Separation Agreements (Employment) (India)

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PRACTICE NOTE

by Nipasha Mahanta, Sayantani Saha and Vikram Shroff, Nishith Desai Associates

Status: Law stated as at 01-Dec-2023 | Jurisdiction: India

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A Practice Note setting out the key considerations and legal issues when an employer is entering

into a separation agreement with an employee on termination of employment in India, including

drafting guidance for the separation agreement.

An employer may decide to terminate employment in

India and want to enter into an agreement with the

affected employee(s). There are a number of important

legal issues that arise when entering into such an

agreement. This Note provides an overview of the key

aspects of a mutual separation agreement in India. It

considers:

• The form and scope of settlement.

• Any statutory obligations in relation to the mutual

separation agreement.

• The timing of when the mutual separation agreement

should be provided to employees.

• The admissibility of pre-agreement negotiations and

whether they are legally binding.

• The common provisions which should be included in

the mutual separation agreement, including possible

issues surrounding the separation date and garden

leave.

• Payments, including any mandatory payments

required.

• The inclusion of restrictive covenants.

• The execution formalities for mutual separation

agreements.

Form of Settlement

In India, mutual termination is often achieved by

executing a mutual separation agreement between

the parties. A mutual separation agreement records

a mutual termination of employment and a waiver

and release of claims (in consideration of an ex gratia

payment). The mutual separation agreement also

typically contains the post-termination obligations

of the outgoing employee towards the employer for

example, non-disclosure of conﬁdential information,

non-disparagement, and so on.

Some employers use a waiver and release of claims letter

instead of a more formal mutual separation agreement.

As such, there are no speciﬁc legal requirements for

mutual separation agreements in India and these

agreements remain largely untested in Indian courts.

Scope of Settlement

The parties’ statutory rights (for example, payment

of wages and gratuity under law) cannot be waived

contractually. Various judicial pronouncements have

established that no person can waive any of their

statutory rights unless both the following conditions are

satisﬁed:

• The parties have a direct private beneﬁt from the right

sought to be waived.

• The conferred right does not pertain to any matter

involving public interest.

Any provision in an agreement is also void if it either:

• Restricts a party absolutely from enforcing their rights

under or regarding any contract or limits the time

within which the party may enforce their rights.

• Discharges any party from any contractual liability on

the expiry of a speciﬁed period to restrict any party

from enforcing its rights.

(Section 28, Indian Contract Act, 1972.)

Therefore, while a waiver of statutory claims is

commonly included in separation documents as a

deterrent, such a provision is not enforceable.

Employment-related disputes covered by the Industrial

Disputes Act, 1947, can be resolved by conciliation,

arbitration, or litigation. Other terms of employment

related to post-separation conﬁdentiality obligations

and non-solicit obligations, among other things, are

contractual obligations in nature that can be addressed

by parties in a mutual separation agreement.

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Separation Agreements (Employment) (India)

There are no statutory requirements in relation to claims

or disputes that must be expressly addressed in the

mutual separation agreement.

Timing

Mutual separation agreements remain largely untested

in Indian courts, given that employee resignations

(at the behest of the employee) and employment

terminations (at the behest of the employer) are the

common forms of employment separations. Therefore,

there are no speciﬁc legal requirements pertaining to

mutual separation agreements. The process is largely

driven by market practice.

A copy of the proposed mutual separation agreement

is typically provided to the employee as part of the

employer’s separation discussions with them.

Pre-Agreement Negotiations

Pre-Agreement Negotiations:

Documents and Communications Used

as Evidence

The common law concepts of “settlement privilege”

and “without prejudice” on documentation and

communications are generally recognised under the

Indian Evidence Act, 1897 (Indian Evidence Act), in

relation to civil disputes. Section 23 of the Indian

Evidence Act protects admissions from being made

in court if the parties expressly agreed against that

disclosure. However, the relevant provisions do not apply

directly to proceedings before industrial tribunals and

labour courts, which are the relevant bodies in relation

to employment matters.

There are cases where Indian courts observed that offers

and counteroffers made to resolve disputes amicably

are generally without prejudice to the rights and

contentions of the parties. However, there is not enough

jurisprudence on this subject, especially regarding

separation negotiations and related settlement terms.

Pre-Agreement Negotiations: Legally

Binding?

Pre-separation agreement negotiations are not legally

binding, until conﬁrmed as binding in the mutual

separation agreement.

Separation Agreement: Subject to

Contract and Without Prejudice

The concepts of subject to contract and without

prejudice are generally recognised in the context of the

Indian civil law of evidence, but the agreement need not

state that it is subject to contract and without prejudice.

This is because mutual separation agreements in India

are typically executed after separation negotiations

between the parties have concluded. Employment

separation-related negotiations with employees

typically take place verbally but are then ﬁnalised with

the execution of a written mutual separation agreement.

Mutual Separation Agreements

The agreement should avoid using the term

“termination,” as a mutual separation agreement

is structured as an amicable separation between

the parties and not an “employment termination”

by the employer under Indian labour laws (which

is a unilateral termination of employment by the

employer). It is recommended to use terms, such as

“separation,” “employment cessation/separation date,”

and “separation payment” instead of terms, such as

“termination,” “termination date,” and “termination

payment.” Incorrect usage of these terms may lead to

different legal implications (see, for example, Payments).

Parties

In India, there is no legal requirement regarding what

information about the parties must be included in a

mutual separation agreement. However, as a matter of

practice and to avoid ambiguity, agreements typically

contain certain identifying information about the parties,

including:

• Names.

• Addresses.

• Taxpayer permanent account numbers (PAN) for

individuals and corporate identity numbers (CIN) for

companies.

Separation Date

Employment may end either on the date of execution of

the mutual separation agreement or on a date agreed

on by the parties in the agreement, which can be on

any date before the expiry of the contractual notice

period. In this event, the employee is paid in lieu of the

unexpired notice period. This is required under Indian

federal and state labour statutes, regardless of whether

it is provided for in the terms of employment. It may also

be mutually agreed that the employee will serve the

entire notice period.

Garden Leave

The employee can be placed on garden leave during

the notice period or before the employment cessation

date or both, which is common practice (see Separation

Date). The Bombay High Court has clariﬁed that garden

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Separation Agreements (Employment) (India)

leave provisions can only apply to a period preceding the

termination of employment and not after termination

(VFS Global Services Private Limited v Mr. Suprit Roy

2008 (2) BomCR 446).

If the employee is placed on garden leave and the

mutual separation agreement is executed before the

employment cessation date, the employee’s obligations

during the garden leave period should be reiterated in

the mutual separation agreement.

The terms of the garden leave can be agreed on in the

mutual separation agreement regardless of whether

it was provided for in the terms of employment. It is,

however, common practice in India to include a garden

leave clause in an employment agreement (especially

for mid- or senior-level employees).

Under various state-speciﬁc shops and establishments

acts (applicable to commercial establishments) and the

Factories Act, 1948 (applicable to manufacturing units

and factories), an employee accrues annual leave that is

to be used at their discretion. As a result, the employer

cannot set off any unused annual leave against the

employee’s notice period or garden leave period, or

both, except at the employee’s request.

Payments

Ex Gratia Severance or Retrenchment

Compensation

Where an employee is retrenched (that is, terminated

by the employer), they are entitled to severance or

retrenchment compensation calculated at the rate of

15-days’ pay for every year of service over six months if:

• They are categorised as a workman under Indian

labour laws (that is, not an employee engaged in

managerial and administrative capacities or in

a supervisory capacity drawing a monthly salary

exceeding INR10,000).

• They have been employed for at least a period of

240 days.

(Section 25F, Industrial Disputes Act, 1947.)

Because a mutual separation is an amicable

separation related to a resignation (and accordingly

not a retrenchment under Indian labour laws), this

retrenchment compensation is not payable in the case

of mutual separations. However, to achieve an amicable

separation, it is common practice to factor an amount

mirroring the statutory severance payment into an

ex gratia payment to the employee under the mutual

separation agreement.

The ex gratia amount varies depending on multiple

factors (including the type of industry, nature of work

performed by the employee, years of service, and

past practices followed by the employer). The market

practice is generally to offer one-month’s pay for every

completed year of service (while a terminated workman

is entitled to only 15 days per year of service).

It is recommended to separately reference the ex-gratia

payment in the mutual separation agreement, given

that the ex gratia amount (which exceeds the statutory

payments) is usually offered to incentivise the employee

to separate amicably and as consideration of the

employee agreeing to abide by the obligations set out

in the mutual separation agreement. Some employers

also provide a detailed breakdown of the separation

payments to the employee (including the full and ﬁnal

settlement amounts and ex gratia amounts) in an annex

to the mutual separation agreement to document

having made such payments.

Other Payments

In addition to an ex gratia payment, other separation

payments include:

• Payment in lieu of notice (which is factored into the ex

gratia amount in cases where the employee separates

with immediate effect).

• Any contractual bonus or arrears.

• Payment against encashment of unused and

accumulated annual leave, as applicable.

• Gratuity.

The Payment of Gratuity Act, 1972 applies to employers

with at least ten employees. Employees who have

completed at least ﬁve years of continuous service

are entitled to a gratuity payment of 15 days’ wages

for every year of service or part thereof in excess of

six months (section 4, Payment of Gratuity Act, 1972).

Gratuity can be capped at INR2 million.

Amounts Payable to Employee: Termination with

or Without Cause

No-cause terminations in India are not permissible. At-

will employment is not recognised in India and therefore

employment termination can only be with cause or on

account of misconduct.

Payments on termination depend on whether the

termination is for misconduct or other reasons. Where

termination is for:

• Reasons other than misconduct, certain payments are

triggered, such as:

– severance or retrenchment compensation of

15-days’ pay for every year of service exceeding

six months (for workman category individuals

continuously in service for at least 240 days);

– payment in lieu of notice (minimum one month);

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Separation Agreements (Employment) (India)

– gratuity (if the employee has completed at least ﬁve

years of continuous service);

– leave encashment; and

– any other payments owed under the contract.

• Misconduct, there is no need to pay severance or

retrenchment compensation and payment in lieu of

notice, but the other types of payment listed above

are typically applicable. However, if the employee is

terminated for certain prescribed acts of misconduct,

the gratuity may be forfeited by the employer. Under

some state laws, and subject to the employment

contract, notice requirements may also not be payable.

Payments Made to Employee on Separation:

Taxation

Retrenchment compensation up to INR5 lakhs paid

to a workman on separation of employment is not

subject to income tax deducted at source under the

Income Tax Act (see Payments). However, all other

compensation payable on termination and mutual

separation (including the ex-gratia payment) is treated

as “proﬁts in lieu of salary,” which is considered taxable

income. Contractual payments received on separation

also attracts tax liability. Gratuity of up to INR 20 lakhs

paid to an employee on separation is exempt from

taxation under the Income Tax Act. Leave encashment

of up to INR 25 lakhs paid to an employee at the time of

retirement is exempt from taxation.

There is no legal requirement to speciﬁcally state that

taxes are payable against the separation payments.

However, for clarity, employers typically include a

statement that separation payments are subject to tax

withholding.

Time Limits on Payments: Wages

Section 5(2) of the Payment of Wages Act, 1936 (POWA),

states that where a person’s employment is terminated

by or on behalf of the employer, the “wages” earned

by the employee must be paid before the expiry of the

second working day after employment is terminated.

However, the applicability of the POWA to commercial

establishments varies between different states.

An employer may assert that a mutual separation

is not technically an employment termination by

the employer and therefore should not trigger this

obligation under the POWA. However, the employer

must still comply with requirements for the timing of

payment of all wages as deﬁned widely under the POWA

to include “any remuneration payable under any award

or settlement between the parties.” Employers must

generally pay wages within:

• Seven days after the wage cycle (for employers with

up to 1,000 employees).

• Ten days after the wage cycle (for employers with

1,000 or more employees).

(Section 5, POWA.)

However, the Code of Wages, 2019 (Wage Code), which

has been notiﬁed in the ofﬁcial gazette but not yet made

effective, subsumes the POWA once effective. Under the

Wage Code, payments of wages where the employee has

resigned from employment must be made within two

days from the date of separation. This is to also cover

mutual separations, as they are not treated separately

under Indian law.

Time Limits on Payments: Gratuity Payments

Gratuity payments must be paid to an eligible employee

within 30 days from the date of termination (section

7(3), Payment of Gratuity Act, 1972).

Time Limits on Payments: State-Speciﬁc

Requirements

State-speciﬁc shops and establishments acts (which

apply to commercial establishments located in certain

Indian states) may also provide a time limit within

which wage and payments on termination must be

made to employees. For example, under the shops and

establishments acts applicable in some Indian states,

payment of wages representing the employee’s untaken

leave must be made within two days after termination of

employment.

References

It is not common to include a mutually agreed reference

in the mutual separation agreement.

However, employees are typically issued an experience

or service certiﬁcate that they can submit to prospective

employers, which serves as a conﬁrmation that the

individual was employed with the organisation and

typically includes the dates of hire, date of separation,

and the employee’s designation at the time of

separation.

In some cases, the issuance of a service certiﬁcate

is a statutory requirement, depending on the

laws applicable to the employer. For example, the

Model Standing Orders framed under the Industrial

Employment (Standing Orders) Act, 1946, which

applies to factories and commercial establishments in

some states, requires the employer to issue a service

certiﬁcate to outgoing employees. Whether this

requirement applies is determined based on:

• The nature of the establishment or industry.

• The number of workmen.

• The state in which the establishment is located.

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Separation Agreements (Employment) (India)

Return of Company Property

A mutual separation agreement should ideally include a

clause providing for the employee to:

• Return any property belonging to the company before

the separation date.

• Delete any information relating to the business and its

contacts within the employee’s possession.

A separation agreement should also include a clause

enabling the employer to deduct the cost of any

damaged or unreturned company property.

Conﬁdentiality

The conﬁdentiality clause in mutual separation

agreements typically reiterates the existing obligations

contained in the employment agreement or the

proprietary information, or both, and any inventions

assignment agreement, executed by the employee at

the time of commencement of employment.

Employers should ensure that the agreement clearly

deﬁnes the information to be protected as conﬁdential

information, to the extent feasible and reasonable in

terms of its coverage.

Restrictive Covenants

Restrictive covenants can be included in mutual

separation agreements. Although post-termination

non-compete clauses are commonly included in mutual

separation agreements, these clauses are generally not

enforceable, as they are considered a “restraint of trade”

under Indian contract law principles (Percept D’Mark

(India) Pvt. Ltd. v Zaheer Khan & Anr. AIR 2006 SC 3426).

The only exception to this rule is that someone selling

goodwill of a business may agree with the buyer to

refrain from operating a similar business “within

speciﬁed local limits,” provided that these limits are

deemed reasonable by the court in consideration of the

nature of the business.

The validity of restrictive covenants is generally

determined based on the standards of reasonability,

in consideration of duration and geographical limits of

the restriction at issue. In India, courts tend to adopt

interpretations favorable to employees to protect their

rights, given the heavy bargaining power of employers.

Separability or Severability

Separability clauses are commonly incorporated within

mutual separation agreements, to avoid the entire

agreement being held void or unenforceable due to the

illegality, invalidity, or unenforceability of a part of the

agreement.

Execution Formalities

Under the Indian Stamp Act, 1899, and state-speciﬁc

stamp duty enactments, any “instrument” (which

includes an agreement) that confers a right or creates

an obligation must be stamped at or before signing.

Stamping of the document essentially indicates

payment of a small amount of duty to the government.

An instrument that is un-stamped or under-stamped

(with an insufﬁcient payment) may not be admissible

as evidence in a court. At that stage, the court may re-

direct the parties to adjudicate the document (that is,

calculate the stamp duty and penalty on it), which may

signiﬁcantly delay enforcement.

In certain Indian states, intentional non-stamping is a

criminal offence.

Stamping may be done by:

• Purchasing stamp paper of the requisite

denomination and printing the document on the

stamp paper.

• Franking of the document at local designated banks.

• Purchasing an electronic stamp (only in certain Indian

states).

The stamp duty amount is calculated based on the type

of the agreement, the covenants in the agreement, and

the applicable state stamping regulations. The state-

speciﬁc schedule containing prescribed stamp duties

for general agreements should be consulted when

determining the stamp duty for mutual separation

agreements.

Signing

The mutual separation agreement must be signed by

both the employer and the employee. An authorised

representative empowered to act on behalf of the

employer, either by power of attorney or board

resolution, can execute the agreement on the employer’s

behalf. Although it is advisable for evidentiary purposes

to have a contract attested by witnesses (typically

one or two), there is no legal requirement for witness

signatures. The agreement may be signed either

manually or using an electronic signature.

Language

The agreement can be executed in English or the local

language if both parties understand the terms of the

agreement.

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Separation Agreements (Employment) (India)

Filing

There is no requirement to notify or ﬁle, mutual

separation agreements with any government

authorities, as they are typically treated as voluntary

resignations (not retrenchments).

Other Common Terms

Mutual separation agreements typically reiterate post-

separation obligations contained in the employment

contract or in standalone agreements (such as a

proprietary information and inventions assignment

agreement), including obligations of:

• Non-solicitation

• Non-disparagement including non-disparagement on

social media.

• Non-disclosure of conﬁdential information of the

employer.

A mutual separation agreement may also include a

clause stating that the employee cannot assign the

rights and obligations under the mutual separation

agreement.