The Bombay High Court (“Court”) in Anil Govind Ganu v. Innovative Technomics Private Limited and Ashwini Anil Ganu v. Innovative Technomics Private Limited (W.P. No. 160 of 2024 & W.P. No. 161 of 2024), on August 20, 2024 held that an entry for gratuity payments reflected on the liability side of the balance sheet of the company does not constitute an ‘agreement’ under section 4(5) of the Payment of Gratuity Act, 1972 (“Act”). Consequently, a claim for gratuity cannot be made by merely relying on such an entry.

Facts:

The petitioners are ex-promoters and directors of the first respondent-company, claiming that they drew salary as employees during the tenure of their service. The petitioners transferred 100% equity stake in the company to the purchasers under a Share Purchase Agreement (“SPA”), which was signed in September 2012. Thereafter, the petitioners tendered their resignations and demanded payment of gratuity, claiming that a provision was made in the annual accounts for payment of gratuity amounting to approximately INR 1.21 crores. Petitioners also claimed that as per an agreement (i.e., the specific provision / entry made in the company’s balance sheet as on March 31, 2012, for payment of gratuity to directors (“Balance Sheet Entry”), they were entitled to receive better terms of gratuity under section 4(5) of the Act, and the maximum permissible cap provided under the Act was not applicable to them.

As the Controlling Authority-cum-Labour Court and the Appellate Authority-cum-Industrial Court (on appeal) had rejected the petitioners contentions, the present petitions were filed before the Bombay High Court.

Submissions by the petitioners:

The counsel for the petitioners contended that since the petitioners were employed for wages, they would fall within the definition of employees under the Act and by merely functioning as directors, their position as employees should not change. Further, it was contended that the petitioners were treated as employees under the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952, and therefore, it would be unreasonable to accord them a different treatment for the selective purpose of gratuity. 

Regarding the balance sheet entry, it was contended that under section 4(5) of the Act, employers can enter into an agreement to provide better terms of gratuity than that provided for under the Act. The respondent did not object to the gratuity entry at the time of finalizing the balance sheet and thus, there was an agreement for payment of gratuity under section 4(5) of the Act by virtue of the Balance Sheet Entry.

Submissions by the respondents:

The counsel for the respondents contended that the petitioners were in absolute control of the company prior to the sale of their shares pursuant to the SPA, and therefore, cannot be termed as employees under the Act. Further, the names of the petitioners were absent from the LIC Group Gratuity Scheme procured under section 4A of the Act. It was also contended that the pay slips prior to May 2012 were not produced, suggesting that they were deliberately created for claiming gratuity.

Regarding the Balance Sheet Entry, it was contended that the same was prepared by the petitioners themselves, 5 (five) days prior to the execution of the SPA for raising a false claim. Further, even if the entries were to be accepted, it would mean that provision for gratuity was made for all directors, i.e., future and past, and not exclusively for the petitioners.

Issues:

1. Whether the Balance Sheet Entry qualifies as an ‘agreement’ under the section 4(5) Act?
2. Whether the petitioners qualify as ‘employees’ under the Act?

Notably, the Court remarked that while ordinarily, the first inquiry should be whether the petitioners qualify as ‘employees’ within the Act; however, given the substantial amounts alleged to be payable as gratuity, the Court decided to first look into the existence of an agreement under section 4(5) of the Act.

Findings:

Issue 1

The Court noted that under section 4(5) of the Act, right to receive better terms of gratuity than that provided under the Act is contingent on the existence of an award or agreement with the employer. In the present case, since there is no award, only the existence of an agreement was required to be proved. In the absence of an express written agreement, the Court examined whether the Balance Sheet Entry titled, ‘Gratuity payable to Directors’ would constitute an agreement.

The Court, relying on previous Supreme Court decisions differentiated between the ‘acknowledgement’ of a liability, as being distinct from ‘creation’ of such a liability and held that the former would arise only where a liability is created and exists. Thus, the Court noted that a mere ‘acknowledgement’ of a liability would be insufficient to prove existence of a right, and liability arising out of such a right needs to be established independently. Consequently, it was held that in absence of a separate contract establishing the liability in respect of gratuity payments in the instant case, a mere reflection of an entry in the balance sheet would not amount to creation of such a liability under section 4(5) of the Act.

Additionally, the Court noted that the balance sheet was prepared on the instructions of the petitioners themselves 5 (five) days before execution of the SPA. Thus, the contention that the company did not object to the entry at the time of finalizing the balance sheet cannot lead to the inference that the company agreed to pay gratuity to the petitioners.

The Court also remarked that in view of the ‘Entire Agreement’ clause in the SPA, the entire transaction was intended to be governed only by the provisions of the SPA and by no other documents. Thus, if the petitioners are permitted to rely on the balance sheet entries, it will create an additional liability on the purchasers over and above the purchase consideration of INR 23 crores already paid. The Court viewed this as an attempt to extract additional money from the purchasers.

Issue 2

While the Court delved into this issue, it remarked at the outset that as it had already held that there was no agreement under section 4(5) of the Act in the instant case, a determination of whether the petitioners were ‘employees’ was an academic one. The Court observed that in every case a director or managing director of a company who draws salary from the company will not ipso facto be excluded from the definition of ‘employee’ under various labour legislations. Rather, a determination of the same will depend on the facts and circumstances of each case. Notably, the Court also noted that the responsibility to pay gratuity to an employee is on the company and not on the managing directors, directors or shareholders.

For the purposes of the Act, the Court noted that:

1. a person who has ultimate control over the affairs of the company would fall within the definition of employer under section 2(g)(f)(iii) of the Act;
2. section 7(2) of the Act provides that the employer is under obligation to determine the amount of gratuity and give notice to the person to whom gratuity is payable;
3. section 7(3) of the Act states that the employer will arrange to pay gratuity within a specified timeframe.

In light of the above, the Court concluded that an employer himself ordinarily cannot become an employee at the same time, for the purposes of the Act.

In the present case, the Court noted that the petitioners were not ‘employees’ for the purposes of the Act for the following reasons:

1. as of the date of cessation of their relationship and ownership of the company, the petitioners were the only two persons fully in charge of the affairs of the company;
2. the Group Gratuity Insurance Policy, which is required to be obtained mandatorily by the company under section 4A of the Act, contained a list of 57 employees and the names of petitioners are not included therein and neither any contributions are made in the scheme for the petitioners.;
3. salary slips were selectively produced by the petitioners only for May 2012, without any clarity on who appointed them, the terms and conditions of their employment etc.

Additionally, the Court also took into the account the fact that the petitioners were included in the definition of ‘promoters’ in the SPA, as opposed to that of ‘employees’.

Ancillary observations:

The Court noted that section 4A of the Act requires employers to mandatorily obtain insurance from the Life Insurance Corporation of India towards liability for gratuity payment, unless the employer has established an approved gratuity fund. In respect of the approved gratuity fund, section 2(5) of the Income Tax Act, 1961 read with Rule 102 of the Income Tax Rules, 1962 indicates that director(s) having more than 5% voting power are expressly excluded from being admitted to the approved gratuity fund and therefore, not entitled to gratuity. The Court noted that the same principle should be applied to directors having more than 5% voting rights in cases where the company has procured an insurance policy from LIC, and held that as the petitioners held more than 5% voting power in the company, they cannot be paid gratuity under the Act.

Author’s views:

The Court clarified that while an entry in a balance sheet can acknowledge existing liabilities, it does not create new obligations, unless the liability is tied to an explicit agreement. This is a helpful reaffirmation of an existing legal principle previously laid down by the Supreme Court. The Court’s distinction between the director’s role in a company as an employee and as an employer, especially for the purposes of labour legislations, makes it an important ruling.

It is also interesting to note the broad approach taken by the Court in its reading of section 4A of the Act. The Court has held that the principle applicable to section 4A(2) of the Act (which deals with ‘approved gratuity fund’) read with the Income Tax Act and rules framed thereunder, that a director who owns shares carrying more than 5% of total voting power is specifically excluded from being admitted to the gratuity fund (“5% Rule”), should also be applicable to companies which obtain insurance pursuant to section 4A(1) of the Act. As a result, the 5% Rule which as per the letter of the law was only applicable to section 4A(2) has also been made applicable section 4A(1) of the Act by this ruling. Whether this is challenged for judicial overreach and sustained or overruled, will remain to be seen.

Lastly, the interpretation of a boilerplate SPA clause was key to the Court’s decision. The ‘Entire Agreement’ clause in the SPA invalidated any claims towards payment of gratuity based on previous financial records. This underscores the importance of such clauses in corporate transactions for providing further clarity on the rights and obligations of the parties involved, in the event of any dispute.

Please find attached a copy of the judgement. 

This update has been contributed by Armaan Patkar (Partner) and Anoushka Goel (Associate).

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