needs. For instance, a well-drafted contract may state that the employer must pay a specific sum to the employer should he or she wish to leave the company before a certain period. Such provisions are known as employment bonds.

Oftentimes, employers prefer to include employment bonds in their employment contracts as a form of protection against employees who leave prior to completing a minimum period with the company. The court typically upholds a freedom of contract approach, and so parties are free to include whatever provisions they wish. The court, however, does not hesitate to intervene when the contract contains unfair or illegal terms.

Prior to entering an employment contract containing an employment bond, both employee and employer must be aware of their obligations and rights generated by the employment bond clause.

Definition of an Employment Bond

An employment bond refers to an agreement between employee and employer, which states that the employee is to stay with the company for a specific minimum time period after joining the company or after being sent for training. Under this bond, the parties also agree that the employee must pay the employer a certain amount—also known as liquidated damages—as form of compensation should the employer leave before the minimum period agreed upon by the parties.

Such clause is necessary to protect the employer and provide them a form of compensation for any losses suffered. These include the incurred costs of training, as well as potential losses to be incurred while hiring and training a replacement. This bond also acts as a deterrent, preventing the employee from terminating their contract prior to their agreed upon period.

At the surface level, employment bonds appear reasonable and fair. The employer, after all, should be able to receive compensation and recovery for any money spend on training, upskilling, and upgrading an employee—especially if the employee quits and searches for employment elsewhere after the company has already invested in the said employee.

Employment bonds are a useful, employer-friendly tool if used reasonably and fairly. Unfortunately, employment bond restrictions may also be unfair and unethical in some cases. These clauses sometimes ask the employee to pay excessive amounts of money should they leave the company within the bond period. These bonds are sometimes also imposed even though no training, upskilling, or upgrading occurred—which is most certainly unfair to penalised employees.

Fortunately, even while adopting a freedom of contract approach, the court makes it a point to protect employees from being exploited. If the court finds that the terms of an employment bond is excessive or classified as a penalty clause, it may hold the bond unenforceable.

Enforceability of an Employment Bond

No provisions on employment bonds may be found in the Employment Act, and so disputes on this matter must be settled in civil court.

The validity of bond clauses depends on the unique circumstances of each case. Should both parties agree freely to a pre-determined sum of money as an honest estimate of damages, the clause may be enforceable and valid. However, the clause may be unenforceable if it is deemed to be unreasonable or one-sided, or if the sum of money is disproportionate to the amount invested in the employee.
Penalty clauses are also considered illegal, including clauses that prevent an employee from leaving a company even if no training, upgrading, or upskilling costs were incurred.

If the employee opts not to complete the employment bond, he or she may have to pay the liquidated damages stated in the contract. However, if the amount of money is deemed as a penalty as opposed to compensation and an honest estimate of the losses incurred, then the court will determine whether it is still unenforceable and illegal.

Recently, Singapore courts have held numerous employment bond clauses unenforceable because they amounted to penalties as opposed to compensation.

When the Provision is a Penalty

Singapore law uses the 1915 House of Lords decision in Dunlop Pneumatic Tyre Company v New Garage and Motor Company (1915) AC 79 to govern the enforceability of penalty clauses. In Singapore, this continues to be the law even if this verdict was made over a century ago, and was also implemented in Xia Zhengyan v Geng Changqing [2015] 3 SLR 732.

This decision states that the contract is enforceable if the contract calls for the payment of liquidated damages should there be a contract breach, and the damage amount is an honest pre-estimate of the loss stemming from the early termination or breach of the contract.

Furthermore, the court stated that the provision will be deemed a penalty and unenforceable if the damages or obligation sought is excessive and unconscionable compared to the losses that could possibly be proven to stem from the breach of contract. The amount found to be excessive or disproportionate to the loss incurred by the employer will be then regarded as a penalty, and not an honest pre-estimate of the loss.

The UK Supreme Court expanded this traditional test in 2015 by distinguishing between an unenforceable penalty clause and enforceable liquidated damages. In Cavendish Square Holdings v El-Makdessi [2015] UKSC 67, the court detailed that the true test for a penalty is “whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.”

Simply put, the Cavendish test can be performed by asking these questions:
• What legitimate interest does the clause protect, if any?
• Is there a secondary obligation created by the clause?
• Is it in the employer’s legitimate interest to impose such secondary obligation?
• Is the secondary obligation (detriment) on the contract-breaker to protect that interest considered proportional to the legitimate interest of the innocent party—or is it extravagant or unconscionable?

Whether the clause will amount to a penalty, according to the Cavendish decision, will depend on answers to the above-mentioned questions and the unique circumstances of the case.

The Cavendish test is broad and considers all the legitimate interests of the innocent party in imposing the secondary obligation. The provision will not automatically be deemed a penalty clause just because the amount is not an honest pre-estimate of the loss incurred.

Both the Dunlop and Cavendish tests take proportionality into account. The pre-determined amount in Dunlop is compared to the genuine loss that stems from the breach. In Cavendish, the amount is compared to the innocent party’s legitimate interests. Any disproportionality could determine the provision as a penalty clause.

It remains to be seen whether the Singapore courts will follow the more extensive Cavendish approach. Some believe that modern complex commercial cases have made it difficult to apply an honest pre-estimate of loss.

Other Defences to the Employee

When entering an employment contract, all standard rules of contract law apply and should be observed. It automatically follows that normal defences are made available when a claim for breach of contract exists.

For instance, an employee may have a successful defence against an employment bond claim if they can prove that they were under duress or were coerced when they signed the employment contract, or that they did not fully understand the extent of the bond.

The court might also declare the contract as invalid if the employee had much more bargaining power compared to the employee, and therefore persuaded the employee to sign an unconscionable contract.

Another defence in such scenario could be misrepresentation. An employee cannot be expected to honour an employment bond if the promised training, upskilling, and upgrading never transpired.

Of course, the liquidated damages must also be an honest-pre-estimate of the damages as opposed to an extravagant and unconscionable penalty amount when compared to the greatest loss that could believably be proved to have stemmed from the breach.

Summary

Employment bonds are a useful, employer-friendly tool to keep employees from quitting their jobs as soon as a “better” opportunity comes their way after the employer has already invested in the employee. This bond therefore helps employers keep their losses in such situations to a minimum. It is only fair that the employer receives compensation for any money spent on grooming or training an employee.

Employees, however, should always have the right to resign—even during the period agreed upon. Employment contracts are not supposed to “enslave” the employee or stop them from leaving.

Though Singapore courts will likely lean towards holding a party to their obligations in the contract, it is understood that they will not hesitate to declare provisions in an employment bond unenforceable if it is disproportionate, excessive, or amounts to a penalty. If the employer wishes to enforce such bond, it must be proportional and reasonable.

For now, in the absence of guidelines by the tripartite partners, and according to the Dunlop decision adopted in court, the bond amount of damages may only be enforceable if it is a genuine pre-estimate of the loss.

An employment bond clause may not impose a secondary clause that is disproportional, though it remains to be seen whether the courts will follow the Cavendish case’s new approach.