Are Company Directors Employees Under the ESIC Act? A Supreme Court Perspective

18 January 2025 • Karamjeet Kaur

Recommended

Are Company Directors Employees Under the ESIC Act? A Supreme Court Perspective

18 January 2025 • Karamjeet Kaur

Imagine this: You’re a director at a company, attending board meetings, steering corporate strategy, and drawing a handsome remuneration. One day, you receive a notice from the Employees’ State Insurance Corporation (ESIC) demanding contributions based on your pay. You’re perplexed, thinking, “Am I considered an employee under the ESIC Act?” This very question sparked a legal battle that culminated in the Supreme Court’s landmark judgment in Employees’ State Insurance Corporation vs. Venus Alloy Pvt. Ltd., bringing clarity to a grey area in employment law.

Before we move ahead with the analysis of the court’s observations with respect to the determination of employees under the Act, it shall be pertinent to give you a brief outlook of the ESIC Act.

The Employees’ State Insurance Act, 1948 (“ESI Act”) stands as a pioneering welfare legislation in India, designed to provide insurance coverage to employees against certain inevitable risks, including sickness, maternity, and employment-related injuries. Central to the Act is the mandate under Section 38, which obligates all employees working in covered factories or establishments to be insured in accordance with its provisions.

For the Act’s applicability, the term “employee” under Section 2(9)(b) plays a critical role, encompassing individuals earning wages below a threshold prescribed by the Central Government. Rule 50 of the Employees’ State Insurance (Central) Rules, 1950, specifies this wage ceiling, which was last revised to ₹21,000 per month, effective January 1, 2017. Consequently, employees earning up to this limit qualify as “employees” under the Act.

Three key criteria determine the applicability of the ESI Act:

  1. Whether the individual meets the definition of “employee” under the Act.
  2. Whether the remuneration paid qualifies as “wages” as defined by the Act.
  3. Whether the wages fall within the prescribed ceiling.

The first two criteria were at the forefront of a significant legal debate in the case of ESI Corporation v. Venus Alloy Private Ltd., decided by the Supreme Court on February 5, 2019. The central issue revolved around whether company directors receiving remuneration are considered “employees” under Section 2(9) and whether their remuneration qualifies as “wages” under the Act. This case aptly addressed the question – Are Company Directors Employees Under the ESIC Act?

Background of the Case

Venus Alloy Private Ltd., already covered under the ESI Act, regularly contributed to the ESIC for its employees. During an inspection, the ESIC noted that contributions were not being made for the remuneration paid to the company’s directors.

The Employees’ State Insurance Corporation (“Corporation”) issued an order in the year 2005 stating that the directors of Venus Alloy Pvt. Ltd. (“Company”) were receiving remuneration of Rs. 3,000 per month and thus fell under the definition of “employee” as per Section 2(9) of the ESI Act. Consequently, the Corporation demanded contribution payments under the Act for these directors.

Challenging this order, the Company filed proceedings under Section 75 of the ESI Act (deals with Matters to be decided by Employees’ Insurance Court), contending that its directors were not employees and, therefore, not liable for ESI contributions. Both the Employees’ Insurance Court and the High Court ruled in favour of the Company. Aggrieved, the Corporation approached the Supreme Court. 

The ESI Court’s Decision

The ESI Court, relying on precedents and arguments presented by both parties, observed that while managing directors might perform specific tasks that could classify them as employees, there was no evidence or judicial principle to suggest that directors, as a broader category, fit the definition of “employee” under the ESIC Act. The court ruled in favour of the Respondent-Company, declaring the ESIC’s demand void and unfair. 

High Court’s Ruling

On appeal, the Madhya Pradesh High Court upheld the ESI Court’s decision. The High Court relied on judgments from the Bombay High Court, particularly in Sakal Papers Pvt. Ltd. vs. Employees’ State Insurance Corporation and Employees’ State Insurance Corporation vs. Apex Engineering Pvt. Ltd., to conclude that directors do not fall under the definition of “employee” under Section 2(9) of the ESIC Act. It emphasized that unless directors perform specific duties akin to those of regular employees, their remuneration does not attract ESIC contributions.

The Supreme Court’s Analysis

Interpretation of “Employee”

The Court referred to its earlier rulings to highlight that the definition of “employee” under Section 2(9) of the ESI Act is wide and inclusive. A person performing duties connected to the work of a factory or establishment for remuneration can qualify as an employee, even if they hold a dual capacity—such as being a director and an employee.

  • In Employees’ State Insurance Corporation v. Apex Engineering Pvt. Ltd. (1998), the Court held that a Managing Director receiving remuneration for additional duties fell within the scope of “employee” under the ESI Act.
  • Similarly, in Saraswath Films v. Regional Director, ESIC (2010), it was established that the nature of work and remuneration are crucial in determining an individual’s status as an employee.

Key Legal Provisions

  1. Definition of “Employee” [Section 2(9)]: An “employee” is any person employed for wages in or in connection with the work of a factory or establishment to which the ESI Act applies. This includes those employed directly, through an immediate employer, or temporarily lent or hired to the principal employer.
  2. Definition of “Wages” [Section 2(22)]: “Wages” include all remuneration paid in cash to an employee under the terms of employment, covering payments during authorized leave, lock-outs, strikes, or lay-offs. However, specific exclusions such as contributions to pension funds and traveling allowances are provided.

 Application to the Present Case

In the Venus Alloy case, the directors were paid a fixed monthly remuneration. The Court noted that the Company failed to produce evidence disproving the Corporation’s assertion that the directors’ remuneration constituted “wages” under Section 2(22) of the ESI Act. As such, the factual basis of the Corporation’s order remained unchallenged.

Dual Capacity Doctrine

The Court emphasized the applicability of the Dual Capacity Doctrine, which allows an individual to simultaneously hold dual roles within a company—that of a director and an employee. According to this principle, if a director performs specific duties or services for the company under a valid contract of employment and receives remuneration for these services, they are considered an employee under the Employees’ State Insurance (ESI) Act, 1948. This doctrine is particularly significant because it extends beyond Managing Directors to include other directors, provided they fulfil the conditions laid out under the ESI Act.

In essence, the nature of the services rendered and the terms of the contractual relationship take precedence over the title held by the individual within the company. The Court’s reaffirmation of this principle ensures that directors who actively contribute to the company’s operations and are compensated for such contributions are recognized as employees for compliance with statutory obligations like ESI contributions. This interpretation underscores the need for companies to examine the roles and remuneration structures of their directors to determine their obligations under the Act.

The Judgment

The Supreme Court set aside the lower courts’ rulings, holding that the directors of Venus Alloy Pvt. Ltd., receiving monthly remuneration, were “employees” under the ESI Act. Consequently, the Company was liable to pay ESI contributions for these directors.

Implications of the Ruling

  • Wider Applicability of ESI Act: The judgment broadens the interpretation of “employee” to include directors receiving remuneration, emphasizing substance over form in assessing employer-employee relationships.
  • Corporate Governance: Companies must assess whether directors’ remuneration could trigger obligations under labour laws, particularly the ESI Act. Proper documentation of the nature of work and remuneration is essential. It is critical to examine if the contract is a “contract for service” or “contract of service”.
  • Compliance Focus: The decision underscores the need for companies to ensure compliance with labour laws, as failure to pay statutory contributions could lead to litigation and financial liabilities.

You may also like to read:

Leave a comment

Your email address will not be published. Required fields are marked *