Gratuity And Its Interplay With Insolvency Law

Gratuity fund cannot be used for the purposes of discharging corporate debtor’s liabilities and gratuity fund has to be kept separate for discharging liability towards the employees eligible for gratuity under the Gratuity Act.

The Insolvency and Bankruptcy Code, 2016 (“IBC”) was enacted to facilitate the resolution of distressed companies in a time-bound manner, with one of its cornerstone features being the ‘clean slate’ / ‘fresh slate’ principle (“Clean Slate”). The principle, being judicially recognized, guarantees that the buyer/ resolution applicant who invests in such companies, does not inherit the past liabilities of the corporate debtor.

That said, when it comes to certain statutory welfare obligations such as the payment of gratuity, there seems to be a deviation from the established principle of Clean Slate, and in this article, we discuss the gratuity liability (an end of service pay-out payable under the Payment of Gratuity Act, 1972 (“Gratuity Act” to eligible employees) that may fall upon the new management.

Prior to delving into how the gratuity liability may fall upon the new management, it is important to note that under the insolvency proceedings, the treatment of employee dues – particularly statutory dues such as gratuity, can significantly affect the resolution plan.

Understanding treatment of gratuity dues

The IBC, while at one end helps with revival of distressed companies, it also facilities liquidation of the companies. For effecting liquidation, it sets out certain procedures that need to be followed for a structured and transparent hierarchy of distribution of assets, to strike a balance between the competing interests of different classes of creditors (such as secured/unsecured, employees). This mechanism is set out in Section 53 of the IBC, often called the waterfall mechanism of distribution of assets.

These assets are distributed from what is called the liquidation estate. The components which either form part or do not form part of the liquidation estate are set out in Section 36 of the IBC. One important component that does not form part of the liquidation estate is, “assets owned by a third party which are in possession of the corporate debtor including all sums due to any workman or employee from the provident fund, the pension fund and the gratuity fund.”

Thereby implying that gratuity fund cannot be used for the purposes of discharging corporate debtor’s liabilities and gratuity fund has to be kept separate for discharging liability towards the employees eligible for gratuity under the Gratuity Act.

Although this provision applies to liquidation, its purpose is reflected in Section 18 of the IBC, which outlines the duties of the interim resolution professional (“IRP”). Section 18(1)(f) states that the IRP must take control of assets over which the corporate debtor has ownership rights. However, the Explanation to Section 18 clarifies that assets owned by third parties and in possession of the corporate debtor held under trust or under contractual arrangements, are excluded. Interpreting the above, the National Company Law Appellate Tribunal, Delhi (“NCLAT”) in Jet Aircraft Maintenance Engineers Welfare Association Vs. Ashish Chhawchharia RP of Jet Airways (India) Ltd. & Ors, Company Appeal (Insolvency) No.752/2021 (“Jet Airways”) (also affirmed by the Supreme Court of India (“SC”)), held that, “if a Corporate Debtor maintains a fund for payment of provident fund, gratuity fund and other retirement benefits to its workers and employees, that shall be an asset, but IRP is required to take control and custody of the assets over which the Corporate Debtor has ownership rights by virtue of Section 18(1)(f)(i). When we look into the explanation to Section 18(1), the assets comprising provident funds, gratuity funds or a pension fund and belonging to be maintained by Corporate Debtor, are assets on which employees and workmen have right although assets are in possession and control of the Corporate Debtor. The above mentioned assets, thus, are not to be taken control by IRP, after initiation of CIRP.”

Based on the above, it is clear that during the insolvency proceedings as well, gratuity dues are treated different from other dues, and these cannot be classified in the information memorandum¹ as assets of the corporate debtor and have to be utilized fully for payment of gratuity fund of the workmen and employees.

Understanding the Clean Slate principle

Section 31(1) of the IBC states that the resolution plan once approved is binding on the relevant stakeholders, including guarantors - “If the Adjudicating Authority is satisfied that the resolution plan...meets the requirements .. it shall by order approve the resolution plan which shall be binding on the corporate debtor and its employees, members, creditors, including the Central Government, any State Government or any local authority to whom a debt in respect of the payment of dues arising under any law for the time being in force, such as authorities to whom statutory dues are owed, guarantors and other stakeholders involved in the resolution plan.”

The courts have interpreted the above provision and observed that Section 31(1) ensures that the successful resolution applicant starts running the business of the corporate debtor (distressed company) on a fresh slate as it were.

Departure to the Clean Slate principle in light of Stesalit decision

In M/s. Stesalit Limited v Union of India (“Stesalit”), WPA 532 of 2025 (decision rendered recently – February 2025), the Single bench of the Calcutta High Court (“HC”) upheld the order of the controlling authority under the Gratuity Act and directed the new management to make payment of gratuity to an ex-employee, who had resigned from the petitioner company before it was taken over by a new management under the insolvency proceedings. The court emphasized that gratuity dues are distinct from the corporate debtor’s assets and must be paid in full, regardless of the change in the company’s management.

Factual background

As regards facts, the respondent was an ex-employee of the petitioner company, and had filed a claim for gratuity amount before the IRP during the corporate insolvency resolution process (“CIRP”) of the petitioner company, which was admitted but not fully awarded under the approved resolution plan submitted by the successful resolution applicant, i.e., the present petitioner company. The petitioner company alleged that the respondent employee did not challenge the resolution plan, or the amount awarded to him before the National Company Law Tribunal (“NCLT”).

However, he filed an application under the Gratuity Act before the controlling authority, who allowed the application and directed the payment of gratuity along with interest under its order (“Order”).

Contention by the petitioner company

Aggrieved by the Order, the petitioner company filed a writ petition before the HC, challenging the Order contending inter alia that (i) now the petitioner company is under a new management; (ii) that the IBC has an overriding effect over the provisions of the Gratuity Act; and (iii) that the respondent employee had indulged in forum shopping and abuse of process of law by filing the application under the Gratuity Act despite having an award under the resolution plan.

Findings of the Calcutta HC

• The Calcutta HC held that the controlling authority had the jurisdiction and authority to decide the issue of gratuity as the company never closed down or went into liquidation and the insolvency proceedings were a recovery mechanism for creditors.
• Further, while hearing the matter, the Calcutta HC found that the corporate debtor had not maintained any fund for gratuity, and, it appears that the petitioner company was contesting gratuity payment on the said basis as well. In this regard, the Court upheld the finding of the controlling authority, which had held that, “The absence of such a fund does not influence the treatment of excluded dues-like gratuity dues-under Section 36 of the IBC. Gratuity payments are classified as excluded dues, and thus they remain outside the scope of asset distribution among creditors, as stipulated by the waterfall mechanism in Section 53. Therefore, the respondent’s reliance on the absence of a gratuity fund is unfounded in this context.”
• The controlling authority had further held that, when submitting the resolution plan, the respondent needed to recognize that, until the company ceased operations, the employer held no proprietary right over the amounts towards any dues owed to workers-including salaries, provident fund contributions, and gratuity-constituted assets already earned by the worker, as they had been accrued through the employees’ services. Therefore, it was necessary to include them within the resolution plan. It was further held that failing to account for these obligations reflects a significant oversight by River Rail in the submission of the resolution plan and the acquisition process. This negligence compromised the rightful entitlements of the workers, disregarding their status as earned and excluded dues. It held that the said amount is not an asset of the corporate debtor and therefore IRP/RP has to release the dues as and when it is due and payable irrespective of the fact that whether the corporate debtor has been maintaining a separate fund or not.
• A very notable observation was made on the due diligence requirement and ‘caveat emptor’ principle by the controlling authority, is as follows: “In light of the above arguments and cited case law, I find that River Rail, as the entity that assumed control of the corporate debtor, demonstrated a lack of due diligence when submitting the resolution plan by disregarding the mandatory provisions under the Payment of Gratuity Act, 1972. This omission reflects a significant oversight on River Rail’s part, as it failed to adequately account for the gratuity obligations owed to employees. Such negligence does not absolve River Rail from its responsibility to honor these dues, nor should the applicant bear the consequences of the company’s oversight. Furthermore, this principle falls under the doctrine of Caveat Emptor, a fundamental tenet in commercial transactions that translates from Latin as “let the buyer beware”. Under this common law principle, the buyer is responsible for conducting thorough due diligence on any prospective purchase to fully understand the assets, liabilities, and potential obligations that accompany it. In this context, River Rail, as the buyer taking over the corporate debtor, had an inherent duty to conduct comprehensive due diligence on all financial and legal obligations tied to the employees’ dues. This due diligence should have extended to evaluating the company’s statutory responsibilities, including any outstanding gratuity payments due to employees. By not ensuring that the workers’ gratuity dues were either maintained in a secure fund or explicitly addressed as excluded assets within the plan, River Rail disregarded its obligations to the employees. This negligence not only breached the workers’ entitlements but also demonstrated a lack of compliance with the Caveat Emptor principle. River Rail’s actions reflected a substantial departure from required due diligence standards. The resolution plan submitted disregarded the legal distinction between priority dues and excluded dues, which are legally recognized as workers’ assets earned through their labor and not subject to distribution under Section 53 of the IBC. Additionally, Section 14 of the Payment of Gratuity Act, 1972, confers this Act with overriding authority, clearly stating that “the provisions of this Act or any rule made thereunder shall have effect notwithstanding anything inconsistent therewith contained in any enactment other than this Act. Accordingly, River Rail cannot evade its liability for gratuity payments under the guise of other statutes, as the Gratuity Act takes precedence. In view of above, I hold that the present management shall pay gratuity to the applicant.”
• The Calcutta HC then relied extensively on judicial precedents include Jet Airways to hold that since gratuity dues were excluded from the liquidation estate of the corporate debtor, they were required to be paid in full to the employees under a successful resolution plan. Accordingly, the Calcutta HC upheld the order of the controlling authority whereby the new management of Stesalit Limited was directed to pay the balance amount along with interest.

Analysis and Conclusion

The recent ruling in Stesalit underscores that while the Clean Slate principle is at the heart of the insolvency law, it is not absolute and is subject to statutory welfare obligation such as gratuity, which seems to be exempt from full extinguishment.

That said, in a recent decision of the NCLAT in Calyx Chemicals and Pharmaceuticals Private Limited v Ravindra Athavale & Ors., Company Appeal (AT) (Insolvency) No. 522 (“Calyx”) certain former employees of the corporate debtor had approached the jurisdictional NCLT seeking payment of gratuity from the resolution applicant arguing, inter alia, that the resolution plan did not make provision for any payment towards gratuity for employees who were not on the roll of the corporate debtor as on the CIRP commencement date. The NCLT allowed the applications filed by the former employees. However, the NCLAT observed that the resolution plan had not made any provision for payment of gratuity for employees who were not on the corporate debtor’s rolls as on the date of initiation of CIRP and if any stakeholders had issues with the resolution plan, they were required to approach the NCLT or NCLAT within the stipulated timeframes of the IBC. The NCLAT further relied on decisions of the SC in Ghanshyam Mishra v Edelweiss Asset Reconstruction Company, 2021 9 SCC 657 (“Ghanshyam Mishra”) and CoC of Essar Steel v Satish Kumar Gupta, 2020 8 SCC 531 (“Essar Steel”) to reiterate the position that once a resolution plan is approved by the NCLT under Section 31 of the IBC, new surprise claims cannot be flung on the resolution applicant in a belated manner as the approved resolution plan sought to crystallize all dues owed to the stakeholders in the insolvency proceedings and ensure that the new management can run the corporate debtor on a fresh slate.

Accordingly, in the present instance, it appears that the employee has indirectly reopened an approved resolution plan by approaching the controlling authority for the payment of gratuity without making appropriate representations before the jurisdictional NCLT or the NCLAT. While the employee may have been entitled to gratuity by satisfying the requirements under Section 4 of the Gratuity Act, it appears that the decision of the Calcutta HC in upholding the direction that the new management is required to pay the employee the remaining gratuity dues is contrary to the decisions in Calyx, Ghanshyam Mishra and Essar Steel. The Calcutta HC has seemingly ignored the decisions in Calyx (while a reference to this decision has been made as part of the respondent’s submission, there is no further discussion on this)², Ghanshyam Mishra and Essar Steel.

The above said, resolution applicants must be proactive while investing in distressed companies and should undertake a thorough due diligence to understand the liabilities of such companies (including gratuity). While charting out the resolution plan, resolution applicants must account for the same in the resolution plan by determining the gratuity liability, regardless of the fact whether the corporate debtor provisions for the same – by making appropriate adjustments in the deal value.

In summary, while the decision of the Calcutta HC in Stesalit is currently under appeal before the Division Bench of the Calcutta HC and it remains to be seen how the Calcutta HC will now adjudicate the same, based on the decision of the Single Bench, resolution applicants must, prior to investing in the revival of a corporate debtor, thoroughly navigate the complex landscape of employee entitlements, given claims related to gratuity post resolution plan acceptance may be entertained (which is a deviation from the Clean Slate principle).

Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature.