Priority of Distribution (Waterfall Mechanism) under Section 53 of
the Insolvency and Bankruptcy Code: Examining the Rights of
Operational Creditors, Government Dues, and Secured Lenders
An Analytical Study of the Statutory Order of Priority in Liquidation
under the Insolvency and Bankruptcy Code, 2016
1. Abstract
Before 2016, a company sinking under debt in India had no single, predictable law to fall
back on, and recovery often dragged on for years across multiple overlapping forums. The
Insolvency and Bankruptcy Code, 2016 (“IBC”) was enacted to fix this, and at the heart of what
happens when a company finally goes into liquidation sits Section 53 — popularly called the
“waterfall mechanism.” It decides, in a fixed order, who gets paid first when a company’s assets
are sold and there is not enough money to satisfy every creditor.
This article studies Section 53 in plain terms, situates it within the broader liquidation
framework of the Code, and examines how it treats three groups: secured lenders, operational
creditors, and the government. The research is doctrinal, built on the bare statute, the IBBI
(Liquidation Process) Regulations, landmark Supreme Court rulings, and the Insolvency and
Bankruptcy Code (Amendment) Act, 2026. The article finds that while the waterfall was designed
to bring certainty, judicial swings — most visibly the Rainbow Papers ruling — briefly disturbed
that certainty before being reined in by the Supreme Court and, more recently, by Parliament. It
closes with suggestions for fairer, clearer recoveries.
Keywords:
IBC, Section 53, Waterfall Mechanism, Secured Creditors, Operational Creditors,
Government Dues, Liquidation, IBC Amendment Act 2026.
2. Introduction
Insolvency law in India travelled a long, bumpy road. For decades, a sick company could
be dragged through the Board for Industrial and Financial Reconstruction, winding-up petitions
before High Courts, and separate debt-recovery routes under the RDB Act and SARFAESI —
often all at once.1 None of these laws spoke to each other, and a creditor could spend more years
in court than the debtor spent building the business. The Bankruptcy Law Reforms Committee
studied this and recommended a single, time-bound code — which became the IBC.
The Code has two ambitions: rescuing viable businesses through the Corporate Insolvency
Resolution Process (CIRP), and, where rescue fails, an orderly liquidation. It is this second limb
where Section 53 does its work. A fixed order of priority removes the guesswork that would
otherwise cause every creditor to rush to court, since the liquidator must pay strictly level by level,
with nothing reaching a lower level until the one above is paid in full. This article asks three
questions: how does Section 53 work and relate to Sections 33, 35 and 52; how does the waterfall
treat secured creditors, operational creditors and the government; and how have courts and
Parliament responded to the friction this hierarchy has generated. The scope is confined to
corporate liquidation under Part II of the Code.
3. Legislative Framework of Section 53 IBC
Liquidation is meant to be the last resort. Section 33 lets the NCLT order liquidation mainly
where the Committee of Creditors finds no resolution plan workable, or the resolution window
lapses. The objective shifts from rescue to orderly winding down, maximising whatever value
remains for stakeholders. Once liquidation begins, the liquidator takes over from management. Section 35 gives wide powers — to take custody of assets, sell the company as a going concern or piecemeal, and institute or defend legal proceedings.
These powers exist because someone must convert scattered assets into cash, since Section
53 only operates once there is a pool of money to distribute. Secured creditors have a special choice
even before Section 53 applies. Section 52 lets them either relinquish their security to the estate
and be paid through the waterfall, or enforce it independently outside the process, while still
contributing to liquidation costs and workmen’s dues.
Section 53 then supplies the actual distribution rule. Sub-section (1) lists successive layers,
each paid in full before the next is touched. Sub-section (2) disregards any private arrangement
that lets one creditor jump ahead of an equally-ranked creditor, closing an obvious loophole. The
IBBI Liquidation Process Regulations, 2016 flesh out the mechanics — how claims are verified,
how a separate liquidation account is kept, and, under Regulation 21A, how a secured creditor
enforcing security independently must still contribute where the estate lacks funds for costs and
workmen’s dues.
Together, Sections 33, 35, 52 and 53 form one connected machine: Section 33 starts
liquidation, Section 35 arms the liquidator, Section 52 settles secured creditors’ options, and
Section 53 finally tells everyone who gets paid and how much.
4. Understanding the Waterfall Mechanism
Picture money poured into a series of stacked buckets. The first must fill completely before
overflow reaches the second, and so on; if money runs out midway, that bucket divides what little
arrived proportionately among its claimants, and every bucket below stays empty. That is how
Section 53(1) works — a strict cascading hierarchy, not a proportional sharing of the whole pool
at once.
The design balances two values: honouring the commercial bargain secured creditors
struck when lending against collateral, and protecting the most vulnerable participants, particularly workers. Section 53 places insolvency costs and workmen’s dues very high up, secured creditors immediately after, and works down through progressively less protected classes.
4.1 The order of priority, level by level
The first charge on sale proceeds covers the costs of running the process itself — the
liquidator’s fees and process expenses. Nothing moves down the ladder until these are paid in full.
Next, two groups stand together: workmen, for wages over the twenty-four months before
liquidation, and secured creditors who relinquish their security to join the common pool. They
share this level proportionately if money runs short.
After that comes a level for employees who are not “workmen” in the strict sense, covering
twelve months of unpaid wages — a narrower window reflecting stronger protection for the more
vulnerable workforce.
The fourth level belongs to unsecured financial creditors, who never held collateral, so
their recovery depends entirely on what survives the levels above.
The fifth level places two different claims together: government dues for the two years
preceding liquidation, and whatever remains unpaid to a secured creditor after enforcing its
security. Placing government dues here, rather than higher, was a deliberate choice — Parliament
did not want tax authorities to enjoy the old “Crown debt” preference.
Everything unpaid by this point falls into a residual sixth level — most operational
creditors’ dues end up here, along with government dues older than two years. Because so many
claims converge here, and the levels above usually consume most of the money first, recoveries at
this level tend to be smallest or nil.
Only after Level 6 is fully paid does anything reach preference shareholders, and only then
equity holders. Very few liquidations ever generate enough value to reach this final stage.
4.2 A few points easy to miss
Ranking within a level is equal, not sequential. Operational creditors have no dedicated
level of their own — their dues sit in the residual Level 6, which is why they tend to recover far
less than financial creditors. Government dues are deliberately split between Level 5 and Level 6 depending on age. And equity holders are paid only if every creditor down to Level 6 has been paid in full, a condition that rarely arises in practice.
5. Rights of Different Stakeholders
5.1 Rights of Secured Creditors
A secured creditor’s loan is backed by a specific asset — land, machinery, receivables, or
shares — over which a charge exists. This gives the lender a direct claim over that asset, apart
from its general right to repayment. Section 52 gives such a creditor a genuine choice: relinquish
the security and join the Section 53 pool, or enforce it independently.
Most banks relinquish security because Section 53 places them, with workmen’s dues, at
Level 2 — among the very first paid, a considerable privilege over unsecured lenders and
operational creditors further down. The 2026 amendments add precision: where a secured asset’s
value is less than the debt owed, the creditor is secured only to that value, and unsecured for the
balance — closing a long-standing ambiguity.
5.2 Rights of Operational Creditors
Section 5(20) defines an operational creditor as anyone owed an operational debt —
broadly, dues from supply of goods or services, employment, or dues payable under law.6 Typical
operational creditors include suppliers, contractors, landlords and utility providers. Within the
waterfall, most fall into the residual Level 6, with no dedicated protected slot — the biggest
structural disadvantage they face, since by the time distribution reaches Level 6, proceeds are often
exhausted.
The picture is somewhat better at the resolution stage: Section 30(2)(b) requires a
resolution plan to pay operational creditors at least what Section 53 liquidation would give them
— a floor, not parity with financial creditors, as Essar Steel confirmed. Operational creditors also
have far less voice in the process than financial creditors, who alone sit on the Committee of
Creditors.
5.3 Government Dues
Under the old “Crown debts” doctrine, the State enjoyed preferential recovery ahead of
ordinary creditors. The IBC departed from this: Section 53(1)(e)(i) placed government dues (for
the two preceding years) at Level 5, well below secured creditors, workmen and unsecured
financial creditors, with older dues falling to Level 6. That clarity was disturbed by a 2022 ruling
that let a statutory tax charge count as a “security interest,” effectively elevating the tax department
to secured-creditor status. This unsettled liquidation practice and triggered litigation and,
eventually, legislative correction, discussed next.
6. Judicial Interpretation and Recent Supreme Court Developments
Four Supreme Court decisions between 2019 and 2023 shaped how Section 53 works in
practice, and a 2026 legislative reform has now settled much of what they left open.
6.1 Essar Steel v. Satish Kumar Gupta
Facts: Essar Steel owed about ₹49,000 crore to financial creditors and ₹5,000 crore to operational
creditors. The CoC approved ArcelorMittal’s plan by a 92% majority, paying the two classes very
differently; NCLAT tried to equalise payments.7
Issue: whether operational creditors deserve
parity with financial creditors, and how far tribunals may interfere with a CoC-approved plan.
Decision: The Supreme Court set aside the NCLAT order, holding CoC “commercial wisdom”
largely non-justiciable, and that operational creditors need only receive the Section 53 liquidation
value — not equal treatment. This fixed the meaning of the “fair and equitable” floor as a
minimum, not a benchmark for parity.
6.2 Ghanashyam Mishra v. Edelweiss Asset Reconstruction
Facts: Government authorities raised tax demands against a corporate debtor after its resolution
plan was approved, arguing those dues survived because they were never included.8
Issue: whether an approved plan extinguishes claims, including government dues, not included in it, even against
non-participating authorities.
Decision: The Court held all such claims stand extinguished, binding every stakeholder including
the government — the “clean slate” principle. This complements Section 53 by confirming
government claims must be pursued within the Code’s framework, not resurrected later.
6.3 State Tax Officer v. Rainbow Papers Ltd.
Facts: Rainbow Papers owed Gujarat sales tax secured by a statutory first charge under state VAT
law; its claim was rejected as belated, and the State argued the charge made it a secured creditor.9
Issue: whether a charge created by statute counts as a “security interest” under the Code.
Decision: A two-judge bench agreed with the State, effectively placing the tax department on par
with secured lenders. This alarmed lenders and resolution applicants because it appeared to
override the very hierarchy Section 53 was meant to protect.
6.4 Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat Pvt. Ltd.
Facts: An electricity distributor attached a liquidation-bound debtor’s assets for unpaid dues,
relying on the Electricity Act’s overriding clauses to recover outside the liquidation process.10
Issue: whether sector legislation can trump the Section 53 waterfall.
Decision: The Court held Section 238 of the IBC overrides the Electricity Act, and confined
Rainbow Papers to its facts, noting government dues “are placed much below” secured creditors
even where a statutory charge exists. When the Rainbow Papers review was dismissed in 2023,
the Court noted a co-ordinate bench could not comment on its correctness, leaving some doctrinal
untidiness for Parliament to resolve.
6.5 The IBC (Amendment) Act, 2026
This uncertainty pushed Parliament to act. The IBC (Amendment) Bill, 2025 was
introduced in August 2025, passed by both Houses in March 2026, and received Presidential assent
on 6 April 2026 as Act No. 6 of 2026.11
Its Section 53-related provisions take effect once separately notified, but the substance is
settled: “security interest” under Section 3(31) now covers only interests created by agreement,
excluding those arising merely by operation of law — legislatively overturning Rainbow Papers.
A new explanation to Section 53(1)(e)(i) confirms government dues cannot claim priority above
Level 5 regardless of any statutory charge. Under-secured creditors are now secured only up to
their security’s value, and valid inter-creditor priority arrangements will not be disregarded.
7. Challenges and Suggestions
7.1 Challenges
● Operational creditors, particularly small suppliers, face persistently low recovery because
their claims sit almost entirely in the unprotected residual level.
● Until the 2026 amendment is notified, the conflicting signals from Rainbow Papers and
Paschimanchal Vidyut leave some pending cases in a grey zone on government dues.
● Liquidations routinely exceed statutory timelines, eroding the very value Section 53 is
meant to distribute fairly.
● Balancing secured lenders’ commercial expectations against equitable outcomes for
unsecured and operational creditors remains, at bottom, a policy trade-off.
7.2 Suggestions
● Prompt notification and consistent application of the 2026 amendment’s government-dues
provisions would remove the largest recent source of uncertainty.
● A modest, ring-fenced improvement in operational creditors’ priority would improve
outcomes for vendors with the least capacity to absorb total loss.
● Stricter enforcement of liquidation timelines and better oversight of liquidators would
preserve more distributable value.
● A single, harmonised judicial approach — ideally settled by a larger bench where
genuine conflict exists — would reduce repeated litigation of the kind Rainbow Papers
generated.
8. Conclusion
Section 53 is often called the “heart” of the IBC, and the description holds up. It converts what
would otherwise be a chaotic scramble among creditors into an orderly, predictable sequence,
protecting the idea that credit markets can function with reasonable confidence about what happens
if a borrower fails.
At the same time, the waterfall makes value judgments about whose interests matter more —
secured lenders and workmen are protected early, while operational creditors and the government
are pushed further down the queue. The last four years show how a modern statute matures: Essar
Steel and Ghanashyam Mishra confirmed its basic architecture, Rainbow Papers unsettled it,
Paschimanchal Vidyut pulled the law back towards the text, and the 2026 Amendment Act has
now removed the ambiguity through express language. What remains is the harder task — ensuring
the certainty the law now offers on paper translates into faster, fairer recoveries for every class of
creditor, particularly operational creditors, whose position remains the waterfall’s most debated
feature.
9. References / Bibliography
Statutes
● The Insolvency and Bankruptcy Code, 2016, No. 31, Acts of Parliament, 2016 (India).
● The Insolvency and Bankruptcy Code (Amendment) Act, 2026, Act No. 6 of 2026
(India).
● The Gujarat Value Added Tax Act, 2003, Guj. Act No. 1 of 2005, § 48 (India).
● The Electricity Act, 2003, No. 36, Acts of Parliament, 2003 (India), §§ 173–174.
Supreme Court Cases
● Committee of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta, (2020) 8 S.C.C.
531 (India).
● Ghanashyam Mishra & Sons (P) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd., (2021)
9 S.C.C. 657 (India).
● State Tax Officer v. Rainbow Papers Ltd., 2022 SCC OnLine SC 1162 (India).
● Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat (P) Ltd., 2023 SCC OnLine SC
842 (India).
● Swiss Ribbons (P) Ltd. v. Union of India, (2019) 4 S.C.C. 17 (India).
Books and Journal Articles
● M.S. Sahoo & Anuradha Guru, Insolvency and Bankruptcy Code, 2016: A Miscellany of
Perspectives (2019).
● Subham Mangla & Dirshi Shah, Why the IBC Bill’s Fix for Waterfall Is a HalfMeasure?, IndiaCorpLaw (Oct. 7, 2025).
● Rakshit Agarwal & Tarun Ashok, SC Ruling in Paschimanchal Vidyut: Analyzing the
Treatment of Statutory Dues as Secured Credit, IndiaCorpLaw (Aug. 15, 2023).
IBBI Regulations, Reports and Websites
● IBBI (Liquidation Process) Regulations, 2016 (India), as amended.
● Report of the Bankruptcy Law Reforms Committee, Vol. I, Ministry of Finance,
Government of India (Nov. 2015).
● Report of the Insolvency Law Committee, Ministry of Corporate Affairs, Government of
India (Mar. 2018).
● IBC Laws, https://ibclaw.in; India Corporate Law Blog, https://indiacorplaw.in; IBBI,
https://ibbi.gov.in.
Author: Prafull Shelake
.