Employment Contracts

A Note prepared by Lalitha Sreenath and MR Sreenath, Professors, IIM Indore

for the purpose of class discussion.

1. Introduction
There are two types of contracts in the context of employment:
a) Contract of service, and
b) Contract for service.
The term contract of service refers to the legal relationship between an employer and employee
whereas the term contract for service refers to the legal relationship between a principal and a
contractor.

2. Contract of Service
It may be noted that the terms contract of service, contract of employment, employment
contract, and employment relationship are interchangeable.
The concept of employment involves three ingredients, i.e.,
a) the employer one who employs or engages the services of other persons,
b) the employee one who works for another for hire, and
c) the contract of employment the contract of service between the employer and employee
under which the employee agrees to serve the employer subject to his control and
supervision.

2.1. TERMS AND CONDITIONS OF EMPLOYMENT

The employment relationship normally begins with the acceptance by the employee of the letter of
appointment (or offer letter) issued by the employer. The appointment letter usually contains
various terms and conditions of employment like designation, job profile, salary and place of
posting. The contract of employment is not only governed by the terms expressed in the
appointment letter, but also by the implied terms, usages, practices, customs, settlements,
standing orders, company policies and rules, legislations, court orders etc. Various sources can be
arranged in a hierarchical fashion.
The sources of terms of employment are given below:
a) Statutes or laws of the country.
b) Awards given by the courts and tribunals.
c) Settlements signed by the employer and the employees under the Industrial Disputes Act,
1947.
d) Standing orders, if applicable.
e) Express terms of employment as specified in appointment letters and other related
correspondence.
f) Customs, usages and practices prevalent in the organization.
g) Implied terms and conditions of employment relationship.
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h) Rules, regulations and policies framed by the employer for performance of duties and
conduct.

2.1.1. Statutes or Laws of the country

Various labour laws form the most important source for terms and conditions of service in an
employment contract. There are several legislations seeking to define and regulate the terms and
conditions of employment of different categories of employees. For ex., the Factories Act 1948
contains many provisions which impact the terms and conditions of employment in factories
working conditions (hours of work, overtime, holidays, leave);
health (cleanliness, ventilation, lighting, spittoons);
safety (fencing of machinery, protective gear); and
welfare (canteen, creche).
Likewise, the employment relationship is also subject to the provisions of various other laws like:
Industrial Employment (Standing Orders) Act 1948
Shops and Establishments Acts of various States
Minimum Wages Act 1948
Payment of Wages Act 1936
Payment of Bonus Act 1965
Maternity Benefit Act 1961
Payment of Gratuity Act 1972
Employees Provident Fund &Miscellaneous Provisions Act 1952
Employees State Insurance Act 1948
Workmens Compensation Act 1923
Contract Labour (Regulation & Abolition) Act 1970
Laws are placed at the top of the hierarchy of various sources of terms and conditions of
employment. In case of conflict, they override all other sources of terms and conditions of
employment. No contract of employment should contain any term or condition that is less
advantageous to the employee than what is provided in the law. However, it must be noted that the
laws lay down only the minimum level of benefits that workers entitled to. Subject to the legal
provisions, employers can frame rules and regulations governing employment in their organisation.

2.1.2. Awards of Courts and Tribunals

Next in the order of importance are the awards (judgments) of courts and tribunals. These are
subordinate to the statutory provisions, but superior to other sources. These can modify the
contract of employment or the certified standing orders or the settlements between the employer
and the employees.
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2.1.3. Settlements signed under the Industrial Disputes Act 1947

Settlements signed before a conciliation officer as per the provisions of the Industrial Disputes Act
1947 are next in order of priority. Since such settlements are arrived at as per the provision of the
law, they have an overriding effect over the customs, usages, practices, implied and expressed
terms of contract etc.

2.1.4. Standing Orders

Standing orders under the Industrial Employment Standing Orders Act 1946 are fourth in order of
importance, in case they are applicable to the concerned establishment. (Standing Orders are
discussed in a subsequent section of this Note.)

2.1.5. Express terms and conditions

These are fifth in line of importance. Sources of these terms will generally be seen in the letters
issued by the employer and accepted by the employee. Such express terms could be seen in the
following documents:
a) Letter of appointment, illustrating various terms and conditions of service like designation
of employee, job profile, place of posting, salary etc. This is generally the primary contract
document between an employee and his employer.
b) During the course of employment the employer issues various letters to the employee
amending the terms originally agreed to in the letter of appointment. Some examples of
such letters are:
o Letters of annual increment amending the salary originally agreed upon.
o Letters of promotion changing the grade and the position of the employee.
o Letters of transfer indicating the change in place of posting.
o Letters indicating the change of nature of work for e.g., a typist asked to perform the
job of a cashier.
o Letters stopping the increments or reversion to lower job or position by way of
punishment.
These are only a few examples of how the original terms of employment are amended from time to
time. These amended terms, once notified to the employee and accepted by him, become part of
the revised contract of employment. They become binding on both the parties.

2.1.6. Customs, usages and practices

At the time of employment whether specifically expressed or not, customs, usages and practices
become part of the employment contract unless they are in conflict with any other sources specified
at points 1 to 5 above. Several examples of customs, usages and practices can be cited which
become an integral part of the employment contract over a period of time. Some examples are
given below:
a) Employer providing two cups of tea every day to the employees.
b) In an organization, there exists a custom of giving 4 Kgs. of vanaspati ghee to every
employee during the Diwali festival.
c) Distribution of sweet boxes on festivals.
d) Giving festival advances on certain occasions during the year.
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These and many other customs and practices could be seen in industry, which over a period of time,
have acquired a status of rightful terms and conditions of the employment contract.

2.1.7. Implied terms and conditions

An employee is governed by several implied terms and conditions of employment. For ex., it need
not expressly be stated that an employee has to perform his duties (i) diligently with due care and
caution, (ii) honestly, (iii) personally, and (iv) faithfully.

2.1.8. Rules, Regulations, Policies, Orders and Instructions

Next in order of importance are the company rules, regulations, policies, orders and instructions
framed/issued either for an individual employee, job or a group or all employees in the organisation.
These may relate to leave, medical benefits, leave travel concession, housing, conveyance,
discipline and workplace conduct. In order that these rules, regulations etc. become enforceable, it
is essential that they are reasonable, lawful and should not be in any way contradictory to any of the
six items described above, unless, of course, they are more liberal in favour of the employee.

2.2. TERMINATION OF THE EMPLOYMENT CONTRACT

Every employment contract, unless it expressly provides the time span, gets terminated in any of
the following events:

2.2.1. Termination of the contract by the employer

A. Superannuation (Retirement)

As and when an employee reaches the age of superannuation (retirement), the contract of
employment gets terminated unless the employer offers an extension to the same for a specified
time and the employee accepts the same. Age of superannuation is generally specified in the
standing orders. However, if they are not applicable to the establishment, the age of retirement
must be specified either in the appointment letter or in the company rules.

B. By way of punishment

An employer may terminate the employment of an employee by way of punishment in case the
employee commits serious misconduct warranting this extreme punishment.

C. Retrenchment and closure

Under the provisions of the Industrial Disputes Act 1947, an employer may resort to retrenchment
of surplus labour or close the establishment thereby terminating all the employees.

2.2.2. Termination of the contract by the employee

The employee has only one option or method to terminate the contract. He can resign from the
services of the employer at his free will and thereby terminate the contract of employment.
Generally the letter of appointment or Standing Orders or Company rules specify the method of this
form of termination wherein the employer may specify the time frame that he needs to make
alternative arrangements and relieve the employee. The time frame so specified is known as notice
period required for severance of the contract by the employee.
There are, of course, cases wherein the employees also abandon the employment.
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2.2.3. Death of an employee

Death of an employee naturally leads to automatic termination of the employment contract.

Consequent to the death of an employee, the employer is expected to settle all the dues of the
employee with the legal heirs of the deceased. However, the employer cannot claim any damages
from the employee's legal heirs.

3. Contract for Service

As already stated, a contract for service refers to the legal relationship between a principal and a
contractor. The principal engages the contractor to do certain work or service. The contractor
executes this work or service in one of the following ways:
1. The contractor does the work in his own premises either by himself personally or by employing
other employees. For ex., the principal entrusts the work of stitching curtains to a contractor.
The contractor takes the cloth provided by the principal to his premises, stitches the curtains
either by himself or by employing some other persons and delivers them to the principal.
2. The contractor does the work in the premises of the principal personally and singly. For ex., the
principal entrusts the task of repairing his refrigerator to a contractor. The contractor comes to
the premises of the principal and personally repairs the refrigerator.
3. The contractor does the work in the premises of the principal by employing some other
employees. For ex., the principal gives to a contractor the task of running a canteen in their
factory premises. The contractor does the job by employing some other employees.
The third option had often been misused in the past by businesses. Instead of employing regular
employees to do their normal work, businesses used to engage contractors to do the work in their
premises with the help of the contractors own employees, thereby escaping the obligations
imposed by various labour laws.
In the absence of legal protection, the employees employed by the contractor have been the most
exploited group of workers. So, to protect their interests, the Parliament had enacted the Contract
Labour (Regulation and Abolition) Act 1970 (which is discussed in a subsequent section of this
Note).

4. Distinction between Contract of Service & Contract for Service

'Contract of service' differs from 'contract for service' in several ways. Justice Subba Rao observed:
There is a well understood distinction between a contractor and a workman and between
contract for service and contract of service ... A'contractor' is a person who, in the pursuit of an
independent business, undertakes to do specific jobs of work for other persons, without
submitting himself to their control in respect to the details of the work. Therefore, there is a
clear-cut distinction between a contractor and a workman. The identifying mark of the latter is
that he should be under the control and supervision of the employer in respect of the details of
the work.
To know whether a relationship in a given case is a contract of service or a contract for service, the
Courts have laid down the following tests:
a) Is there a measure of control indicative of an employer-employee relationship?
b) Is the person carrying out the work for and on behalf of the employer or in business on his
(or her) own account?
c) Is the person free to accept or refuse work at will?
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d) Is the person supplied with a uniform and equipment?

e) Is the person subject to disciplinary or grievance procedure?
f) Must the person take holidays when and as directed?
g) Is the person paid regularly either weekly or monthly?
Some of these points are discussed below.

4.1. EXCLUSIVE EMPLOYMENT

One of the basic characteristics of any employment is that the employee is in exclusive employment
of an employer. A contractor can work for more than one client at a time but this is not true with an
employee. In some cases, an employee may get into a full time employment with one employer and
a part time employment with another for the periods of the day fixed by each employer, but within
the specified period, he is in the exclusive employment of only one employer and cannot perform
the work for both.

4.2. RIGHT OF CONTROL

Right to control or interfere with the work of an employee is a power vested with an employer. Such
a right may or may not exist in the case of a contractor engaged by the same employer. It is this
right which distinguishes a contract of service and a contract for service. The difference between an
employee and the contractor would depend upon the degree of control exercised by the employer
and if the degree of control is not such as to bring them in the category of employees, then they are
contractors.
An employee acts under direct control and supervision of his employer and is bound to conform to
all the reasonable and lawful orders given to him in course of employment, while a contractor may
be engaged to merely produce a specified result for which he may adopt his own means and
methods.
Employment relations postulates the right to control rather than the actual control exercised. If a
person has the right to control the manner of doing the work, then it is for him to exercise that right
or not to do so. In practice, he may leave the work to be done by the employee in his own discretion.
To what extent he gives freedom to his employees to work according to their own discretion
depends on the personality of the employer, the competence of the employee and the facts and
circumstances of each situation. However if the right exists, the employer can exercise the same
whenever he chooses. It is, therefore, the existence of the right and not the actual exercise of the
right, which distinguishes a contract of service from a contract for service.
An independent contractor undertakes to produce a given result, and in the actual execution of the
work, he is not under the order or control of the person for whom he does it, and may use his 0wn
discretion in things not specified beforehand. A mere right to issue instructions as to what work
should be done does not necessarily constitute a relationship of employer and employee.

4.3. PART OF THE EMPLOYERS ORGANISATION

An employee becomes part and parcel of the employers organisation, whereas a contractor is
always an outsider to the organisation, even when he may be performing his job within the
premises of the principal. In fact, the contractor is a businessman in his own right, often having his
own organisation and employees.

4.4. RESPONDEAT SUPERIOR

Since the two important characteristics of the contract of employment are (a) the employer's right
to control the manner of work and (b) the employee's requirement to be part and parcel of the
organization of the employer, it is logical that the act of an employee has generally the same
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consequence as regards third parties as if it has been done by the employer himself. So, under the
doctrine of respondeat superior which is based on vicarious liability, the employer would be liable to
third parties for the consequences of the acts which are done by an employee within the scope of
employment.
The principal does not have any such vicarious liability for the acts done by the contractor.

4.5. PERSONAL CONTRACT

Unless expressly permitted by the employer, the employee has to personally perform the work
entrusted to him by the employer. On the other hand, unless expressly prohibited by the principal, a
contractor can get the work done through other workers or sub-contractors.
A contract of service is, therefore, a contract of personal service which automatically gets
terminated with the death of the employee, or upon expiry of a specified period of service,
whichever is earlier. Consequent to the death of an employee, neither the employer can claim any
damages from the legal heirs of the employee nor can the heirs of the deceased employee claim
employment or continuation of same work. On the other hand, even if the contractor dies, the
principal has certain rights against the deceased contractors estate.

4.6. REMUNERATION
Normally, the basic remuneration of an employee is time-baseddaily, weekly, monthly or yearly,
even though there may be additional performance-based incentives. On the other hand, usually,
the remuneration of a contractor is task-based. The principal remunerates the contractor on the
basis of the quantum of work done.

4.7. DISCIPLINARY ACTION

The employee has to maintain discipline in the workplace in accordance with the rules and
regulations applicable to the employers organisation, failing which he may be subjected to
disciplinary action by the employer. On the other hand, the principal has no power or authority to
initiate any disciplinary action against the contractor.

4.8. MACHINERY AND TOOLS OF TRADE

Normally, the employer provides all the required machinery and tools of trade to the employees for
carrying on their work, whereas the contractor uses his own machines and tools.

5. The Industrial Employment (Standing Orders) Act, 1946

This Act requires employers in industrial establishments to formally define the conditions of
employment under them by having certified standing orders.

5.1. APPLICABILITY
The Act applies to every industrial establishment wherein one hundred or more workers are
employed or were employed on any day of the preceding twelve months.
Industrial establishment means
(i) an industrial establishment as defined in the Payment of Wages Act 1936, or
(ii) a factory as defined in the Factories Act 1948, or
(iii) a railway as defined in the Indian Railway Act 1890, or
(iv) the establishment of a person who, for the purpose of fulfilling a contract with the owner of
any industrial establishment, employs workmen.
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5.2. CERTIFICATION OF STANDING ORDERS

The Government shall appoint an officer to be called as the Certifying Officer.
The employer shall submit to the Certifying Officer the draft standing orders proposed by him/her
for adoption in his/her industrial establishment. The draft standing orders should contain all the
matters prescribed by the Act and, so far as is practicable, be in conformity with the model standing
orders set out in the Act.
On receipt of the draft standing orders, the Certifying Officer shall forward a copy thereof to the
trade union, if any, of the workers, or where there is no such trade union, to their representatives,
together with a notice requiring objections, if any, which the workers may desire to make to the
draft standing orders.
After giving the employers and the workmens representatives an opportunity of being heard, the
Certifying Officer shall certify the draft standing orders, after making any modifications or additions
which he deems necessary. He shall then send copies of the certified standing orders to the
employer and to the workmens representatives.
In case of any grievance, either of the two parties can prefer an appeal against the orders of the
Certifying Officer to the appellate authority.

5.3. DATE OF OPERATION OF STANDING ORDERS

Standing orders shall, unless an appeal is preferred, come into operation at the expiry of thirty days
from the date on which authenticated copies thereof were sent; or, where an appeal is preferred, on
the expiry of seven days from the date on which copies of the order of the appellate authority were
sent.

5.4. DISPLAY OF STANDING ORDERS

The text of the certified standing orders shall be prominently displayed by the employer in English
and in the language understood by the majority of the workers on special boards at or near the
entrance through which the majority of the workers enter the industrial establishment and in all
departments thereof where the workers are employed.

5.5. DURATION AND MODIFICATION OF STANDING ORDERS

An employer or worker or a trade union or other representative body of the workmen may apply to
the Certifying Officer to have the standing orders modified. However, certified standing orders
cannot be modified except on agreement between the employer and the workmen and until the
expiry of six months from the date on which the standing orders or the last modifications thereof
came into operation.

5.6. MATTERS TO BE PROVIDED IN THE STANDING ORDERS

a) Classification of workmen, e.g., whether permanent, temporary, apprentices, probationers,
or badlis.
b) Manner of intimating to workmen periods and hours of work, holidays, pay-days and wage
rates.
c) Shift working.
d) Attendance and late coming.
e) Conditions of, procedure in applying for, and the authority which may grant leave and
holidays.
f) Requirement to enter premises by certain gates, and liability to search.
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g) Closing and reporting of sections of the industrial establishment, temporary stoppages of

work and the rights and liabilities of the employer and workmen arising there from.
h) Termination of employment, and the notice thereof to be given by employer and workmen.
i) Suspension or dismissal for misconduct, and acts or omissions which constitute misconduct.
j) Means of redress for workmen against unfair treatment or wrongful actions by the
employer or his agents or servants.

6. Contract Labour (Regulation and Abolition) Act 1970

6.1. PURPOSE OF THE ACT
The purpose of the Act is to regulate the employment of contract labour in certain establishments
and to provide for its abolition in certain circumstances.

6.2. DEFINITIONS

6.2.1. Contract labour

A workman shall be deemed to be employed as contract labour in an establishment when he/she is

hired in connection with the work of an establishment by or through a contractor with or without
the knowledge of the principal employer.

6.2.2. Contractor

A contractor refers to a person who undertakes to produce a result for an establishment other than
to merely supply goods or articles to such establishment through contract labour or who supplies
labour to any establishment and includes a sub-contractor.

6.2.3. Principal employer

A principal employer is the owner or manager or any other person responsible for supervision and
control of the establishment.

6.2.4. Establishment

An establishment means any office/department of the government or local authority, or any place
where any industry, trade, business, manufacture or occupation is carried on.

6.2.5. Workman

"Workman" means any person employed in or in connection with the work of any establishment to
do any skilled, semiskilled or un-skilled, manual, supervisory, or clerical work for hire or reward,
whether the terms of employment be express or implied, but does not include any such person--
a) who is employed mainly in a managerial or administrative capacity; or
b) who, being employed in a supervisory capacity, draws wages exceeding five hundred rupees
per mensem; or
c) who is an out-worker, that is to say, a person to whom any articles or materials are given
out by or on behalf of the principal employer to be worked upon either in the home of the
out-worker or in some other premises, not being premises under the control and
management of the principal employer.
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6.3. APPLICABILITY
The Act applies to
a) every establishment in which twenty or more workmen, are employed or were employed on
any day of the preceding twelve months as contract labour;
b) every contractor who employs or who employed on any day of the preceding twelve
months twenty or more workmen.

6.4. PROHIBITION OF CONTRACT LABOUR

The Act empowers the appropriate government to order the prohibition of employment of contract
labour in certain jobs/areas through issue of notification after consultation with the Contract Labour
Advisory Boards constituted under the Act.
Employment of contract labour may be prohibited in any process, operation or other work in any
establishment after taking into account the following factors:
a) whether the process, operation or other work is incidental to, or necessary for the industry,
trade, business, manufacture or occupation that is carried on in the establishment;
b) whether it is of perennial nature;
c) whether it is done ordinarily through regular workmen in that establishment or an
establishment similar thereto;
d) whether it is sufficient to employ considerable number of whole-time workmen.

6.5. REGULATION OF CONTRACT LABOUR

6.5.1. Registration and Licence

The contractor should obtain a valid licence from a Licensing Officer appointed by the Government.
No contractor shall undertake or execute any work through contract labour except under and in
accordance with the licence issued in that behalf by the licensing officer.
The principal employer of every establishment intending to get any work done through contract
labour should obtain a valid certificate of registration from a Registering Officer appointed by the
government. No principal employer shall employ contract labour in the establishment without such
valid certificate of registration.

6.5.2. Health and welfare provisions

If the Government prescribes, the contractor should make provision for canteens, rest rooms, first
aid, drinking water, latrines, urinals and washing facilities for his contract labour.
If any of these amenities are not provided by the contractor, such amenity shall be provided by the
principal employer. All expenses incurred by the principal employer in providing the amenity may
be recovered by the principal employer from the contractor either by deduction from any amount
payable to the contractor under any contract or as a debt payable by the contractor.

6.5.3. Responsibility for payment of wages

1. A contractor shall be responsible for payment of wages to each worker employed by him as
contract labour within the prescribed period.
2. The principal employer shall nominate a representative duly authorized by him to be present at
the time of disbursement of wages by the contractor and it shall be the duty of such
representative to certify the amounts paid as wages.
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3. In case the contractor fails to make payment of wages within the prescribed period or makes
short payment, then the principal employer shall be liable to make payment of wages in full or
the unpaid balance due, as the case may be, to the contract labour employed by the contractor
and recover the amount so paid from the contractor either by deduction from any amount
payable to the contractor under any contract or as a debt payable by the contractor.

6.5.4. Penalties

1. Persons who contravene any provision of this Act or of any rules made there under shall be
punishable with imprisonment for a term which may extend to three months, or with fine which
may extend to one thousand rupees, or with both.
2. If the person committing an offence under this Act is a company, the company as well as every
person in charge of, and responsible to, the company for the conduct of its business at the time
of the commission of the offence shall be deemed to be guilty of the offence and shall be liable
to be proceeded against and punished accordingly.
3. Where an offence under this Act has been committed by a company and it is proved that the
offence has been committed with the consent or connivance of, or that the commission of the
offence is attributable to any neglect on the part of any director, manager, managing agent or
any other officer of the company, such director, manager, managing agent or such other officer
shall also be deemed to be guilty of that offence and shall be liable to be proceeded against and
punished accordingly.
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