Scrutinizing The Exclusion Of Gratuity, PF And Pension Fund From Liquidation Estate

INTRODUCTION

When the Adjudicating Authority announces the liquidation of the Corporate Debtor, the liquidator is endowed with the burden of forming a Liquidation estate as per Section 36 of the Insolvency and Bankruptcy Code 2016 (Hereinafter IBC). Following this, the proceeds from the sale of assets are distributed as per the waterfall mechanism enumerated under Section 53. However, certain assets such as statutory dues of workmen, are deliberately kept out of the ambit of liquidation estate. This article purports to decode the rationale behind excluding these claims from the estate and attempts to examine the legal uncertainty around the law.

EXAMINING THE EXISTING LEGAL FRAMEWORK

At the outset, we will look into the aspects of the waterfall mechanism and exclusion of assets from the estate under Section 53 and 36(4)(iii) respectively. Section 53 of IBC, by way of a non-obstante clause, stipulates the order of priority for distributing the proceeds obtained from the sale of the liquidation estate. It is pertinent to note that the waterfall mechanism under section 53(1)(a) treats the “workmen’s dues” for the period of 24 months preceding the liquidation date and debts owed to secured creditors on a pari passu basis. Additionally, the explanation (ii) under this section posits that the term “workmen’s dues” shall have the same meaning as stipulated under section 326 of the Companies Act, 2013. The explanation to section 326 effectively includes provident fund, pension fund, and gratuity fund under workmen’s dues. Hence, the above proposition of law gives the impression that the employee’s statutory dues fall under the waterfall mechanism and are subject to the mercy of the creditors, liquidators and the statutory hierarchy under the waterfall mechanism.

However, the ambiguity arises when section 53 is read along with section 36 of IBC. Section 36(4)(a) excludes certain third-party assets from the liquidation estate. Sub-clause(iii) explicitly excludes ‘all sums due to any workman or employee from the provident fund, pension fund and gratuity fund. In other words, the said provision creates a legal fiction by treating the workmen’s dues as third-party assets in possession of the Corporate Debtor. On this account, it cannot be said that the corporate debtor has an ownership right concerning dues he owed to various social welfare funds. Thus, section 36 confers no right to the liquidator to constitute these funds under the liquidation estate.

From the above views, it is evident that the provisions paint an uncertain and ambiguous picture for both the employees and the liquidator. When regulatory framework alone is considered, it offers much scope for confusion, such as whether the statutory dues of workmen come under the ambit of liquidation estate. Whether the liquidator has the duty to ensure the dues are paid despite the corpus does not exist? In numerous cases, the judiciary pondered upon these questions and cleared the path for legal consistency in due course.

One of the first cases that dealt with this issue was Asset Reconstruction Company Ltd. v. Precision Fasteners Ltd. 2018[1]. The NCLT Mumbai bench in this pronouncement, gave an affirmative answer to the above questions. The decision was the first to rightly differentiate the right of other creditors on the property from that of workmen’s right to life on these statutory dues. It remarked that the rights of workmen are interwoven with the right to life as these funds constitute the most valuable asset of their lives and cannot be interlinked on par with the debts of the creditors. It further affirmed that once a deduction has been made from the workman’ wages, it is then considered as the asset of the workmen but not of CD.

Relying on the above pronouncement, NCLT New Delhi in Alchemist Asset Reconstruction Co. Ltd vs. Moser Baer India Ltd. 2019[2] found the liquidator’s contentions flawed. The Tribunal rightly held that when the funds do not form part of the liquidation estate, then the question of distribution under section 53 cannot arise. Besides, it held that if there is any deficiency in the funds, then the liquidator has to make sure that the payments are realized and distributed accordingly along with interest.

The workers’ Union in State Bank of India v. Moser Baer Karamchari Union & Anr, 2019[3], challenged the liquidator’s actions for processing the Pension and Provident fund payments under the waterfall mechanism. The NCLAT Delhi upheld the contentions of the Union. It reiterated that Provident Fund, Pension Fund and Gratuity Fund shall not come within the meaning of assets of the CD for the distribution.

Though in few decisions such as Regional Provident Fund Commissioner v. Karpagam Spinners Pvt Ltd[4], a contrary approach has been taken, the aforementioned pronouncements present an unequivocal view that the statutory dues of the workmen are at the highest priority and cannot be treated as part of the Estate of the Corporate Debtor.

OVERRIDING EFFECT OF IBC

The IBC has an overriding effect over other enactments, recently the application of the said effect was discussed in the case of SBI v Moser Baer specifically to disregard the exclusion of the employees’ statutory dues from the estate. The Tribunal in the said pronouncement, examined the definition of workmen’s dues as assigned to it under Section 326 of the Companies Act, 2013. It contrasted the definition assigned to workmen’s dues under section 326 of the Companies Act, 2013 and workmen’s dues as mentioned under section 53 of the Code. It noted that Section 53(b)(i) relates to workmen’s dues restricted to a period of twenty-four months preceding the liquidation commencement date. Further, it was of the view that the liquidator could not derive the meaning assigned under section 326 while applying Section 53. It went on to say that Section 326 of the Companies Act is relevant for the limited purpose of understanding workmen’s dues which can be more than the provident fund, the pension fund and the gratuity fund kept aside and protected under Section 36(4) (iii). The Bench upheld that the IBC will have an overriding effect in case of inconsistency in any other law. Conclusively, it was decided that Section 53(1)(b) when read with Section 36(4) will have an overriding effect on Section 326(1)(a) of the Companies Act.

DUTY OF THE LIQUIDATOR IN CASE THE FUNDS ARE NOT MAINTAINED

Now that we have dealt with the exclusion of PF dues, pension fund and gratuity fund assets from the liquidation estate, the obvious question arises: what lies ahead for the workmen if no fund is made available by the Corporate Debtor despite taking contributions from them?

The NCLT in the Precision Fasteners case, recognized the duty of the liquidator to not obliterate the liquidation process by paying the dues under the head of PF/Pension Fund//Gratuity Fund in priority to other debts. Besides, it held that EPFO would have the first charge over the assets until the dues are settled. Along similar lines in the Nagalingam Muthiah[5] case, it was adjudicated that if the liquidator is not able to pay off the amount due and claimed by the EPFO within the time stipulated by the NCLT, the EPFO is free to proceed with the sale of the attached properties.

In another case[6], the adjudicating authority has directed the liquidator to provide sufficient provision for payment of Gratuity to the workmen. It ruled that the liquidator cannot avoid the liability to pay Gratuity to the workmen on the ground that the CD has not maintained separate funds or a fund at all.

In addition, the NCLT Allahabad in Standard Chartered Bank v. JVL Agro Industries Ltd[7] gave directions to the liquidator to make payment of the gratuity policy of LIC which has become due. Besides, AA directed the liquidator to procure a new policy for the remaining employees. Further, in case there is any deficiency to the Provident Fund, Pension Fund and Gratuity Fund, then the liquidator shall make sure that the fund is made available to the appropriate accounts, even if the Company had not diverted the requisite amount[8].

Contrary to the above pronouncements, recently the NCLAT New Delhi in Savan Godiwala v. Apalla Siva Kumar[9] has taken a perverse view. It ruled that if no fund is constituted by the Corporate Debtor, then the liquidator cannot be directed to pay Gratuity to the employees because the liquidator has no domain to deal with the assets of a third party. The said verdict has distorted the legal certainty by interpreting the law against the objective of the Code. It construed the provisions in a limited sense, thereby polarizing the interests of the stakeholders. By virtue of the said demerits, it seems apt for the Apex Court to overrule the decision at the earliest as it is at odds with the interests of the workmen in general.

CONCLUSION

In conclusion, the provident fund, the pension fund and the gratuity fund provide the social safety net to the workmen and employees. Hence, they are essential to be secured in the event of liquidation of a company.[10] Although the existing regime safeguards the interest of the workers, it still leaves the scope for regulatory and judicial developments. Unless these issues are comprehensively addressed, the ray of hope for securing workers’ lives cannot be seen.

[1] 2018 SCC OnLine NCLT 27284

[2] 2019 SCC OnLine NCLT 118

[3] 2019 SCC OnLine NCLAT 447

[4] 2019 SCC OnLine NCLT 1640

[5] 2021 SCC OnLine NCLT 559

[6] Id. 3

[7] 2020 SCC OnLine NCLT 1470

[8] Id. 2

[9] 2020 SCC OnLine NCLAT 191

[10] Report of the Joint Committee on the Insolvency and Bankruptcy Code, 2015 submitted on 28^th April 2016 – 16_Joint_Committee_on_Insolvency_and_Bankruptcy_Code_2015_1.pdf (ibbi.gov.in)