The Liquidator has no powers over the Assets excluded from the Liquidation Estate – By Mr. Chidambaram Ramesh

The Liquidator has no powers over the Assets excluded from the Liquidation Estate

– By Mr. Chidambaram Ramesh [Author of The Law of Employees’ Provident Funds – A Case-law Perspective]

In general, the liquidation of the corporate debtor results in the seizure of the Company’s activities and realisation of all its assets, forming a ‘liquidation estate’ to satisfy as many creditors’ claims as possible. The debts are ranked equally within each category when the liquidation estate is distributed according to the pari passu rule. Certain assets, though in possession of the corporate debtor, are deliberately kept outside the meaning of the ‘liquidation estate.’ Third-party assets in possession of the Corporate Debtor at the time of Liquidation are classic example of this genre. The Insolvency and Bankruptcy Code, 2016 has included the provident fund, pension fund and the gratuity funds as third-party assets by way of legal fiction. The NCLT has recently ruled that the Liquidator has no powers over these assets which are expressly excluded from the Liquidation Estate, ringfencing it from the clutches of the liquidation process.

M/s Karpagam Spinners Private Limited (Corporate Debtor) underwent the Corporate Insolvency Resolution Process (CIRP) by the order dated 19-07-2017 passed by the NCLT, Chennai Bench. The Interim Resolution Professional came to notice that the business of the Company was attached and Company was under the control of the Receiver appointed by the Employees’ State Insurance Corporation (ESIC) for recovery of its statutory dues. In the meantime, the Employees’ Provident Fund Organisation had also attached the machinery of the Company and left the attached properties in the custody of the Receiver.

In the meantime, the NCLT ordered the Company’s winding up, and the RP was appointed as the Liquidator. During the visit to the premises of the Company, the Liquidator found that some of the machines mentioned in the inventory of the ESIC were found missing. On the directions of the NCLT, the Liquidator filed a complaint with the Deputy Commissioner of Police (Law and Order), Tirunelveli Town, to investigate the missing machinery.

On liquidation of the Company, the creditors submitted their claims with the Liquidator. The EPFO also claimed the statutory dues payable by the Corporate Debtor. The Liquidator rejected part of the EPFO’s claim for the following reasons.

(a) The Corporate Debtor was not responsible for payment of the statutory Provident Fund dues for the period during which the business was under attachment by the ESIC, and a receiver was in charge of the affairs of the Company.

(b) The claim of the EPFO was classified under section 53(1)(f) of the Code as ‘other remaining debts’ and the dues in the waterfall mechanism provided for the distribution of proceeds from the sale of the liquidation assets.

(c) The EPFO, having failed to safeguard the machinery after attachment, is liable for the loss caused to the machinery of the corporate debtor and therefore, while determining the claim under Section 39 of the I & B Code, the loss caused to the machinery by the EPFO would be deducted from the claim admissible.

The NCLT, Chennai Bench, in its order dated 21^st January 2019, [1] allowed the contentions of the Liquidator and dismissed the application filed by the EPFO.  

Against the decision of the NCLT, Chennai, the Regional Provident Fund Commissioner, had preferred a Company Appeal[2] in the NCLAT, New Delhi. In its interim order dated 6^th August 2019, the NCAT directed the Liquidator to file an affidavit on whether he treated the Provident Fund as an asset of the Corporate Debtor. The Appellate Tribunal further directed the Liquidator to deposit the Provident Fund dues with the Regional Provident Fund Commissioner. The other issues raised by the Liquidator could be heard on merit. In compliance with the NCLAT order, the Liquidator had deposited a sum of Rs.75,23,608.40/- with the Provident Fund Commissioner. In its subsequent order dated 5^th September 2019, the NCLAT directed the NCLT, Chennai Bench, to decide which authority is entitled to receive the money mentioned above, which was kept in the custody of the Regional Provident Fund Commissioner.

After hearing the Liquidator and the Provident Fund authorities, the NCLT, Chennai, has passed the final orders on 7^th September 2021,[3] affirming the following legal positions.

• A conjoined reading of Section 36 and Section 53 of the I & B Code would show that the Liquidator can exercise his powers only in relation to the assets which are falling under sub-section (3) of Section 36 of the Code, and the distribution thereof is to be made only in respect of the assets which are falling under Section 36(3) of the Code.
• The Liquidator cannot exercise any power over the assets expressly excluded from the meaning of ‘Liquidation Estate’ under Sub-Section (4) of Section 36 of the Code.
• Section 36(4)(a)(iii) of the Code states that any amount due to any workman or employee from the Provident Fund, the Pension Fund and the gratuity fund will not form part of the Liquidation estate and cannot be used for recovery in liquidation.
• The Employees’ Provident Fund Organisation (EPFO), whose dues do not form part of the Liquidation Estate, is required to be satisfied at first and then the remaining amount, if any, will be brought into the coffers of the “Liquidation Estate” and to be distributed under Section 53 of the Code.

It is clear from the afore-mentioned order that the Liquidator has no control over the following kinds of assets under Section 36(4) of the Code, though they are in possession of the Corporate Debtor at the time of liquidation.

(a) Assets owned by a third-party which are in possession of the corporate debtor, including – (i) assets held in trust for any third party; (ii) bailment contracts; (iii) all sums due to any workmen or employee from the provident fund, the pension fund and the gratuity fund; (iv) other contractual arrangements which do not stipulate transfer of title but only use of the assets; and (v) such other assets as may be notified by the Central Government in consultation with any financial sector regulator;

(b) Assets in security collateral held by financial service providers and are subject to netting and set-off in multi-lateral trading or clearing transactions.

(c) Personal assets of any shareholder or partner of a corporate debtor as the case may be, provided such assets are not held on account of avoidance transactions.

(d) Assets of any Indian or foreign subsidiary of the corporate debtor; or

(e) Any other assets as may be specified by the Insolvency and Bankruptcy Board of India, including assets which could be subject to set-off on account of mutual dealings between the corporate debtor and any creditor.

Many countries have incorporated such exclusion clauses in their insolvency laws before introducing the Indian insolvency code. For example, Article 110 of the Labour Code of the Philippines enjoins that the workers’ dues should have a preference in the event of bankruptcy or liquidation of the Company. The unpaid wages and other monetary claims should be paid in full before the claims of other creditors. Similarly, the Bankruptcy Code of Ukraine explicitly states that the trust property shall not be included in the liquidation estate either of the trustee or a trustor. There is also a carve-out for the trust property ringfencing it from the moratorium on enforcement of the secured property under the insolvency law.

When the draft Bill was submitted, the Parliamentary Committee believed that the debtor’s outstanding dues to the employees’ provident fund, pension fund and gratuity funds would not be included in the liquidation estate assets of the bankrupt so that these dues can be fulfilled. Thanks to the Parliamentary Panel recommendations, the provisions contained in Section 36(4)(a)(iii) of the Code were introduced to safeguard the social security interests of the workers. Thus, the law is clear.  Now, it is in the hands of the Liquidators; they are the ultimate executors to adhere to the above proposition of law strictly.

Reference

[1] (2019) ibclaw.in 22 NCLT

^[2] Company Appeal (AT)(Insolvency) No.311 of 2019

[3] Regional Provident Fund Commissioner-I, Tirunelveli vs M/s Karpagam Spinners Private Limited and another, [MA/99/IB/2018 in TCP/225/IB/2017] order dated 7th September 2021