[Payment Of Gratuity Act] Mere Reflection In Balance Sheet Doesn't Give Rise To Gratuity Claim In Absence Of Underlying Agreement: Bombay HC

While considering the claim for payment of gratuity by the Directors of a company, the Bombay High Court has observed that an entry in the liability column of the balance sheet of the company cannot be considered an 'agreement' between the company and directors under Section 4(5) of the Payment of Gratuity Act.

Justice Sandeep V. Marne stated “…it cannot be stated that mere reflection of an entry in the liability column of balance sheet would amount to creation of a right which never existed. Such right will have to be independently established either through a transaction or a document in the form of a contract.”

The petitioners are ex-promoters and directors of the respondent company, claiming payment of gratuity for their services. The Controlling Authority/Labour Court rejected the application of the petitioners. It held that the petitioners were not covered under the definition of 'employee' under the Payment of Gratuity Act, 1972, as they were in control over the affairs of the company. In an appeal, the Appellate Authority/Industrial Court also rejected the petitioner's plea.

The petitioners thus appealed to the High Court. The petitioners contended that the entries made in the Balance Sheet should be considered as an agreement for payment of gratuity.

Mere entry in balance sheet does not give rise to liability in absence on any agreement

The High Court referred to Section 4(5) of the Payment of Gratuity Act, which provides for right of an employee to receive better terms of gratuity under 'any award or agreement or contract' with the employer. The Court stated that for the application of Section 4(5), the existence of a specific agreement or contract must be proved.

The Court referred to the judgment of the Supreme Court in Asset Reconstruction Company (India) Ltd., was about the applicability of provisions of Section 18 of the Limitation Act for extension of the period of limitation for filing an application under the IBC. In this case, the Apex Court had held that an entry in the balance sheet would amount to acknowledgement of debt under Section 18 of the Limitation Act.

However, the High Court distinguished between 'acknowledgement' of liability from 'creation' of liability. It observed that 'acknowledgement' of liability would only arise in respect of some 'right'. This means that the liability must arise out of a transaction or contract. It stated that mere acknowledgement' would not be enough to prove the existence of right and liability

The Court noted that mere reflection of an entry in the liability column of the balance sheet would not lead to the creation of a right that never existed. It stated that the right has to be independently established either through a transaction or a document in the form of a contract.

“Therefore mere 'acknowledgment' would not be sufficient to prove existence of right and liability arising out of such right must be independently established. In absence of proof of existence of 'liability in respect of a right', mere acknowledgement through a balance sheet entry would not amount to creation of such liability.”

Here, it noted that the petitioners did not produce any written agreement or contract to show that the respondent company agreed to pay any gratuity. It was of the view that “…that in absence of any underlying agreement or contract, it cannot be stated that mere entry in balance sheet would give rise to creation of liability for the First Respondent-Company to pay gratuity under the provisions of subsection (5) of Section 4 of the Payment of Gratuity Act.”

The Court further took note of the admissions of petitioners in their cross-examination. It observed that there was no understanding or agreement between the petitioners and the company for payment of gratuity.

The Court thus held that there was no agreement between the petitioners and respondent company as per Section 4(5). Hence, petitioners cannot claim gratuity by relying on entry in the balance sheet.

Directors excluded from gratuity fund under Section 4A

The Court also noted that the names of the petitioners' were not included in the list of employees for whom gratuity is insured by purchasing an insurance policy from Life Insurance Corporation of India under Section 4A of the Act. Under Section 4A, the employer is required to obtain insurance from LIC for liability towards gratuity payment under the Act.

The Court also referred to Rule 102 of Income Tax Rules, 1962, which excludes the director of a company from being admitted to the gratuity fund if the director owns a share carrying more than 5% of the total voting power. Noting that the petitioners had more than 5% voting power, the Court said that they could not be entitled to gratuity under the Act.

Even though the Court held that the petitioners' were not entitled to gratuity it made certain observations on whether a director or managing director of a company could be considered as an 'employee'.

The Court noted that every case of a director of a company cannot be excluded from the definition of 'employee'. It observed that a director, working for the company and drawing remuneration can be considered an employee for various labour-related legislations, depending on the facts and circumstances of each case.

Referring to the definition of 'employer' under Section 2(g) of the Payment of Gratuity Act, it stated that a director who has ultimate control over the affairs of the establishment would be considered as an employer under the Act. Here, it noted that the petitioners were in complete control over the affairs of the company and that they were founder promoters of the company and also functioned as its managing directors.

The Court then referred to the Share Purchase Agreement (SPA), under which the petitioners transferred 100% equity stake in the company in favour of the purchasers. It noted that the SPA distinctly defined promoters and employees. The names of the petitioners were included under the definition of 'promoters' of the respondent company in SPA.

The Court stated that the alleged liability created under the entries in the balance sheet would not bind the respondent company in view of the 'Entire Agreement Clause' in the SPA. It observed that “The 'entire agreement' clause is always intended to incorporate the entire transaction between the parties to be governed only by the covenants of the SPA and by no other documents.”

It opined that if petitioners are permitted to rely upon entries in the balance sheet for the purpose of creating a liability, it would constitute an additional liability over a consideration already paid to the petitioners.

“If Petitioners are permitted to rely upon entries in the balance sheet for the purpose of creating a liability on purchasers for amount of Rs.1,21,96,154/-, the same would constitute an additional liability for the purchasers towards the sellers, over and above the consideration of Rs.23 crores already paid to Petitioners under the SPA. In my view, therefore this is a clear case where Petitioners are attempting to extract additional amounts from the purchasers over and above the consideration price of Rs.23 crores.”

The Court thus held that the petitioners' claim for gratuity was rightly rejected by the Controlling and Appellate Authorities.

Case title: Anil Govind Ganu & anr. vs. Innovative Technomics Pvt. Ltd. & ors. (Writ Petition No. 160 Of 2024 And Writ Petition No. 161 Of 2024)

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