Treatment of Employment Benefits under the Insolvency and Bankruptcy Code, 2016

[Medha Rao is an Advocate based in Bengaluru]

Following the reasoning of the National Company Law Tribunal (NCLT), Mumbai in Asset Reconstruction Company (India) Limited v. Precision Fasteners Ltd. [‘Precision’], the NCLT, Delhi in Alchemist Asset Reconstruction Co. Ltd. v. Moser Baer India Limited [‘Alchemist’] has also held that the dues owed to workmen from provident fund, gratuity fund, and pension fund shall not form part of the ‘liquidation estate’ pursuant to section 36(4)(a)(iii) of the Insolvency and Bankruptcy Code, 2016 and is an asset of the workmen lying with the corporate debtor. On the other hand, the NCLT, Chennai Bench in Regional Provident Fund Commissioner-I v. Karpagam Spinners Private Limited [‘Karpagam’] has upheld the treatment of provident fund claims under section 53(1)(f) of the Code as “other debts and claims” and dismissed the claims of the Regional Provident Fund Commissioner that, pursuant to section 11 of the Employees’ Provident Fund and Miscellaneous Provisions Act, 1952, the amounts due to employees provident fund shall have a first charge on the assets of the establishment.

What constitutes ‘liquidation estate’ is provided under section 36 of the Code. Section 36(4) has been produced herein:

(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–

……

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

Once the liquidation estate is ascertained, section 53 of the Code, often referred to as the “waterfall clause”, provides for the distribution of assets. Under the waterfall clause, it is relevant to note that “workmen’s dues” for the period of 24 months preceding the liquidation date are treated pari passu with debts owed to secured creditors. Moreover, explanation (ii) to section 53 states that “workmen’s dues” will have the same meaning as section 326 of the Companies Act, 2013. Of significance is that section 326 includes within its definition of “workmen’s dues” provident fund, gratuity fund, and pension fund.

In the cases mentioned above, the applications were filed against the liquidator on the ground that dues owed to workmen under the pension fund cannot be limited to 24 months and in fact ought to be paid in their entirety as the Employees’ Provident Fund and Miscellaneous Provisions Act, 1952 provides for a first charge on the assets of the establishment. In  both Prescision and Alchemist, the contention of the liquidator that the pension fund, gratuity fund, provident fund ought to be limited to the extent of 24 months, given section 326 of the Companies Act, 2013 read with section 53 of the Code, was disregarded without sufficient justification placing reliance solely upon section 36(4)(a)(iii) of the Code. Further, the contention that section 238 of the Code would override section 11 of the Employees’ Provident Fund and Miscellaneous Provisions Act, 1952 was also disregarded as incorrect on the ground that there was no inconsistency between the two provisions. In fact, owing to section 36(4)(1)(a)(iii) of the Code, the position of workmen and employees remains further strengthened. In Karpagam Spinners, section 36(4)(a)(iii) of the Code was never taken into consideration. This judgment also raises the question of treatment of provident fund, gratuity fund and pension fund where statutory authorities have filed their claims with the liquidator.

A literal interpretation of section 53 of the Code read with section 326 of the Companies Act, 2013 and section 36 of the Code shows that there lies an evident inconsistency between the provisions. It is significant to note that, as captured in the Report of the Joint Committee of the Lok Sabha, based on the representations of the representative of the Employees’ Provident Fund Organisation, section 36(4)(a)(iii) of the Code was inserted with the object of exempting provident fund from the liquidation estate. However, the same report also acknowledges that “workmen’s dues” will include pension fund etc.”. The effect of the non-obstante clause under section 53 of the Code in its relation with section 36(4)(a)(iii) has not been dealt with thus far.

This situation of conflicting judgments and lack of clarity on the treatment of pension fund, gratuity fund and provident fund presents a difficult scenario for liquidators. In fact, a situation where a first charge on the assets of the corporate debtor is a requisite in the event of liquidation will also affect to a large extent the commercials proposed by prospective resolution applicants in the resolution process. This can be primarily attributed to section 30(2)(b) of the Code which requires that the resolution plan:

provides for the repayment payment of the debts of operational creditors in such manner as may be specified by the Board which shall not be less than the amount to be paid to the operational creditors in the event of a liquidation of the corporate debtor under section 53;

[emphasis added]

This, read with regulation 38(1) of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 which requires the resolution plan to give priority to operational creditors over financial creditors, may make it difficult for resolution of companies where dues owed to workmen under pension fund, gratuity fund and provident fund are substantial as the commercials of the resolution plan will now have to take this into consideration. It also puts a constraint on negotiations for resolution plan with the financial creditors who may be unwilling to pass a resolution plan where they are forced to share a substantial portion of the “pie” with workmen who, it may now be argued, are in the least entitled to get their provident fund, pension fund and gratuity fund in their entirety.

– Medha Rao