Gratuity Dilemma vis-à-vis Liquidation Process under the IB Code

Introduction

A liquidation proceeding stands initiated once the corporate insolvency resolution process fails. Section 33 of the Insolvency and Bankruptcy Code, 2016 (IB Code) sets out the conditions laying down three scenarios wherein liquidation proceedings can be initiated against the corporate debtor.

 

First, when the adjudicating authority does not receive the resolution plan upon expiry of the insolvency process or it rejects the resolution plan.[1]

 

Second, when the resolution professional intimates the adjudicating authority that the committee of creditors has decided to liquidate the corporate debtor.[2]

 

Third, when any person, whose interests are prejudicially affected when the approved resolution plan is contravened by the corporate debtor, makes an application to the adjudicating authority to initiate liquidation proceedings.[3]

 

Once the liquidation process is initiated, the same concludes with the distribution of the assets of the corporate debtor in accordance with the waterfall (distribution) mechanism provided under Section 53 of the IB Code.

 

This column seeks to discuss about one peculiar aspect of liquidation wherein it is sought to be ensured that workers of a corporate debtor suffer the least on account of the expiration of the corporate debtor.

 

“Gratuity” and its Interplay with IB Code

While the Payment of Gratuity Act has not explicitly defined the term “gratuity”, it can be understood to be a sum payable by the employer to his workers upon completing service for the prescribed period of time.[4] Now once the company is brought to an end by the liquidation, then clearly such payment is to be paid to the workers.

 

Simultaneously, the IB Code provides for the formation of a “liquidation estate”[5] containing all the assets of the debtor. It is these proceeds that will be distributed to the respective stakeholders (creditors) in terms of waterfall mechanism under Section 53 of the IB Code.

 

Issue arises because if the gratuity falls under the “liquidation estate” and is to be distributed in terms of Section 53, then the workers may not get their dues in total. For instance, assuming that the only asset of the company is the gratuity sum to the tune of Rs 1 crore. Now if this sum forms part of the liquidation estate, then this sum of Rs 1 crore will be distributed firstly towards the insolvency resolution process costs and liquidation costs. If these costs run over Rs 1 crore, then the entire gratuity amount will be consumed under these expenses only. Otherwise, if these costs are, let us say, Rs 50 lakhs, then the remaining Rs 50 lakhs will be distributed towards the workers’ dues for the period of 24 months preceding the liquidation commencement date and dues towards secured creditors. The list goes so on and so forth.

 

However, Section 36 of the IB Code stipulates certain payments that are not to form part of the “liquidation estate”. Section 36(4)(a)(iii) of the IB Code stipulates that:

(4) The following shall not be included in the liquidation estate assets and shall not be used for recovery in the liquidation:

(a) assets owned by a third party which are in possession of the corporate debtor, including–

(i)-(ii)                             ***

(iii) all sums due to any workman or employee from the provident fund, the pension fund and the gratuity fund;

 

In other words, any amount due to the workers from the pension fund, provident fund, and the gratuity fund will not form a part of the liquidation estate of the corporate debtor and will not be used for recovery in liquidation.

 

Since in many instances, liquidation results in the complete closure of the business of the ailing debtor, which results in the termination of the employment of the workers. In legal parlance, this discharge of workers amounts to their retrenchment i.e. the termination of service of workers by the employer for any reason other than punishment inflicted by way of disciplinary action.[6] Naturally to protect the workers, funds such as pension fund, provident fund, and the gratuity fund are kept out of the liquidation distribution and to be used solely for the benefit of the workers.

 

This question was even dealt with by the National Company Law Appellate Tribunal (NCLAT) in Somesh Bagchi v. Nicco Corpn. Ltd.[7] (Somesh Bagchi) as well SBI v. Moser Baer Karamchari Union[8] (Moser Baer – NCLAT) wherein the Appellate Tribunal had held that gratuity does not form a part of the liquidation estate.

 

Unsettled Legal Issues Arising with Gratuity

Now further issue arises on whether a liquidator can be directed to make provision for the payment of gratuity to the workers in case the erstwhile management of the corporate debtor did not create such fund for the workers.

 

The recent ruling by the National Company Law Tribunal (NCLT) Allahabad in Standard Chartered Bank v. JVL Agro Industries Ltd.[9] (Agro Industries) brings out the trouble in how to counter balance the workers benefit wherein the employer had faulted in not providing for gratuity; all the while respecting the statutory limitations of the authority of a liquidator.

 

In Agro Industries[10], a resolution proceeding was initiated and consequently a moratorium was declared and a resolution professional was appointed. Since, no resolution plan was approved by the committee of creditors, the liquidation proceeding was initiated. The corporate debtor had nearly 500 employees some of whom had filed an application for payment of their dues after the public announcement of liquidation was made. The corporate debtor had taken gratuity policy for 92 of its employees from Life Insurance Corporation (LIC), and the other 403 were not covered by it. It was further represented before the NCLT that the corporate debtor has requisite funds to cover the gratuity payments of the rest of its employees as well as pay the renewals for the already existing policyholders.

 

The NCLT referring to the ruling in Alchemist Asset Reconstruction Co. Ltd. v. Moser Baer India Ltd.[11] (Moser Baer – NCLT) which had been upheld by the NCLAT allowed the same and directed the liquidator to pay for the existing holders whose premiums are due as well as procure a new gratuity policy for the other 403 employees.

 

The precedent of Moser Baer – NCLT[12] referred to by the NCLT in Agro Industries[13] was primarily on the issue of whether gratuity funds could be used to make up the “liquidation estate” and consequently available for distribution amongst other creditors in terms of Section 53 of the IB Code. Allowing the prayer of the workers, the NCLT held that amount due towards the workers cannot be used for the purposes of distribution in terms of Section 53 of the IB Code.

 

In Moser Baer – NCLT[14], the Court further directed the liquidator that in cases there is any deficiency to the provident, pension or the gratuity funds; the liquidator shall ensure that the fund is available in these accounts, “even if their employer has not diverted the requisite amount”.

 

This order was impugned by the State Bank of India – a secured creditor of Moser Baer in SBI v. Moser Baer Karamchari Union,[15] where the limited question that came before the NCLAT was whether the gratuity dues formed a part of the liquidation estate. Holding the answer in negative, the NCLAT decided not to interfere with the order of the NCLT.

 

However, complications arise from the facts that confronted the NCLAT in its ruling in Savan Godiwala v. Apalla Siva Kumar[16] (Siva Kumar) wherein the NCLAT had held that if there has been no fund set aside for the payment of gratuity, provident and pension dues then the liquidator cannot be directed to do so.

 

The ex employees of the corporate debtor herein had contended that since corporate debtor had failed to maintain a gratuity fund or obtain insurance for the fulfilment of its liability towards payment of the gratuity to its employees, the gratuity dues payable to the employees shall be treated as an asset of the employee lying in possession of corporate debtor and as such, cannot be treated as a claim at par with other creditors.

 

In the counter the liquidator submitted that if there is no separate fund for gratuity payments, the same cannot be done from the running accounts of the corporate debtor, presumably because under the statutory scheme[17] of the IB Code the gratuity funds are excluded from the ambit of “liquidation estate”.

 

The NCLAT, firstly, discussed judicial precedent in Moser Baer – NCLAT[18] and Section 36(4)(a)(iii) as to how funds such as gratuity and provident funds do not form part of liquidation estate, therefore, are outside the purview of any discussion on “liquidation estate”. Secondly, it referred to Section 36(2)[19] of the IB Code to reason that the liquidator holds the funds in the “liquidation estate” in a fiduciary capacity for the purposes of distribution amongst creditors in terms of Section 53 of the IB Code, therefore such funds cannot be used for any other purpose except the distribution mechanism under Section 53 of the IB Code. Thirdly and finally, the NCLAT referred to the facts and circumstances, where there was no separate fund provided by the erstwhile management for the purposes of gratuity funds.

 

Resultantly, the NCLAT concluded:

  1. [i]n a case, where no fund is created by a company, in violation of the statutory provision of Section 4 of the Payment of Gratuity Act, 1972, then in that situation also, the liquidator cannot be directed to make the payment of gratuity to the employees because the liquidator has no domain to deal with the properties of the corporate debtor, which are not part of the liquidation estate.[20]

 

The Agro Industries[21] case refers to a situation where funds for payment of gratuity have been set aside by the corporate debtor but are not enough to cover the dues. Siva Kumar[22] talks about a situation where the corporate debtor has failed to comply with its statutory obligation of creation of gratuity funds under the Payment of Gratuity Act – in such a situation no funds can be set aside by the liquidator since she/he lacks the domain to do so. Therefore, the ratio of Siva Kumar[23] seems to hold that unless there are funds specifically set aside for the payments of premium for gratuity; funds from the “liquidation estate” cannot be used for the payments of such payments. On the other hand, the Moser Baer – NCLT[24] as a matter of principle rules that provident, pension and gratuity funds should be kept duly furnished by the liqudiator even if the employer did not divert the requisite amount.

 

Conclusion

It is now a settled position of law that gratuity funds due towards the workers fall outside the scope of the liquidation estate, and cannot be used for payments of dues of other creditors.

 

That still leaves a difficult position (at least in equity) if the statutory duty to cover the workers with gratuity and provident is avoided purely on account of the illegality of the erstwhile management who originally did not create any funds for the payments of premiums towards these funds. The only consequence is that the workers stand to lose the rightful coverage.

 


† Akaant Kumar Mittal is an advocate at the Constitutional Courts, and National Company Law Tribunal, Delhi and Chandigarh. He is also a visiting faculty at the NUJS, Kolkata and the author of the commentary Insolvency and Bankruptcy Code – Law and Practice. 

†† 4th year law student at the National University of Juridical Sciences, Kolkata. She can be contacted at lavanya218024@nujs.edu

[1] S. 33(1), Insolvency and Bankruptcy Code, 2016.

[2] S. 33(2), Insolvency and Bankruptcy Code, 2016.

[3] S. 33(3), Insolvency and Bankruptcy Code, 2016.

[4]Payment of Gratuity Act, 1972.

[5]IB Code, S. 36.

[6]S. 2(oo), Industrial Disputes Act, 1947.

[7]2018 SCC OnLine NCLAT 833 .

[8]2019 SCC OnLine NCLAT 447.

[9] CA No 294/2019 in CP No (IB) 223/ALD/2018, order dated 10-12-2020 (NCLT).

[10] Ibid.

[11]2019 SCC OnLine NCLT 118.

[12]Ibid.

[13] CA No 294/2019 in CP No (IB) 223/ALD/2018, order dated 10-12-2020 (NCLT).

[14] 2019 SCC OnLine NCLT 118.

[15]2019 SCC OnLine NCLAT 447.

[16]2020 SCC OnLine NCLAT 191.

[17]See IB Code, S. 36(4)(a)(iii).

[18] 2019 SCC OnLine NCLAT 447.

[19]IB Code, S. 36(2) stipulates:

“(2) The liquidator shall hold the liquidation estate as a fiduciary for the benefit of all the creditors.”

[20]2020 SCC OnLine NCLAT 191.

[21] CA No 294/2019 in CP No (IB) 223/ALD/2018, order dated 10-12-2020 (NCLT).

[22] 2020 SCC OnLine NCLAT 191.

[23] Ibid.

[24] 2019 SCC OnLine NCLT 118.

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