This article is written by Widaphi Lyngdoh and Pradyumna Mishra, students of National Law University, Jodhpur. In this article, they have discussed employee protection goals in India, emphasizing mainly on a balance between workmen dues and claims of creditors under IBC and whether it is a fair practice or not.

“.. However, last but not the least, we request the creditors and the Resolution Professional to somehow see that the Company is sold as a going concern and the interest of workers/ employees be protected to their level best.” [1]

-The Hon’ble high court in the matter of Reid & Taylor

Introduction

The requirement to pay workmen dues was always there not only legally but also socially, because of the lower socio-economic standard of the workers. Lack of knowledge of their rights and laws were the most exposed factor in the bankruptcy of a debtor. In most of the cases, it was found that companies started doing such dues and payments through ‘strategic bankruptcy’. And hence stringent laws were needed to ensure the protection of right and payment of workmen dues. 

Earlier the act did not provide any safeguard or any mechanism for the payment of workmen dues. Also, there were substantial problems as the workmen dues were on a lower priority and the 11th Schedule of the Code proposes that there should be no application of Section 326 and 327 of the Companies Act, 2013 in the event of liquidation under the Code. Due to this, section 11 of the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 was rendered null and void.

Hence in 2016, the LokSabha realized the need to provide social security to the employees and the priority under the waterfall mechanism is given to the workmen dues.

The mechanism provided under IBC 2016 can better be understood as a marketing mechanism which aims at protecting the interest of the useful corporate debtors and provides a liquidation mechanism for unviable corporate debtors. This liquidation mechanism is one of the most undefined but reasonable aspects of the code, which is tagged in terms of procedure and hierarchy. Such tagging has been done for section 53 of the Code as ‘Waterfall mechanism’. It aims to distribute sale of liquidation assets in a hierarchy, where the use of the word ‘shall’ makes it compulsory to adhere to the hierarchy provided under section 53. 

Section 53 of the IBC envisages the liquidation waterfall mechanism which provides the hierarchy of payment after the sale of liquidation assets. Priority should be given to the debts below to all other debts.

• The expenses incurred during the liquidation proceeds and resolutions. 
• The dues of workmen for a twenty-four months period after the liquidation commencement dates and debts owed to secured creditors.
• Wages and unpaid dues of the employees, other than the workmen for 12 months period preceding the commencement of liquidation proceedings. 
• Financial debts owed to unsecured creditors.
• Amount due to the Central Government and the State Government for the period of two years in whole or in part including the amount to be received on account of Consolidated Fund of India and the Consolidated Fund of a State.
• All other debts owed to a secured creditor, including unsecured debts.

During an insolvency proceeding, workers who are the nerve Centre of a company adversely suffer. With the amendment of the Act and the Code, consideration has been given to prioritize the “workmen dues”. However, the term has not been defined in the code itself and instead explanation to section 53 has placed reliance for its definition on Section 326 of the Companies Act. Ironically, both the sections (Section 326 and 327(7)) application are not included during liquidation proceedings under the court. This, in turn, creates a gap in the interpretation of the term “workmen dues” and its definition has become open to interpretation which is explicated (usually) in such a manner which is detrimental to the workmen’s interest. Even after such eloquent drafting, the legislatures were unable to provide clarity with regards to the formation of liquidation assets under section 36 of the code rather they have provided the hierarchy of payment with the use of word ‘workmen dues’. No further clarification was given on what all payments will be included.

Where does the problem lie?

The implication of the term “workmen dues” as used under Section 53 carries a tinge of ambiguity. If we look at the explanation, as stated above, the term corresponds to meaning as assigned under Section 326 of the Companies Act, 2013 (Companies Act). Different kinds, almost all types of payment due to workers are included within its ambit (under the term workmen due). These sums even include dues in respect of pension, gratuity, provident funds and any other fund meant for the workmen’s benefit. Hence, relying on the explanation of Section 53, an inference can be drawn that even security dues which are workmen dues are covered under the ambit of waterfall provision.

The above reason was adopted by the liquidator for denying payment of gratuity and social security dues to workmen assigned for Moser Baer India Limited (corporate Debtor). Instead, he included these under the waterfall mechanism.

Significance of Provident Fund Dues

The intricacies of the proceedings of insolvency are sometimes used against the workers by the employers by way of “Strategic bankruptcies” to elude statutory dues and to renegotiate the rights and wages of the workers due to their lack of understanding of the complex process.

No safeguard was provided in the initial stages of the draft court; however, the representatives of the EPF Organization briefed the Joint Parliamentary Committee during the course of the deliberations that lower priority had been placed on the payment of debts in the draft code and the EPF dues. Moreover, Section 326 and 327 of the Companies Act, 2013 will not be applicable in cases of liquidation as proposed by Schedule 11th of the Code. Pursuant to this, Section 11 of the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 was rendered null and void.

The Attention of the committee was also being drawn towards the Supreme Court Judgments which rendered that priority should be given to the EPF dues over any other debt. [2]

The Joint Parliamentary committee pursuant to the above submission, submitted to the LokSabha in its report on the 28th of April, 2016 that “the provident, the gratuity and the pension fund provides a social safety net to the workmen and employees, hence it needs to be secured in the event of bankruptcy of a partnership firm or liquidation of a company.” [3]

It also stated in its recommendation, that the sums which are due to any employee or workman from the pension, provident and the gratuity fund shall not be included in the liquidation estate assets.

The dues that are payable under the MP and EPF Act are statutory dues which are payable to the workers. And it is one’s Right to life’s intrinsic fragment. Hence, a distinction can be drawn between wages which aren’t protected and rights which are protected from the creditors. Due to this reason, the committee decided that clause 36(4)(a)(iii) of the code will be substituted by “all sums due to any workman or employee and from the provident, the gratuity and the pension fund”. [4]

Moreover, recommendations were made as to the inclusion of new sub-clauses under Section 155(2) “all sums due to any workman or employee from the provident fund, the pension fund and the gratuity fund.” [5]

Section 155 states “that all property which belongs or is vested in the bankrupt shall be included in the estate of the bankrupt on the day of the commencement of the proceeding. It lays down three things that should not be included, these are, property held by the bankrupt on trust for any person, the excluded assets and lastly all the sums that are due to any employee or workman from the pension, gratuity and the provident fund shall be excluded.” [6]

Similarly, workmen’s Gratuity funds have been safeguarded from attachment during either liquidation or winding up.

Harmonizing with the above-said provision, the 2016 IBC also excludes gratuity funds from being part of the bankrupt’s estate or the liquidation estate.

Since the gratuity funds, the pension funds and provident funds provide a social safety net for workmen, their proceeds are secured and will not be included in either the bankrupt’s estate or the liquidation estate.

Case Laws

In the case of Precision Fasteners Limited v Employees’ Provident Fund Organization the Hon’ble National Company Law Tribunal, Mumbai Bench gave a clear guideline to liquidate employee’s provident fund before paying any other creditor. Hon’ble NCLT said that EPFs are worthy enough to get prioritized higher than the creditors. The Bench stated, “the sums which are due to employees and workmen from the gratuity, provident and Pension funds under sub-clause (iii) of section 36, shall not be included in the liquidation estate.”

It further stated that workmen and employees are entitled to provident fund and other benefits by the virtue of the operation of law, such benefits and dues are the assets of the employees and not the company, Court used the deeming fiction to infer that there is no need to make a separate interest to legitimize such claims as such interest are already there in the form of pension fund/provident fund etc. Earlier, as per the EPF Act, the provident fund had an overriding effect over all other dues including unsecured and secured creditors. However, IBC 2016, by excluding workmen’s dues from the liquidation estate did two things; firstly it extended the earlier law that was in existence, secondly, it strengthened the right of the workmen regarding PF/Pension/Gratuity fund dues by entirely excluding this asset from the liquidation estate which in turn leaves it open to the PF authority or the workmen to realize their pension fund/gratuity fund/provident fund dues without waiting in a queue of the water-fall mechanism.” [7]

While deciding the above duty to ensure that the workmen dues are excluded from the liquidation estate and they are consequently paid to them as per section 53 are of the liquidator, the main objective is to make employees realize that their interests are given higher priority even from the cost of liquidator which is deducted from the liquidation estate. The Court provided the reasoning for the above by interlinking the workmen dues with the Right to Life. The court observed that a workman spends and works his whole life considering that some part of his salary will be saved which will be given to him after retirement and that will be a valuable source of income and support for him. Thus you cannot include workmen dues in the liquidation estate to pay off the debt of the company and infringe the inalienable right of people. Other dues shall also include provident fund, pension and gratuity payment as these must be considered as the property of workers lying with corporate debtors. Hence these payments cannot be claimed by the creditors as a matter of right. 

Similarly, in the case of Alchemist Asset Reconstruction Company Ltd. v Moser Baer India, the NCLT Bench was of the view that assets of the corporate debtor do not include provident, pension, and gratuity fund as mentioned in section 53 of the act for the settlement of the claims of the creditor. 

A fine comparison and distinction were drawn between section 326 of Companies Act and section 53(1)(b)(i). Where Section 53 covers workmen dues for the period of 24 months, section 326 does not provide any such time limit or period. Adhering to the judgment of Precision Fasteners Limited v Employees’ Provident Fund Organization it held that workmen dues are not the part of the corporate debtor’s assets and they are the property of the employees. Hence as per section 36 employees’ dues including provident fund, pension and gratuity fund shall be excluded from the liquidation estate. 

Moreover, the above case also settled the position of law by restricting the overriding effect of Section 268 of the Companies Act. Section 268 empowers the Companies to act to override the IBC 2016 in case of any contradiction. But in this case, the court prevented workmen dues from this overriding effect and held that it will not have any bearing over the assets of the workmen (relating to Provident Fund, Pension Fund and gratuity). The Hon’ble Bench has taken the following view by providing reasoning that protection of workmen is the intention of the IBC 2016 and hence no law in force should infringe that. 

Thus the intention of the code is to deliberately keep provident fund and pension fund away from the liquidation estate and from the clutches of the liquidation process in what so manner under the strict protection of section 36. In simple terms, these dues should be paid on priority before the liquidation process commences and should not be subject to the mercy of the creditors or the priority-ladder of the waterfall mechanism.

Conclusion

Workmen and employees are the pillars of strength of the economy; therefore, safeguarding their interest during their employer’s insolvency and bankruptcy proceedings is a necessity. Also focusing on recuperating jobs of employees (social and human Capital) from an unfeasible to a feasible enterprise should be indispensable.

The following comments were made by The International Association of Restructuring, Insolvency and Bankruptcy Professionals on the inefficacy of insolvency regimes in resolving problems related to the experiences of the employees in events of insolvency of their companies: “Whenever a company goes through a liquidation process treatment of workmen dues is an emotional and survival question for the employees. Employees, who are the lifeblood of the enterprise, they are the assets of the company but not their pensions. Nowadays newspapers are filled with the news of employees not getting their benefits. The legacy costs associated with employees’ benefits, pension claims and wages can amount to an enormous sum and is often among one of the most intractable issues when it comes to the confrontation in restructuring a company.” [8]

Glancing at other countries’ legislation, the aspect of employees’ interest at the time of insolvency is well recognized in the UK as two separate laws are enacted for dealing with insolvency and employment matters. For employment separate Transfer of Undertakings (Protection of Employment) Regulations (TUPE) has been enacted which priorities workmen dues in liquidation. [9]

In Italy, the Marcora Law in order to rescue employees from companies which are distressed, employee’s buyout is practised. Moreover, a collaboration between stakeholders was also made possible by creating schemes of financial support that provides assistance to distressed companies suffering through economic difficulties. Workmen participation was highly encouraged in running and facilitating the everyday work of the firm. The employee buyout in Italy has created and saved as many as 239,300 jobs and 257 new employees owned firms were created wherein most of them have adopted the worker cooperatives model, managed and owned by the employees themselves. [10]

The legislature of Italy has created favourable mechanisms and legal frameworks in order to help raise employee’s capital.

The attempt of the IBC 2016 and every other regime or legislation in the world at large is to find and create a balance between the employment protection goals on one hand and rescuing companies that are insolvent on the other.

In India by the virtue of the waterfall mechanism the code aims at protecting the social and legal rights of the workmen in the liquidation process. Waterfall mechanism not only ensures distribution but also works as a watchdog which prevents practices like ‘Strategic Bankruptcy’. 

To further this idea the bankruptcy and insolvency code since its enactment has provided relief to different classes, the unique feature of the waterfall mechanism has not been given the clarity and understanding it deserves.

Moreover, the IBC along with empowering employees with the requisite legislature to help them in recovering their unpaid wages and salaries during the resolution proceedings of the corporate debtors also allows them to keep their source of livelihood alive.

Adding on to that, the new precedents that evolved in recent years has helped in furthering the trend and in upholding the purpose of the legislature as well as the act.

References

[1] Edelweiss Asset Reconstruction Co. Ltd. v Reid and Taylor India LimitedC.P.No.382/IB/MB/MAH/2018.

[2] E.P.F. Commissioner v. O.L. of Esskay Pharmaceuticals (2011) 10 SCC 727.

[3] Report of the joint committee on the Insolvency and Bankruptcy Code, 2015, Sixteenth Lok Sabha, April, 2016/vaisakha 1938(saka).

[4] Section 36(4)(a)(iii) of The Insolvency and Bankruptcy Code, 2016.

[5] Section 155 (2) (d) of The Insolvency and Bankruptcy Code, 2016.

[6] Section 155 of the Insolvency Bankruptcy Code, 2016.

[7] Precision Fasteners Limited v Employees’ Provident Fund Organisation C.P.(IB)1339 (MB/2017)

[8] International Association of Restructuring, Insolvency and Bankruptcy Professionals, 2005.

[9] Jensen Anthony. A report on Insolvency, Employee Buy Rights and Employee Buyouts, A strategy for Restructuring.Ithaca Consultancy.

[10] VoineaAnca. The path to worker buyouts: Does the UK need its own ‘Marcora Law’?