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What Happens To Employees When a Company Goes Bankrupt?

By Nandini Agarwal

The Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as the “Code”) has brought a dynamic change in how the law treats companies undergoing insolvency and bankruptcy. This statute has aided in providing a smoother procedure for the resolution or liquidation of a firm. The code provides two directions for a company which is insolvent, meaning that it can no longer pay off its debts. The first being an option to implement a resolution plan which would help restructure the company in a manner that helps it get out of its debts and the second is liquidation where the company sells its assets and liabilities to pay the creditors to whom money is owed. This Code allows the company to reform and obstruct premature liquidation hence saving jobs and providing the company an opportunity to grow. However, despite the benefits that the Code provides, there are some problematic areas that are yet to be corrected. Even though the Code has undergone several amendments in the last 6 years, it is yet to bring provisions for issues that are faced by the employees during an insolvency process. For example, the liquidation of Jet Airways left thousands of employees without a job and savings.

One of the main forms of capital that a firm has is human capital. Many countries like the US, Sweden and Japan also recognize the importance of recycling the capital that is constituted in the form of fixed assets, as well as human capital. Despite the important role that the employees and workmen play in the well-being of a company and the economy there, India does not provide adequate safeguards for them once the company is liquidated.

During bankruptcy, the employees are often seen as expendable. During the procedure, their savings and pensions are spent on survival (of the company). One of the hardest obstacles that a resolution professional may face while planning to restructure a company is the legacy cost—wages, pensions and benefit schemes which cost enormous amounts of money. Moreover, aside from the financial problems that the employees face during the insolvency process, there is also the emotional turmoil that they go through due to the loss of job security along with  financial distress.

The Code does have mechanisms that allow employees to claim their salaries and wages which were unpaid in the course of business up to 12 months before the liquidation process is initiated. Workmen can claim their dues for twenty-four months.

The Court distinguishes between workmen and employees. As per the code, they both qualify as operational creditors. While the term employment has not been defined anywhere in the code, the term workmen is said to have the same meaning as that in the Industrial Disputes Act as per Section 3(36) of the code. And what’s that definition?

Section 53 of the Code provides a waterfall mechanism. It states the priority based on which the proceeds—obtained from liquidation—are distributed. Each category is to be paid in full before the next category is considered. The subcategories within each category are paid Pari Passu (side by side on equal footing). The issue here is that employees and workmen face here is that financial creditors are given preference before the operational creditor. As per the committee in 2015, the resolution plan should provide for workmen and employees. This will enable them to initiate insolvency proceedings so that instead of waiting around for years and delving into their savings, they can settle their dues quickly before they are able to move on to another job. However, when it comes to liquidation, the operational creditor receives peanuts while the financial creditors recover at least a part of their loans due to the waterfall mechanism. In short, it is skewed towards financial creditors rather than employees.

During the pandemic the minimum requirement was raised from 1 lakh to 1 crore rupees. It made it difficult for employees to initiate proceedings against the company considering that unlike financial creditors, the Code does not allow operational creditors to club together and file an application for insolvency of the corporate debtor. This change was necessary during the pandemic as it helped reduce the burden on the tribunals by reducing the number of cases being filed significantly. However, this measure was initially supposed to be temporary, but it seems to shift towards a more permanent policy which raises great concern since the average wage in India is less than 10,000 rupees as per the ILO  report 2012.

Case Laws – 

The adjudicating authority has played an important role in providing the employees the right over the amount due to them in the form of precedents.

The case of Suresh Narayan v Tayo Rolls, was one where the authorized representative filed a case on behalf of 284 workers under section 9 of the Code. This application was rejected by the NCLT on the basis that an application under section 9 of the Code must be filed by an individual cut accepted by NCLAT because the application was complete, and showed the presence of a debt and debtor was clear and not disputed by the corporate debtor. In this case the NCLAT decided that operational creditors can file an application in a joint capacity by a person who is authorized for the same> However, the court added that if the individual claim of the operational creditor is less than 1 lakh (the previous threshold) then the application can be rejected and deemed non maintainable. This case was nevertheless ruled out by the Supreme Court in the case of J.K Jute Mills Mazdoor Morcha v. J.K Jute Mills Co. where the supreme court ruled that when there is a joint application, Form 5 (which is used for the application of a case by employees and workmen) does not need to specify individual claims separately and that the joint application under this form is filed on behalf of all workmen.

In the case of Nitin Gupta v Applied Electro Magnetic Pvt Ltd, the tribunal decided that the amount of salary due to an employee is a part of operational debt. An employee can admit an application under section 9 of the Code if the amount of salary due is equivalent to Rs.47 lakh or above. The tribunal found it inappropriate to give the resolution applicant complete power to decide the fate of the workmen and employees of the corporate debtor while rejecting the resolution plan. Providing this amount of power violates the law and causes injustice to the employees and workers. A resolution plan should provide an estimated number of employees to be terminated and the labor laws must be complied for the plan to be accepted by the tribunal.

The payment of workmen and employee pensions and provident funds are excluded from the scope of the liquidation assets. Therefore, the workmen and employees have access to their savings as they have a fundamental right to life, while the rights that creditors possess are merely property rights.

From the attempts of the tribunal and the law, the practical application of the code, it can be deduced that the code is constantly evolving and providing safeguards for those who are not represented properly. In cases like Keshav Sponge, the firm gets liquidated as a going concern for the sake of the employees whose livelihoods depend on the company’s operations as it would mean that a bigger company would buy the insolvent firm as is with some changes to help it run as a healthy company by giving it the resources to continue functioning without dismantling it. This way the employees would be able to keep their jobs and a steady flow of income. 

Conclusion – 

The IBBI  is yet to find a way that would provide a sense of security for the employees of a business which is on the verge of liquidation. An employee buyout is a good strategy to rescue a company and has proven to have positive outcomes for all stakeholders. This method has been rather successful in other countries and therefore there is a possibility that it may be equally successful in India as well.

There exists a disparity between the rights of employees and workmen. Even though the courts have attempted to bridge the gap, it is still difficult for employees to get their dues if a company goes into liquidation. The aspect of job security and turmoil is not taken into consideration. Employees should be given more importance so that they can ensure their financial stability and find another job instead of waiting for the company to wind up or implement a resolution plan. It would reimburse them after a long time has passed but their savings would be drained out.

Nandini Agarwal is a fourth year law student at OP Jindal Global University.

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