Gratuity Payment Dilemma: Are Employees Entitled After 5 Years with Multiple Contractors?

Gratuity Payment Liability

Employees have worked under the contractor for more than five years in three consecutive WOs/Extn WOs. Now, a new contractor has received the Tender/WO under the same principal employer. Not a single employee was terminated from their employment after rendering continuous service for not less than five years. No one received superannuation, retirement, or resigned, nor was there any death or disablement due to accident or disease under the same principal employer and two different contractors. Employees are asking for their gratuity payment from the last contractor. Is the last contractor liable to provide gratuity to all employees?

Dear friend,

It is clearly discernible from your narration that it is only an "Umbrella Contract," the primary and predominant feature of which is that only the contractor changes while the group of contract labor continues to serve the same principal employer successively forever under different contractors as per the principal employer's choice. Though such a contract can be termed as 'sham' without any hesitation, unfortunately, the practice remains ubiquitous, particularly in large manufacturing units, for the sake of keeping the hiring and firing of skilled labor simple and convenient.

Therefore, it is better to advise the previous contractor, under whom the contract labor served for 5 years and above, to settle their gratuity amounts on his exit. Otherwise, as the Principal Employer, you would be liable.

Contractor's Liability for Gratuity

The post is not clear, but I am assuming that the contractor has not retained the old employees and has brought in his own. In that case, the contractor will be liable for gratuity as the workers were his employees for that period.

There is no clause that states the Principal Employer is liable for gratuity, but there are Supreme Court judgments ordering the Principal Employer to pay. So, you will be liable.

If the employees are continuing with the new contractor, even then it is better to settle their gratuity. Why would the new employer pay for the gratuity of the older period when he was not the employer? Also, from a cost point of view, it is cheaper to settle them and let them start anew.

Dear Member,

Primarily, since all have completed 5 years of continuous service under the previous contractor, all are eligible to receive gratuity from the previous contractor.

Understanding the Points

1. If it is a comprehensive work order (inclusive of material and labor), we first need to check whether the cost of all statutory compliance has been included in the contractor's scope and properly mentioned in the agreement. If so, the contractor must pay the gratuity, and the Project Engineer (PE) should instruct them to do so. Until all statutory compliance is fulfilled, the PE should hold an adequate bill/amount. If the contractor refuses to pay, the PE can pay the same and debit the amount to the contractor (certain procedures need to be followed).

2. If it is only a Manpower contract (Third-Party management with a fixed Service Charge on monthly Cost to Company), although legally the contractor is liable to pay the gratuity (if mentioned in the agreement), if the contractor was paid only a nominal service charge (either fixed or 4%-5% of CTC) which generally includes the Return on Investment, administrative charges, and other overhead costs, how will the contractor bear the cost? In such cases, if the matter goes to court, the PE will also be in trouble.

So, in my opinion, the main point here is what the agreement terms say and whether gratuity was part of the cost or not.

I have a different perception regarding the ratio decidendi of the Madras High Court's judgment in Madras Fertilizers Ltd v. The Controlling Authority case on the interpretation of the term 'wages' under the Payment of Wages Act, 1936 concerning the Principal Employer's liability to pay gratuity to contract labor, with reference to the vicarious liability imposed on them to pay wages under section 21(4) of the CLRA Act, 1970.

Therefore, my conclusion is that irrespective of the presence or absence of any clause pertaining to the payment of gratuity to the contract labor in the service contract between the Principal Employer and the contractor, it is the Principal Employer's responsibility to settle the gratuity claim first and then proceed to recover the same from the respective contractor.

Dear Umakanthan Sir, I learned a lot from your comments, in which you provide suggestions based on various acts or court verdicts.

Gratuity Payment Responsibility

However, on this topic, it is not so important whether the Principal Employer (PE) is liable or not. More important is whether, in the first instance, gratuity should be paid by the contractor or by the PE. I described various situations above through which we can ascertain who is primarily responsible for paying the gratuity.

We all know under the CLRA Act if the contractor fails to meet any statutory obligation, the PE is responsible. However, being the immediate employer, the contractor has the primary liability for gratuity payment. Moreover, under the Gratuity Act, the Principal Employer is not mentioned anywhere. I would like to state that the matter is more related to the Gratuity Act instead of the CLRA Act.

Court Judgments on Gratuity Liability

Regarding the reference to the Madras High Court Judgment, I have read an article that describes: “The liability of the principal employer for the payment of gratuity to contract labor under the P.G Act 1972 is also in the twilight as there are divergent views among different High Courts. For instance, in Cominco Binani Zinc Ltd. V. Pappachan [1989 LLR 123], the Kerala High Court held that neither the C.L.R. Act nor the P.G Act provides that the employees engaged through the contractor would be entitled to gratuity from the principal employer, and as such, the principal employer would not be liable to pay gratuity to the contract labor. On the contrary, the Madras High Court has held in Madras Fertilizers Ltd. v. C.A under the P.G Act [2003 LLR 244] that the principal employer can be directed to pay gratuity to his contract labor subject to reimbursement by way of recovery from the contractor.”

Please refer to the second last line, "Principal Employer can be directed." That itself explains if the contractor failed to pay, then only the PE can be held responsible.

Practical Approach to Gratuity Payment

Based on my experience and practical approach, I suggest first checking where the gratuity cost was absorbed. If the gratuity cost was not paid in the bills, then how can we ask the contractor to pay gratuity? But if the contract was comprehensive in nature and the contractor accepted to bear all statutory costs, then the contractor is liable to pay gratuity.

I share the same views in the link below (related to payment for increased wages as per the MW Act).
https://www.citehr.com/630526-princi...c-arrears.html

In the end, I would like Mr. RAJEKc5Q to visualize the case and provide proper inputs so that senior members can offer the most relevant solutions.

Gratuity Liability in Genuine vs. Sham Contracts

In respect of employees who are engaged by a contractor with whom the principal employer has a genuine contract, the contractor shall be responsible for discharging the gratuity liability. However, in the case of a sham contract, the principal employer is bound to pay gratuity. In a sham contract, the contractor is merely an agent on paper, and all decisions are made by the principal employer. Keeping the same employees under different contractors indicates that the contract is not genuine. Furthermore, in this scenario, the principal employer is not just concerned with the number of persons engaged by the contractor but is also focused on who is engaged and possesses sufficient knowledge about the individuals involved. Therefore, I believe the principal employer is responsible for making gratuity payments.

Contractor Liabilities and Gratuity Concerns

Gone through all the comments. I myself am a contractor. Let me share with you the actual situation. While we are bidding on the tender, the Principal Employer (PE) writes that the contractor is liable for all legal responsibilities. On the other hand, the PE provides a certain Performa where we have to fill in the rates that the Bill of Quantities (BOQ) gives, with only the option of M.W+ PF+ESI+ Service Charge. There is no column for Bonus, leave encashment, or gratuity. Sometimes the bonus column is there, but not the other columns. Now, please let me know, in this scenario, what are the contractor's liabilities towards gratuity, etc.

Yes, in most cases nowadays, the manpower remains the same, only the contractor changes.

Contractor's Responsibility for Long-term Contracts

It is for the contractor to decide at what rate he should accept the contract. If the contract is expected to last for more than 5 years, obviously, he should envisage a payout like gratuity. Accordingly, the service charges should be adjusted.

Including Bonus as a Cost

Regarding the bonus, I don't think that any principal employer will disown it. You can very well include it as a cost to the company.

Absorbing Workmen from Previous Contractors

Very important. If you are absorbing the workmen who were under some other contractor's rolls (workmen remain the same but only the contractor changes), you should be more vigilant and should not accept the contract unless an agreement is reached about unpaid statutory liabilities.

Rightly said by Indu-Bala,

Due to cost optimization, many PEs have started the practice of awarding contracts based on existing MW, a few statutory compliances, and a Fixed Service Charge.

Hence, in my comment, I insisted on first checking whether the Gratuity cost was included and accepted in the contractor’s scope. If so, then the PE should insist the contractor pay and must HOLD adequate bills until all statutory clearances are provided by the contractor. But if only wages, PF-ESI, and leave costs are paid to the contractor, then the PE is liable for gratuity (either pay directly or generate a separate invoice and reimburse the same).

Dear Madhu sir,

Ethically, your suggestion is right: "before signing any agreement, the contractor should first get statutory clearance for the previous period." But practically, if he applies this pattern, he will lose the contract. Hence, the contract is initiated on the assumption of "Dekha jayega."

Here, the PE should play a vital role in including all statutory components (not only existing but projected as well, like MW Revision, PL, Gratuity, EC Policy, etc.) in the cost calculation (contract agreement).

Ours is a project-based company (Prime contractor) having Municipal & Industrial clients. We sub-let various jobs to many contractors (only manpower + comprehensive). I have been dealing with more than 100 such contracts and consider projected costs as well in the contract process-approvals.

However, we process the monthly bills on actuals (as per the existing pattern) and take necessary approval-amendments for projected costs (MW, PL, Gratuity, Actual Bonus payment).

We never had any such situation. I hope all learned members will agree with my points-suggestions and correct me if I am wrong.

I faced a similar situation in the power sector in Jharkhand and observed that this issue existed in most power plants (O&M jobs). It was a job contract for two years, but after the completion of three or four re-tender processes, the contractor continued, and the contract labor came under the purview of Gratuity. When the contractor changed and the same labor continued their job in the said power plant, they raised the issue of Gratuity. Here, the P.E. authority just forwarded the issue to ALC/RLC. However, when the contractor denied it, the principal employer held only the security deposit and the last two or three months' bills, which is not at par with the amount of Gratuity payable. Though the matter is not yet resolved and is under the jurisdiction of RLC or mutually settled between the ex-contractor and the laborers.

Different systems in AP and WBPDCL

Different systems are followed in AP and WBPDCL. Each contract is to be renewed only after the full and final settlement. Not only that, the amount of Gratuity is kept under the cooperation of Contract labor unions. Whenever any contractual workman retires or dies, the settlement is done along with Gratuity without any dispute. However, in AP and Gujarat, the cost of Gratuity is paid on a monthly basis in different terms.

Escalation charges in the power sector

Now, in the power sector, there is a start to include the process of escalation charges, in which the cost against Gratuity is included at the time of tender valuation or submission.

This is my practical experience: either pay the Gratuity or settle the matter amicably with the contract labor representative; otherwise, the case will be under the jurisdiction of the law.

Dear friends,

Though the opinions expressed by the learned members in this thread about the liability of payment of gratuity to contract labor and the difficulties associated therewith are valid and logical, unfortunately, they are from the perspective of either the contractor or the principal employer. But the necessity for the enactment of the CLRA Act, 1970, and its enforcement since then are only from the perspective of the contract labor.

Having said so, I don't intend to say that the Act, as it stands today, does not take into account the hardships faced by the contractor and the principal employer in the matter of compliance with the provisions of the Act as well as the provisions of the allied Acts applicable to the establishment of the principal employer. That's the reason for the conspicuous absence of definitions of terms like 'core activity', 'incidental activity' though the former has been defined under Section 2(1)(p) of the yet to be enforced "The Occupational Safety, Health and Working Conditions Code, 2020", of course, with some exceptions. Thus, the contract labor is essentially just another form of indirect employment with a migratory nature. But the actual practice is different in labor-intensive industries. The ground reality is that in certain manufacturing industries, including those of public sector enterprises, there is a permanent mismatch between the total number of regular employees and the contract labor and in terms of wages and other conditions of employment as well. Therefore, I would not have any hesitation in reiterating that like water, though which has a liquid form but not of any shape of its own, but taking its container's shape only, contract labor derives its employment rights and benefits from the principal employers' establishment only. Thus arises the need for the vicarious liability enjoined upon the PE under Section 21 of the CLRA Act, 1970.

Sorry that really I am unable to accept the argument of our friend Mr. Pan Singh on the basis of the omission of certain expenses by the PEs into the contractors' charges based on cost optimization. The concept of vicarious liability always revolves around the ultimate beneficiary of an act only. Therefore, such a contract between the contractor and the principal employer omitting certain heads of statutory commitments would be opposed to public policy under Section 23 of the Indian Contract Act, 1872, and becomes void.

Whenever a legal provision like Section 21 of the CLRA Act, 1970, which fastens vicarious liability on one of the two parties to a contract is interpreted, one should bear in mind the spirit of the law which tries to set right the possible mischief. If Mr. Singh carefully reads paragraph 19 of the Madras High Court's original judgment, he would understand certainly how meticulously and convincingly the learned Judge interpreted the definition of the term 'wages' under Section 2(vi) of the Payment of Wages Act, 1936 with reference to Section 21(4) of the CLRA Act, 1970.

Therefore, I am sure that he would certainly accept that the literal as well as the beneficial interpretation of the provision of Section 21(4) of the CLRA Act, 1970 by the honorable Madras High Court in the letter and spirit of the Act puts an end to the controversy on the liability to pay gratuity to the contract labor.