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Workmen Dues vis-à-vis Insolvency Bankruptcy Code – Sunk Rights under Sinking Enterprises?

By Swarnendu Chatterjee & Bhargavi Chandrasekharan

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The Insolvency and Bankruptcy regime of India has evolved steadily since its beginning in 2016, benefitting from the jurisprudential osmosis. The primary objective of the Insolvency and Bankruptcy Code, 2016 (“Code”), single umbrella legislation consolidating all aspects pertaining to the resolution and liquidation of a Corporate Debtor, is to balance the interests of all the stakeholders involved. Workmen, the nerve centre of a company, are also the least sophisticated of the stakeholders. This article attempts to study the providence of the workmen of an insolvent employer within the scheme of Code.

Evidently, the drafters of the Code have been alive to the relative vulnerability of the workmen. Workmen dues, for the period of 24 months preceding the liquidation commencement date, are ranked pari passu with the debts owed to secured creditors who have relinquished their security interest under S. 53 of the Code, thereby according to them the highest priority in the liquidation hierarchy, next only to the costs of insolvency resolution and liquidation process.

Further, the ambiguity created by S. 52 of the Code on the claims of workmen if the secured creditors exercised their right of enforcement, was addressed with the insertion of S. 21A in the Insolvency and Bankruptcy Board of India (Liquidation Process) (Amendment) Regulations, 2019. Regulation 21A(2) of the Liquidation Regulations requires that secured creditors who realize their security interest contribute towards the payment of dues of workmen in the same manner as they would have if they had relinquished their security interest to the liquidation estate.

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The Insolvency Law Committee[2] has categorically justified the intent behind Regulation 21(A)(2) to protect the interests of workmen who stand to lose a substantially in the liquidation process if the secured creditors that realize their security interest outside the liquidation process are not required to deposit towards the workmen dues. The very distinction drawn between employees and workmen in S.53(1)(b)(i) and S.53(c) reveals the legislative intent of prioritizing the claim of blue-collar employees i.e., workmen, over the while collar employees.

It is fairly clear that under the present Code, the employees in general and workmen specifically should be able to legitimately expect a minimum level of entitlements in the event of the employer undergoing corporate insolvency resolution process. Two questions of significant importance arise at this point

  1. What constitutes the minimum level of entitlement for a workman?
  2. How does a workman set to recover it?

Answering the second question first, the Code envisages two classes of creditors, financial and operational. Workmen are not only part of the corporate debtor’s enterprise but creditors in their own right and thereby the workmen along with the employees fall within the category of Operational Creditors.[3] On the triggering of an Insolvency Resolution Process, two situations can arise under the legislation, (i) Resolution and (ii) Liquidation.

Unfair resolution

When an enterprise is viable, retention and rehabilitation of assets is preferred over liquidation of assets, which results in preservation of employment and better returns for the creditors. A resolution plan, in accordance with S.30 (2) (b) of the Code read with Regulations 31 and 38 of the CIRP Regulations, 2016, is presented by a resolution applicant who wishes to takeover the business of the Corporate Debtor as a going concern. In Edelweiss Asset Reconstruction Company Ltd. v. Bharati Defence and Infrastructure Ltd., the NCLT, Mumbai rejected the resolution plan as “prejudicial” and “causing injustice” as it provided for downsizing of employees/workmen in contravention to the labour laws[4].The implication in the process of revival in contradistinction with the process of liquidation is that, the business of the erstwhile Corporate Debtor is continued without any break and consequently, there is no default retrenchment/discharge of workmen as warranted as under S.33(7) of the Code.

Often the enormity of the legacy costs[5] associated with employee wages, benefits and pension claims contribute to the treatment of workmen as expendable resources during the reorganization of an enterprise. The flawed assessment of the value of company as solely a subset of maximization of shareholders’ interest[6] creates a disparity in the event of corporate restructuring, making it easy to target dues to workmen, in the pursuit to cut expenses. The Supreme Court in the judgment of Committee of Essar v. Satish Gupta[7] has made it clear that the workmen cannot be deprived while considering the viability and feasibility of a resolution plan. There is merit in the argument that welfare dues payable to the workmen, has to be paid in its entirety, even if such benefits have not been deposited post deduction by the erstwhile Corporate Debtor. While wage dues of workmen may undergo substantial reduction, any resolution plan which proposes phasing out the statutory dues in a percentage manner ought to be rejected as being violative of labour legislations like the Payment of Gratuity Act, 1972, Employees Provident Fund and Miscellaneous Provisions Act, 1952 and Industrial Dispute Act, 1947.

S,238 – Does it override welfare legislations?

Not contemplating the payment of these dues at the stage of resolution may lead to catastrophic outcomes, particularly in the context of the wide and unbridled scope given to S.14 (moratorium) and S.238 (overriding powers) of the Code.

In a creditor driven resolution process as contemplated in the Code, the committee of creditors appointed resolution professional’s role assumes importance. While a resolution plan undergoes judicial scrutiny, certain key decisions taken in the day-to-day management of the company by the resolution professional may impact the workmen adversely. Workmen as a class depend upon their employer for their current and future income[8]. In a scenario where a resolution professional lays-off or closes down units of a company without applying the mechanisms enshrined under the Industrial Disputes Act, 1947, workmen run the risk of being stranded jobless and penniless. With the doors to seek recourse also closed in the light of S.14 of the Code, there is an additional burden of going remediless. 

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It is a trite law that in case of an inconsistency arising between two special provisions, the legislation enacted latter will prevail over the former[9]. However the application of the non-obstinate clause enshrined under S.238 to supersede welfare legislations benefiting the workmen is unwarranted and incorrect, primarily because the welfare legislations and the Code operate in distinctly different domains. Even so, an overriding power ought not to be relied on to take away the fundamental rights of workmen.

Liquidation

The law aims to quickly and efficiently liquidate the assets to maximize recoveries to the creditors when an enterprise is unviable. While the Corporate Debtor goes into liquidation, the workmen and employees under S.33(7) of the Code are deemed discharged and the dues of the creditors is recovered under the waterfall mechanism provided under S.53 of the Code. The payments in accordance with such waterfall mechanism are made from the liquidation estate defined under S.36 of the Code[10]. S.36(3) prescribes the assets which are to be considered a part of the estate and S.36 (4) explicitly excludes “all sums due to any workman or employee from the provident fund, the pension fund and the gratuity fund” from said estate.

In Precision Fasteners[11], the NCLT, Mumbai has observed that the specific exclusion of dues in respect of statutory benefits from the liquidation estate is to treat such dues as the asset of the workmen lying with the employer and protect it from dilution during the process of liquidation of estate. This position has been upheld by the NCLAT in the State Bank of India v. Moser Baer Karamchari Union[12] while denying preferential payment of social security dues to workmen as falling outside the scope of S.36 and by extension, S.53 of the Code. Meaning, the workmen are not entitled to anything more than unpaid wages in the event of liquidation process.

On the same lines, the NCLT in Precision Fasteners observed that dues pertaining to social security benefits are fundamental to workmen’s right to life and livelihood enumerated in Article 21. Interestingly, the NCLT has provided for an absolute priority for dues pertaining to welfare of employees in contrast with the time-specific priority for wage-based dues prescribed by the Code under S.53(1)(b).

In this context, it is prudent to appreciate that S.53(1)(b)(i) of the Code refers to “workmen dues” and not “workmen wages.” Explanation II to S.53 of the Code alludes to S.326 of the Companies Act, 2013 to define the term “workmen dues.” However this explanation is rendered otiose and nugatory by S.327 (7) of the Companies Act, 2013 which bars the application of S.326 and S. 327 Companies Act, 2013 to proceedings under the Code. S.178 (payment of debts during bankruptcy) of the Code, the only other time the term “workmen dues” appears does not offer any definition to expand upon. The gap in the legislation in respect of what workmen dues is pending consideration before the Apex Court in the matter of Moserbaer Karmchari Union v. Union of India and Ors.[13]

A comparative study[14] of treatment of employee claims from 62 jurisdictions reveals that such claims may, inter alia, include unpaid wages, vacation benefits, holiday pay, severance pay, termination pay, travel expenses, and other contracted-for benefits like health insurance, life insurance, long-term disability insurance, and retiree medical benefits[15].

Fact remains that despite being wholly reliant on the corporate debtor for their income and often unintentionally, the workmen get into a creditor-debtor relationship with their employer with remarkably less choices. The power, albeit theoretically, that vests in an Operational Creditor in the meeting of Committee of Creditors does not translate to anything advantageous to the workmen. This is due to their unique relationship with the employer, unequal bargaining power, information asymmetries, disparity in awareness and resources to understand the complexity of proceedings. In addition to these factors, smaller companies with non-unionized workforce find themselves unequally poised vis-à-vis the unionized workmen. The outstanding pay and benefits are often left to the mercy of the liquidation process.

The interpretation excluding the dues pertaining to social security benefits from the process of liquidation along with the presently dormant status of definition of workmen dues is ripe for abuse as it leads to workmen being denied their statutory entitlement post forced discharge from the insolvent company. This sets the precedent for piecemeal litigation pushing the workmen to approach multiple forums in pursuit of relief.

Conclusion

The World Bank has called for special treatment of employee claims during insolvency, recognizing that workers are a vital part of an enterprise. A sound insolvency system requires unambiguous, inclusive, transparent and affordable enforcement to enable a smooth transition. In the interest of the eponymous balance that the Code seeks to achieve, it is imperative to insulate the workmen from the inequitable insolvency resolution process by providing timely payments of their already earned wages and other social security benefits. A positive interplay of the labor, welfare laws with the insolvency legislation is crucial to avoid inequitable consequences.


[1] This article is co-authored by Swarnendu Chatterjee, Advocate-On-Record, Supreme Court of India and Ms. Bhargavi Chandrasekharan, Advocate, Madras High Court.

[2] The Third Report on Insolvency Law Committee dated 20.02.2020

[3] S. 5(20) And (21) Code, 2016

[4]MA 170/2018 CP292/I&B/NCLT/MAH/2017

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

[6]Herbert, Michael, Understanding Bankruptcy, Lexisnexis Legal Text Series, 2005.

[7]2019 SCC 1478

[8] Stewart, Fiona, Benefit Protection: Priority Creditor Rights for Pension Funds (OECD Working Papers on Ins. & Private Pensions No. 6), 2007.

[9]Solidaire India Ltd. v. Fairgrowth Financial Services Ltd., (2001) 3 SCC 71

[10]Bankruptcy estate prescribed under S.155 of the Code also excludes the dues pertaining to provident fund, pension fund and gratuity fund.

[11](M.A.No.576 & 752/2018) In C.P.(IB)1339 (MB/2017)

[12]2019 SCC Online NCLAT 447

[13] WP (Civil) No.421 of2019.

[14] Sarra, Jannis, Recognizing Workers’ Economic Contributions: The Treatment Of Employee And Pension Claims During Company Insolvency, A Comparative Study Of 62 Jurisdictions, 25 (2008), https://www.iiiglobal.org/sites/default/files/105_recognizing_workers_economic_contributions.pdf

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