What Happens to Corporate Social Responsibility (CSR) Funds in Bankruptcy?

Corporate Social Responsibility (CSR) funds are allocated by companies to meet their social, environmental, and community welfare obligations under the Companies Act, 2013. However, when a company enters bankruptcy or insolvency proceedings under the Insolvency and Bankruptcy Code (IBC), the treatment of CSR funds can become a contentious issue. The IBC prioritizes the repayment of debts to creditors, but there are specific legal implications regarding CSR obligations and the utilization of funds during insolvency.

Impact of Bankruptcy on CSR Funds:

Obligations to Spend CSR Funds:

Under the Companies Act, 2013, companies meeting certain profit thresholds are required to spend a percentage of their profits on CSR activities. However, if a company enters insolvency proceedings, its ability to fulfill these obligations may be hindered due to financial strain.

The Insolvency and Bankruptcy Code (IBC) focuses primarily on repaying creditors and addressing the company’s financial distress. The CSR funds that have been earmarked for social or environmental projects may be at risk if the company’s assets are liquidated or if the company is unable to continue operations.

CSR Funds in the Resolution Process:

During the resolution process, the Committee of Creditors (CoC) determines the viability of the company’s operations and may approve a resolution plan that includes provisions for CSR spending. However, the creditors’ interests are prioritized over CSR obligations.

If the company is undergoing restructuring, the CoC might evaluate the continuation of CSR activities, but any CSR-related expenditure would depend on the financial stability of the company and the availability of funds post-payment of creditors.

CSR Funds and Liquidation:

In the case of liquidation, the primary objective is to repay creditors from the proceeds of asset sales. CSR funds are not prioritized, and any remaining funds after creditors' claims have been settled may be directed towards social or community-related initiatives.

If there are surplus funds after settling all debts, it’s possible that the remaining CSR obligations could be fulfilled, but the company's insolvency does not mandate the allocation of funds to CSR activities.

Legal Obligation vs. Creditor Claims:

The legal obligation for CSR spending may conflict with the claims of creditors. While the company may have committed to spending a certain amount on CSR projects, these obligations are not legally enforceable over the rights of creditors under the IBC. The creditors' claims take precedence, and CSR funds could potentially be used to pay off debts.

The CSR spending mandate may become an issue if the company has already earmarked funds for CSR projects before entering insolvency. However, these funds are unlikely to be paid out unless explicitly allocated in the resolution plan or if sufficient funds remain after creditors' claims have been met.

CSR Fund Utilization Post-Insolvency:

Once a company enters insolvency, the utilization of CSR funds must be evaluated by the insolvency professional or resolution professional. The funds can only be utilized for CSR purposes if the company is capable of fulfilling its financial obligations to creditors, and only after taking into account any surplus funds.

In most cases, CSR fund utilization during insolvency is likely to be postponed or reduced as the company focuses on paying off debts and restructuring its operations. CSR projects are typically deprioritized in favor of addressing creditor claims.

Impact on Stakeholders and Public Image:

If a company under insolvency proceedings has committed to long-term CSR initiatives, the suspension or non-payment of CSR funds may affect its public image and brand reputation. Stakeholders, including customers and employees, may view the company's failure to honor CSR commitments as detrimental to its ethical standing.

However, creditors and stakeholders in the insolvency process are likely to view CSR spending as less important than the company’s financial recovery.

Discretionary Power of the Resolution Professional:

The resolution professional (RP) overseeing the insolvency proceedings has the discretion to consider CSR spending if the funds allow for it after creditor claims are settled. The RP can propose CSR initiatives as part of the resolution plan, but this will only happen if there is agreement from the Committee of Creditors (CoC) and sufficient funds are available.

If the company is sold as a going concern, the new owners might decide to continue CSR activities, but this is entirely at their discretion.

Government and Regulatory Oversight:

The Ministry of Corporate Affairs (MCA) may have concerns if a company fails to fulfill its CSR obligations due to insolvency. However, under the IBC, these obligations are secondary to satisfying creditor claims.

The government may also encourage companies under resolution to continue CSR activities as a part of their sustainable business model, but it is not a binding requirement.

Example:

Consider XYZ Ltd., a manufacturing company, which is required to spend 2% of its profits on CSR activities under the Companies Act, 2013. The company enters insolvency and begins the resolution process under the IBC.

Resolution Plan Proposal:

The Committee of Creditors (CoC) evaluates a resolution plan that involves the sale of XYZ Ltd.’s assets. While the company has committed CSR funds, these are not prioritized in the resolution process. The resolution plan is approved with a partial settlement of creditors' dues and no immediate provision for CSR expenditure.

Liquidation:

After XYZ Ltd. is liquidated, the liquidator uses the sale proceeds to settle the claims of secured and unsecured creditors. Any leftover funds are used for miscellaneous obligations, but no CSR-related spending is made because the creditors’ claims have not been fully settled.

Conclusion:

In the context of insolvency or bankruptcy, CSR funds take a secondary position to the repayment of creditors. While companies are legally obligated to spend on CSR activities under the Companies Act, 2013, these obligations are not enforceable over the claims of creditors in insolvency proceedings. CSR funds may be utilized post-insolvency only if sufficient funds remain after settling debts, and any spending on CSR activities will depend on the company’s ability to recover and the resolution plan's provisions.