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HOW EMPLOYEES ARE AFFECTED BY THEIR COMPANY’S INSOLVENCY

INTRODUCTION

Insolvency can be a source of highly distressing situations for the business and its employees both as it creates financial instability within the organization. Insolvency occurs when a company is unable to fulfil its debt obligations and meet its financial commitments.[1] In simple terms, it states that businesses are incapable of settling their debts due to a lack of enough assets and cash flow. When a company faces insolvency, it can directly affect employees by jeopardizing their career trajectories and professional development over the long term. This can have lasting consequences and impede their chances of growth and advancement.

UNDERSTANDING INSOLVENCY

Insolvency is a complex financial situation where an individual, organization, or business is unable to meet its financial obligations and repay its debts within the agreed-upon timeframe. Insolvency occurs when a company owes more debts than the total value of its assets, resulting in a deficit in its holding value. [2]

Insolvency can arise from various factors, such as unforeseen events like changes in laws or regulations, inadequate financial management, heightened market competition, excessive debt repayment, unsuccessful investment ventures, or economic challenges. Cash flow insolvency and Balance sheet insolvency are the two most common types of insolvency. When a company may not have enough cash or funds to cover its liabilities and obligations, even struggles to meet its daily costs is termed cash flow insolvency.[3] On the other hand, when a company’s total liabilities exceed its total assets, resulting in the company facing a struggle to repay its debt in the long term is termed balance sheet insolvency. This situation may arise even if the company has sufficient cash to meet its immediate financial obligations.[4]

PRIORITY FRAMEWORK DURING INSOLVENCY

Section 53 of The Insolvency and Bankruptcy Board (IBC), 2016[5] highlights the importance of the distribution of proceeds from the sale of liquidation assets. According to this framework, priority is given to the workman’s last 24 months’ dues which are given with equal priority to debts owed to secured creditors.[6] Additionally, unpaid dues of employees for the past 12 months are given high priority over dues owed to the Central or State government and unsecured loans.[7] If the insolvent company’s assets are not enough to clear the workman’s outstanding dues or employee unpaid wages or any other claims then the available funds must be distributed according to the priority framework.[8] This means that the first category (workmen’s dues) must be paid in full before the second or subsequent category (dues owed to employees other than workmen) can be satisfied. In a liquidation procedure, the primary objective of these provisions is to safeguard the rights of the workman and the employees by guaranteeing them priority over creditors[9].

EMPLOYEE’S APPLICATION UNDER IBC

In accordance with Section 9[10], a corporate debtor who does not meet the obligation or even omits to provide a notice of dispute within 10 days of receiving a demand notice, as outlined in Section 8[11], the employee (the operational creditor) may submit an application for the start of a CIRP (Corporate Insolvency Resolution Process) against the debtor. As per Section 4[12], the current threshold for the minimum amount of default is set at Rupees one crore, nevertheless, the IBC is only applicable if the minimum amount of default is one lakh rupees and above as specified by the Central Government through a notification dated 24.03.2020. As per Rule 6(1) of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016, it is stipulated that an application for the initiation of CIRP can be lodged in Form 5, which serves the prescribed format for initiating CIRP.[13] Form 5 includes a clause that allows workmen and employees to file a joint application under the ICB provisions.[14] By allowing joint filing, the provision recognizes the collective strength of employees/workmen and enables them to seek redressal in a unified manner. It ensures that their dues are given priority during the insolvency and liquidation process, as per the order specified in Section 53.[15] It is also crucial to ensure that this provision is used judiciously and in compliance with the applicable rules and regulations to avoid misuse or abuse.[16] 

RECENT DEVELOPMENTS

In the case of Sunil Kumar Jain and Ors. v Sundaresh Bhatt and Ors.[17], it has been held that if it can be substantiated that the Interim Resolution Professional/Resolution Professional managed the operations of the company alongside the CIRP process and that the employees worked during this period, their wages/salaries can be considered as part of the CIRP costs and should be paid first in accordance with Section 53(1)(a) of the IB Code[18], as per the ruling of the Hon’ble Supreme Court. Moreover, the employee’s portion of dues should be paid from the retirement fund, employee pension Scheme, or provident Fund which are maintained as distinct entities from the asset liquidation and liquidator does not have any claim to these funds and they are solely reserved for employees.

The NCLT, Mumbai court removed the attachment on the Corporate Debtor’s assets in Precision Fasteners Limited v Employees’ Provident Fund Organization[19] and directed the Petitioner to prioritize the payment to settle the arrears towards the Provident Fund before settling other creditor claims. As per the court’s ruling, in the liquidation process, the liquidator is required to accord priority to the payment of dues under certain employee benefit funds prior to using the waterfall mechanism. As per the Employees’ Provident Fund Act,1952[20], and Section 34(4)(a)(iii) of the IB Code[21], the charge of EPF dues will continue to be in effect until the outstanding dues are settled. The respondents are instructed to authorize the liquidator to sell the Corporate Debtor’s assets and also to prefer payment of Provident Fund dues over other claims in the liquidation process.

RECOMMENDATIONS FOR IMPROVING EMPLOYEE OUTCOMES IN INSOLVENCY
  1. Early Warning Systems: Early warning systems are mechanisms that can help identify signs of financial distress in companies well before they reach a state of insolvency. These systems may include regular financial audits, reporting requirements, and monitoring mechanisms that can detect companies that may be at risk of insolvency even before it reaches a critical stage. The benefit of such systems is that they provide employees with advanced notice of potential financial challenges faced by their employer. This allows employees to prepare themselves for potential job losses allowing them to plan and explore alternative employment opportunities ahead of time. Moreover, early notification can also facilitate communication between employers and employees, enabling a transparent and collaborative approach to addressing financial challenges and finding solutions that may help mitigate the impacts on employees.
  2. Programs for Employee support and wellness: Providing support and efficient resources to those employees who are facing personal or work-related challenges, including those related to insolvency. It can offer various services such as financial counselling, mental health counselling, career coaching, and job search support. By providing access to these services, employers can help employees cope with the emotional and financial stress that may arise from the insolvency of their employer. Also help employees develop new skills, update their resumes, and explore new job opportunities, which can improve their chances of finding new employment quickly.

CONCLUSION

In a nutshell, employees face a myriad of challenges by the insolvency of a company which disrupts both their professional and personal lives. Insolvency can result in uncertainty about job security, potential loss of wages, benefits, and other perks, and have far-reaching and distressing effects on employees. The IBC, 2016[22] encompasses a structure that emphasizes paying salaries or outstanding dues to employees at the time of distribution by the sale or liquidation of assets. Employees in India are empowered with the right to initiate the proposal of the Corporate Insolvency Resolution Process (CIRP). Recent developments in the legal system have acknowledged the significance of prioritizing the dues owed to employees during the insolvency and liquidation process. However, it is crucial to ensure that these provisions are used judiciously and in compliance with applicable rules and regulations to avoid misuse or abuse.

Author(s) Name: Neha Gandhi (Guru Gobind Singh Indraprastha University)

References:

[1] Alicia Tuovila, ‘Insolvencies: Definition, How It Works, and Contributing Factors’ (Investopedia, 23 May 2022) <https://www.investopedia.com/terms/i/insolvency.asp> accessed 11 April 2023

[2] ‘Insolvency’ (Corporate Finance Institute, 08 January 2023) <https://corporatefinanceinstitute.com/resources/commercial-lending/insolvency/> accessed 11 April 2023

[3] ‘Insolvency’ ( Wallstreetmojo) <https://www.wallstreetmojo.com/insolvency/#insolvency-types-and-tests> accessed 11 April 2023

[4] Ibid

[5] Insolvency and Bankruptcy Code 2016, s 53

[6] Ibid

[7] Ritesh Kavdia and Shweta Vashishtha, ‘Employees of Distressed Companies’ (Insolvency and Bankruptcy Board of India) <https://ibbi.gov.in/uploads/resources/ab649d43a68cc4e97d64189a272da8d2.pdf> accessed 13 April 2023

[8] Insolvency and Bankruptcy Code 2016, s 53

[9] Ritesh Kavdia and Shweta Vashishtha (n 7)

[10] Insolvency and Bankruptcy Code 2016, s 9

[11] Insolvency and Bankruptcy Code 2016, s 8

[12] Insolvency and Bankruptcy Code 2016, s 4

[13] Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules 2016, r 6(1)

[14] Insolvency and Bankruptcy Code 2016, form 5

[15] Insolvency and Bankruptcy Code 2016, s 53

[16] Ramchandra Madan, ‘Have the IBC doors shut for workmen & employees?’(SSC Online Blog, 22 April 2020) <https://www.scconline.com/blog/post/2020/04/22/have-the-ibc-doors-shut-for-workmen-employees/> accessed 13 April 2023

[17] Sunil Kumar Jain and Ors. v Sundaresh Bhatt and Ors. (2022) Civil Appeal No. 5910/2019

[18] Insolvency and Bankruptcy Code 2016, s 53(1)(a)

[19] Precision Fasteners Limited v Employees’ Provident Fund Organization (2017) MA 576 & 752/2018 in C.P. (IB) 1339 (MB)/2017

[20] Employees Provident Fund Act 1952

[21] Insolvency and Bankruptcy Code 2016, s 34(4)(a)(iii)

[22] Insolvency and Bankruptcy Code 2016