Employment LawThe Effect of Bankruptcy on Employment Contracts in India

INTRODUCTION

Bankruptcy has a significant effect on all the stakeholders of a company, including employees whose livelihood is directly dependent on the financial well-being of their employer. Insolvency of a firm is governed in India by the Insolvency and Bankruptcy Code, 2016 (herein referred as “IBC”), but its interface with employment contracts poses a number of legal and operational issues.

Employees are likely to be in a weak position in cases of insolvency, facing employment insecurity and delayed wages. The IBC outlines a formal process for corporate insolvency, but it falls short in offering robust provisions to ensure adequate protection for employees.

LEGAL FRAMEWORK GOVERNING BANKRUPTCY AND EMPLOYMENT

The IBC offers a framework strategy to corporate insolvency resolution and liquidation.

Some of the notable provisions impacting employees are as follows:

Under Section 14; moratorium prevents legal action against the corporate debtor, such as claims for wages and employment-related claims. While this is intended to provide the struggling company with some relief, it deprives workers of  legal remedies for unpaid wages. Employees are considered operational creditors under the IBC, and their wage claims are subordinated to those of secured lenders and creditors.

Under the liquidation waterfall mechanism of Section 53, workmen dues are accorded priority along with secured creditors, but managerial staff are considered operational creditors, who usually receive only a portion of their dues. The absence of immediate relief measures makes the employees financially vulnerable during the insolvency process.

The Industrial Disputes Act, 1947, provides for retrenchment and layoff protection with compensation to the retrenched employees. It does not provide for bankruptcy and insolvency situations in itself, leaving employees without any statute protection. Even the Indian Contract Act, 1872 does not address this issue as such.

EFFECT OF BANKRUPTCY ON EMPLOYMENT CONTRACTS

Bankruptcy proceedings impact employment contracts at various stages as enumerated below:

1. During Corporate Insolvency Resolution Process (CIRP)

When a company goes into CIRP, employee contracts are not automatically cancelled but their fulfilment is highly problematic. Employees have no means of collecting unpaid wages which puts them at the mercy of the respective Insolvency Resolution Professional who is in charge. The administrator who assumes control during the CIRP has to decide which employee contracts to extend, amend or cancel based on the company’s economic state and the industry’s prospects. Employees often suffer from protracted delays in payment of salaries as well as structural payment changes so that they conform to the resolution process.

Most importantly, a company may incur savings in relation to staff costs by way of offering a voluntary reduction in salary or by dismissing employees who are not deemed critical to the organization which enhances fear of job losses. Sometimes, the employees are forced to accept new terms of employment that are far more favourable to the company. It is clear that the intention of CIRP is to assist companies who are in distress but there is little to no concern for employees and their situation. There are no guarantees about maintaining gainful employment or financial resources available when awaiting the consequence of the CIRP process.

2. Post-Liquidation

If the corporate debtor goes to liquidation, the employment contracts usually cease as the business is being wound up. Employees become creditors under the liquidation waterfall mechanism in which workmen’s dues have priority over unsecured creditors but managerial personnel are likely to rank below. This categorization implies that while workmen are likely to receive a part of their unpaid wages, other employees are likely to receive little or nothing.

Severance pay and other entitlements are at the sympathy of funds in the liquidation estate, and workers often have to wait months before they get anything. Insufficient statutory severance protection in insolvency laws leaves numerous employees without financial security after liquidation.

3. Employee Benefits and Social Security

Benefits like provident fund contributions to employees are safe during insolvency and do not form part of the liquidation estate. Other benefits, however, like severance pay and gratuity are not assured in express terms and are thus payable out of the company’s available assets. Most employees are unable to recover the full amount of compensation since priority is accorded to secured creditors and cost of resolution process. Lack of a formal relief mechanism for employees worsens their financial hardship during corporate bankruptcies.

CHALLENGES AND RECOMMENDATIONS

The employees are subjected to legal and financial risks during the corporate insolvency process. Being operational creditors, they are at a disadvantage in comparison to financial creditors and secured creditors. The IBC moratorium hinders them from recovering pending wages on time, and they have to wait until the resolution or liquidation process is complete.

Besides, there is no separate employee welfare fund to compensate workers who have suffered from corporate bankruptcy, and they are denied monetary relief. The lack of statutory retrenchment and severance payments only adds to their worsening financial status.

The introduction of a special employee relief fund can give temporary financial relief to workers impacted. Strengthening labour legislation by incorporating insolvency-related provisions can ensure that employees receive severance and pay protection. Additionally, making advance notice mandatory for layoffs due to insolvency would provide employees with the time needed to seek new employment and make necessary financial arrangements.

AMLEGALS REMARKS

While the IBC has transformed corporate insolvency resolution in India, its handling of employment contracts remains a concern. Employees frequently face job losses, delayed wages, and legal uncertainty during bankruptcy proceedings.

Strengthening the protection of employees against insolvency, giving their claims precedence in the waterfall regime, and introducing special financial relief instruments are steps that need to be taken to harmonize company restructuring with the rights of workers. Future law has to build a more employee-oriented insolvency regime so that employees are not the victims of business failure.

– Team AMLEGALS assisted by Mr. Mehul Agarwal (Intern)

For any queries or feedback, feel free to reach out to rohit.lalwani@amlegals.com or mridusha.guha@amlegals.com