To institute a comprehensive insolvency regulatory mechanism relating to corporate entities and the individuals, the Parliament enacted the Insolvency and Bankruptcy Code, 2016. With the enactment of the Code, the issue of the position of Provident Fund claims vis-à-vis claims of secured and unsecured creditors within the bankruptcy proceedings has assumed great importance. Do the accumulated Provident Fund arrears have a higher-ranking claim upon the corporate debtor’s assets than other creditors, rank equally, or do they come below the creditor ranking to receive only the leftovers after other creditors have been paid? Do the attributes of ‘priority over other dues’ and ‘first charge on the assets of the defaulter’ provided under Section 11 of the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 still hold water? So important are these priority stacks that in most insolvencies the lower-rankers get little or nothing.

A brief overview of the I & B Code

The term ‘insolvent’ means that a company can no longer pay their creditors as and when payments are due, and their liabilities exceed their assets. There is a marked distinction between ‘insolvency’ and ‘bankruptcy’ - the former is voluntary and the latter coercive modes of alienation. Unlike the previous laws, where only the debtor was allowed to initiate the resolution or repayment process, the creditors as well as the corporate debtors - both are allowed to initiate the process under the Code.

A financial creditor, an operational creditor or the corporate debtor itself may initiate the corporate insolvency resolution process (CIRS) upon a default of Rs.1,00,000. The Resolution Professional nominated by the applicant is appointed as the interim resolution professional nominated by the applicant is appointed as the interim resolution professional (IRP). The IRP constitutes a Committee of Creditors (CoC) which consists exclusively of financial creditors. The CoC is required to confirm or replace the IRP as the resolution professional (RP).

Management of the affairs of the Company

Upon appointment of the Interim Resolution Professional, the management of the corporate debtor immediately vests with the IRP and the powers of the Board of Directors/Partners are suspended. IRP plays a key role in the management of the affairs of the corporate debtor and the administration of the CIR process.Section 17(2) (e) provides that the IRP will be responsible for complying with the statutory requirements under applicable laws while managing the affairs of the corporate debtor during the CIRP. Thus, the IRP is the person responsible for timely payment of the EPF and allied dues during this period if the corporate debtor is taken over as an on-going concern.

Corporate Insolvency Resolution (CIR)

The financial restructuring is the first step in corporate rescue.Hence, the Resolution Professional prepares an information memorandum which is required to include inter alia the financials and status of disputes. Any person may propose a resolution plan based on the information memorandum for the corporate debtor’s revival. The Resolution Professional scrutinises the proposed resolution plans. The CoC may either approve a resolution plan by 75% majority or choose to liquidate the corporate debtor. The entire process is required to be completed within 180 days, extendable by a maximum of 90 days with the consent of the CoC. This is however subject to appeals if any made against the orders of the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT). The NCLT confirms whether the resolution plan approved by the CoC complies with the statutory requirements. If the resolution plan does not meet the specified criteria or the CoC decides to liquidate the corporate debtor, the NCLT will pass an order for liquidation.

Liquidation Process

The liquidation may take place in any of the following situations.
(i) No resolution plan is submitted to the NCLT within 180 days (extendable by another 90 days).
(ii) Committee of Creditors or the NCLR rejects the resolution plan
(iii) CoC decided to liquidate anytime during the CIR process and
(iv) Corporate debtor contravenes the approved resolution plan and the prejudicially affected party can apply for liquidation.
In the above cases, the NCLT passes an order of liquidation and makes a public announcement. The Resolution Professional continues as the liquidator, unless removed by the NCLT. No suit or proceedings can be instituted by or against the corporate debtor, subject to the right of a secured creditor to stand outside liquidation. The NCLT assumes the exclusive jurisdiction to decide all matters in relation to the corporate debtor. The entire liquidation process should be completed within 2 years of its commencement.

The liquidator will receive claims from the creditors within 30 days from the commencement of the liquidation process and verify the same. He may accept or reject the claims and determine the value of the claims. He will form a liquidation estate and then apply to NCLT for the avoidance of any preferential/undervalued/extortionate credit transactions. He will sell the immovable and movable property and actionable claims of the corporate debtor by public auction or private contract. Distribute proceeds in accordance with newly prescribed waterfall mechanism. However, the actions of the liquidator are subject to the supervision by the NCLT.

Liquidation Assets

Under the provisions of the Insolvency and Bankruptcy code, the National Company Law Tribunal can order for liquidation under s.33 of the Code if no resolution plan has been materialised before the expiry of the Corporate Resolution Insolvency Process (CRIP), or if it rejects a plan because it does not comply with the provisions of the IBC. The liquidation of a Corporate Debtor involves the selling of its assets and the distribution of the sale proceeds among its various creditors according to the Waterfall mechanism. For the purpose of liquidation, the liquidator shall form an estate of assets which shall be termed ‘Liquidation Estate.’Section 36 of the Code defines what ought to be included and ought not to be included in the ‘Liquidation estate.’

(i) Liquidation estate

Thus, Clause 36 of the Code defining the term ‘Liquidation estate’ includes the following items within its purview.
(a) any assets over which the corporate debtor has ownership rights, including all rights and interest therein as evidenced in the balance sheet of the corporate debtor or an information utility or records in the registry or any depository recording securities of the corporate debtor or by any other means as may be specified by the Board, including shares held in any subsidiary of the corporate debtor;
(b) assets that may or may not be in possession of the corporate debtor including but not limited to encumbered assets;
(c) tangible assets, whether movable or immovable;
(d) intangible assets including but not limited to intellectual property, securities (including shares held in a subsidiary of the corporate debtor) and financial instruments, insurance policies, contractual rights;
(e) assets subject to the determination of ownership by the court or authority;
(f) any assets or their value recovered through proceedings for avoidance of transactions in accordance with this Chapter.
(g) any asset of the corporate debtor in respect of which a secured creditor has relinquished security interest;
(h) any other property belonging to or vested in the corporate debtor at the insolvency commencement date; and
(i) all proceeds of liquidation as and when they are realised.

At the same time, the Code expressly excludes the following items from the meaning of ‘Liquidation estate’ and that these 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 - (a) assets held in trust for any third-party,
(b) Bailment contractors,
(c) all sums due to any workman or employee from the provident fund, the pension fund and the gratuity fund,
(d) other contractual arrangements which do not stipulate transfer of title but only use of the assets, and
(e) such other assets as may be notified by the Central Government in consultation with any financial sector regulator.

(ii) Estate of Bankrupt

Likewise, Clause 155 of the Code provided that the ‘estate of the bankrupt’shall include,
(a) all property belonging to or vested in the bankrupt at the bankruptcy commencement date;
(b) the capacity to exercise and to initiate proceedings for exercising all such powers in or over or in respect of property as might have been exercised by the bankrupt for his own benefit at the bankruptcy commencement date or before the date of the discharge order passed under section 138; and
(c) all property which by virtue of any of the provisions of this Chapter is comprised in the estate.

The estate of the bankrupt shall not include-
(a) excluded assets;
(b) property held by the bankrupt on trust for any other person;
(c) all sums due to any workman or employee from the provident fund, the pension fund and the gratuity fund; and
(d) such assets as may be notified by the Central Government in consultation with any financial sector regulator.

Liquidation Waterfall Mechanism

The order of priority of claims (in which the proceeds from the sale of the liquidation assets be distributed) is set out in Section 53 of the Code. The following debts shall be paid in priority to all other debts.
(a) Firstly, the cases and expenses incurred by the Bankruptcy Trustee for the bankruptcy process shall be paid in full.
(b) Secondly, the workmen’s dues for the period of twenty-four months preceding the bankruptcy commencement date and debts owed to secured creditors shall be paid.
(c) Thirdly, wages and any unpaid dues owed to employees, other than workmen, of the bankrupt for the period of twelve-months preceding the bankruptcy commencement date shall be paid.
(d) Fourthly, any amount due to the Central Government and the State Government including the amount to be received on account of Consolidated Fund of India and the Consolidated Fund of a State, if any, in respect of the whole or any part of the period of two years preceding the bankruptcy commencement date shall be paid.
(e) Lastly, all other debts and dues owned by the bankrupt including unsecured debts shall be paid. Liquidator’s fees are to be deducted proportionately from the proceeds payable to each class.

Importance of Provident Fund dues

It is an accepted view that the workers, due to their lower socio-economic backgrounds, do not necessarily understand the complexities of insolvency proceedings and consequently remain more exposed to the bankruptcy of the corporate debtor. Sometimes, ‘strategic bankruptcies’ may be used as a way of unscrupulous employers to evade the statutory dues and to re-negotiate the wages and other rights of the workers.

Though the provident fund and allied dues are not safeguarded in the draft Code in the initial stages, the representative of the Employees’ Provident Fund Organisation [Shri.Heera Lal Samariya, the then Central Provident Fund Commissioner, Shri.Rajesh Bansal and Shri.Jag Mohan Additional Central Provident Fund Commissioners] during the course of deliberations briefed the Joint Parliamentary Committee that the priority of payments of debts under the Code had been in the draft Code and the EPF dues in the bill had been placed on a lower priority and the 11th Schedule of the Code proposes that s.326 and 327 of the Companies Act, 2013 shall not be applicable in the event of liquidation under the Code. By this, the provisions of Section 11 of the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 are rendered null and void. The representatives of EPFO also drew attention of the Committee to the Supreme Court judgments whereby it was held that the EPF dues shall get priority over all other debts including secured creditors.(Ramesh, 2018)

Taking due note of the above submissions, the Joint Parliamentary Committee, in its report submitted to the Lok Sabha on 28thApril 2016 observed, “[the] provident fund, [the] pension fund and the gratuity fund provide the social safety net to the workmen and employees and hence need to be secured in the event of liquidation of a company or bankruptcy of partnership firm.” The Committee recommended that all sums due to any workman or employee from the provident fund, the pension fund and the gratuity fund should not be included in the liquidation estate assets and estate of the bankrupt.

The dues payable under the EPF & MP Act are statutory dues, ultimately payable to the workers. It forms intrinsic part of their right to life. Thus, there is a sharp distinction between the rights of the workers under a statutory social welfare scheme - a right which is well-protected from the creditors and wages which are not protected.The Joint Parliamentary Committee therefore decided that the clause 36(4)(a)(iii) in the Code may be substituted by the following words.“all sums due to any workman or employee from the provident fund, the pension fund and the gratuity fund.”Similarly, the JPC recommended insertion of new sub-clause 155(2)(d) after the clause 155(2)(c):“all sums due to any workman or employee from the provident fund, the pension fund and the gratuity fund.’Clause 155(2) may accordingly be renumbered 155(2)(d).

As per section 155 of the Code, the estate of the bankrupt shall include all property belonging to or vested in the bankrupt at the bankruptcy commencement date or by virtue of any of the provisions of this Chapter is comprised in the estate. The estate of the bankrupt shall not include (a) excluded assets (b) property held by the bankrupt on trust for any other person (c) all sums due to any workman or employee from the provident fund, the pension fund and the gratuity fund.

Similarly, gratuity funds of workmen are safeguarded from being attached when the employer is winding up or in liquidation. In harmony with the abovesaid provision, the Insolvency and Bankruptcy Code, 2016 excludes the gratuity fund of workmen which may be in possession of the corporate debtor from being the part of the liquidation estate or the estate of the bankrupt.Since the provident funds, pension funds and the gratuity funds provide social safety net for workmen and the employees, the proceeds from such funds have been secured and shall not be included in the liquidation estate assets or in the bankrupt’s estate.

Case Laws

In the case of Precision Fasteners Limited v Employees’ Provident Fund Organisation (M.A.No.576 & 752/2018) in C.P.(IB)1339 (MB/2017), the Hon’ble National Company Law Tribunal, Mumbai Bench, in its order dated 12-9-2018, held that the entire arrears towards the EPF should be liquidated before paying off the other creditors.The observations made by the Hon’ble NCLT, Mumbai with regard to the priority of EPF dues are well worthy of attention. The Bench observed, “when it comes to sums due to any workmen or employees from the provident fund, pension fund and the gratuity fund under sub clause (iii), they shall not be included in the liquidation estate.” It further observed,“….it is an operation of law that says when provident fund is payable to the workmen or employees, such payment dues have to be deemed as an asset of the workmen or the employees, it makes no difference whether it has been maintained in a separate account or not, in view of this deeming fiction, the workmen/employees not need prove that whether any sum (interest) has been explicitly vested with them or not…….. an overreaching interest and title has been created in favour of the workmen in respect to provident fund, etc. Under the old regime to say that provident fund dues will have overriding effect over all other dues including secured and unsecured creditors, Court used to fall back upon EPF Act provisions, but whereas now by exclusion of provident fund dues to the workmen/employees from the liquidation estate, it has not only extended the earlier law that was in existence but also strengthened the right of workmen regarding PF/Pension/Gratuity fund dues, by altogether excluding this asset from the liquidation estate leaving it to open to the workmen or to the PF authority to realize their provident fund/pension fund/gratuity fund dues without standing in the line of water-fall mechanism.”

The Bench also observed that the duty is conferred upon the liquidator and the Tribunal to ensure that provident fund dues are excluded from the liquidation estate so as to enable the workmen realize their saving as well as the matching contribution comes from the employer giving priority even above the costs of liquidator, because the liquidator is also entitled to realize the costs from the liquidation estate only, whereas the workmen for Provident Fund dues need not remain in the line to realize their PF dues from the liquidation estate.” Provident Fund dues of workmen are interwoven with Right to life because the workmen all through their life save some portion of the hard earnings for their later life after retirement, if such sums are being interlinked on part with debts of the creditors of the Company, secured or unsecured as the case may be, then it is nothing but diluting most valuable and inalienable right of a person on part with a property right subordinate to right to life. Now under IBC, PF/Pension/Gratuity fund dues have been taken out from the spectrum of liquidation estate asset by giving a mandate that the PF/Pension/Gratuity fund dues to the workman/employee shall be treated as an asset of the workman lying in the possession of corporate debtor. So, it is not treated as a claim on par with other creditors, it is in fact treated as an asset of the workmen lying with corporate debtor. Since these dues being treated as an asset of the workmen u/s 36(4)(a)(iii) of the code, for realisation of such debt, EPF Act 1952 is applicable, not IBC 2016, the NCLT ruled.

Similarly, the NCLT, Principal Bench, New Delhi, in the case of Alchemist Asset Reconstruction Company Ltd. v Moser Baer India, (IB-378(PB)/2017), in its order dated 19-3-2019, has held that the overriding effect of section 238 of the Insolvency and Bankruptcy Code 2016 over any other law for the time being in force will not have any bearing over the assets of the workmen (relating to Provident Fund, Pension Fund and gratuity) lying in the possession of the Corporate Debtor because the asset is not considered as the part of the liquidation estate. Moreover, to apply s.238 over any other law for the time being in force, the other law must be inconsistent with the provisions of the Code. Since s.36(4)(iii) of the IB Code has excluded the Provident Fund dues of the workmen from the liquidation estate, the Provident Fund dues of the workmen from the liquidation estate assets, treating it as an asset of the workmen lying with the corporate debtor, s.53 is not applicable to say that these dues fall within the ambit of liquidation estate. Therefore, in alignment with the provisions of the EPF Act, in section 36(4) (1)(3), the IB Code has going ahead saying that the dues in respect of the Provident Fund, Pension Fund and Gratuity Fund shall not be treated as part of the liquidation estate, as long as such dues are not treated as part of the liquidation estate, the provisions of the IB Code will not be applicable for realization of such dues from the asset of the Corporate Debtor. The intriguing aspect lying in this scenario is that though it is a due payable by the Corporate Debtor, as to Provident Fund, Pension Fund and Gratuity Fund dues are considered, the Code has treated it as an asset of the workmen lying with the Corporate Debtor. According to s.53, the proceeds from the sale of the liquidation assets are to be distributed in the manner specified therein. Therefore, the aforesaid amount of the workmen dues cannot be a part of liquidation estate assets.

Thus, the Code deliberately and expressly does keep the Provident Fund and Pension Fund arrears away from the clutches of the liquidation process and these dues are well-protected under section 36 of the Code. The Resolution Professional can take control and custody of the ‘liquidation assets’ only after liquidating the entire dues payable by the corporate debtor under the provisions of the EPF & MP Act, 1952. In other words, these dues should be paid on priority well before the commencement of the liquidation process itself and should not be subject to the mercy of the creditors or the priority-ladder of the waterfall mechanism. Whether the arrears relating to administrative charges, penal damages etc., assume the same special status under the Code as the provident fund/pension fund contributions do is a question of further academic discussion.

References:
1.Frequently Asked Questions on The Insolvency and Bankruptcy Code 2016(April, 2017). The Institute of Chartered Accountants of India.
2.Report of the Joint Committee on the Insolvency and Bankruptcy Code, 2015. (presented to the Lok Sabha on 28th April 2916 and laid in the Rajya Sabha on 28th April 2016).
3.The Law of Employees’ Provident Funds - A Cas elaw Perspective. Chennai: Notion Press. Ramesh, C.(2018)
C. Ramesh Author of the book entitled ‘The Law of Employees’ Provident Funds - A Case law Perspective”