Opted Out Before Joining Date But Original Documents Not Being Returned

My wife signed an appointment letter (not a bond) which states that she will have to pay Rs 35000 if she wants to resign. However, she has decided not to join the institute (its a private University) and informed them before the joining date. They had selected back up candidates during the interview but are still trying to enforce the Rs 35000 clause in the appointment letter. They are unaccommodating and are also not even ready to reduce the amount. My questions are:
1. Which law prohibits them from acting they way they are?
2. If I declare the documents as misplaced and simply get new ones made, will that be illegal?

How they are trying to enforce the payment of Rs.35,000/-? If they are asking it in writing, then you need to immediately reply to that. Otherwise, you do not need to do anything at this moment. Let the company ask you in writing first. Verbal communication in this case have no value.
Your wife does not required to pay anything. But for more accurate advice, it is essential to go through the content of the appointment letter.
I fail to understand your statement - "If I declare the documents as misplaced and simply get new ones made, will that be illegal?" Which documents are you talking about?

" If I declare the documents as misplaced and simply get new ones made, will that be illegal?". The query does not disclose any such facts.

Dear Saurabh,
There is nothing to worry. There is no employer=employee relationship estd as yet. The fact that they have already apptt. from the panel vice your wife should strengthen your defence. As such the U'sity has not suffered your wife not having joined the U'sity. Therefore at this point of time you need not hasten for duplicate documents. You should give a written letter asking them to return your originals forcibly withheld by them. If they refuse follow up with a legal notice and file case to restore the documents illegally held by them. You won't panic, sure to get your originals.