1. What is Legal Hierarchy?

Section 53(1) lays down order of priority for liquidation:

Waterfall:

1. Section 53(1)(a) - CIRP Costs + Liquidation Costs in full
2. 53(1)(b)(i) - Workmen dues for 24 months + Secured creditors who have relinquished security - pari passu
3. 53(1)(b)(ii) - Wages of employees for 12 months
4. 53(1)(c) - Unsecured Financial Creditors
5. 53(1)(d) - Government Dues (Central/State) + Amount remaining to Secured Creditor after enforcing security [if shortfall]
6. 53(1)(e) - Any remaining debt + dues
7. 53(1)(f) - Preference shareholders
8. 53(1)(g) - Equity shareholders / Partners

Section 30(2)(b) + Section 30(4) Explanation: Even in Resolution Plan, CoC must consider order of priority under Section 53. Financial Creditors cannot be paid before Operational Creditors to the extent of minimum liquidation value.

Failure to prioritize = Resolution Plan liable to be rejected under Section 31, Liquidator liable for misfeasance under Section 66.

2. Case Laws

Case 1: State Tax Officer (1) v. Rainbow Papers Ltd - Civil Appeal No. 2568 of 2020 - Supreme Court - 6 Sep 2022 - THE CASE THAT DISRUPTED HIERARCHY

Facts: Rainbow Papers was under CIRP. State Tax Dept, Gujarat had claim of Rs. 47.35 Cr under GVAT Act. Resolution Plan approved by CoC paid only 2% to government dues, 100% to secured financial creditors.

Issue: Is State a Secured Creditor because Section 48 of Gujarat VAT Act creates charge on property of dealer for tax dues?

Held by SC (Justice Indira Banerjee & V. Ramasubramanian):

Section 3(31) defines Security Interest to include right, title, interest or claim to property created in favour of secured creditor by transaction which secures payment. Section 48 GVAT creates statutory charge, therefore State is Secured Creditor under Section 3(30). Under Section 53(1)(b)(ii), debts owed to State being secured creditor are to rank equally with other specified debts including workmen dues.

SC set aside Resolution Plan, held it must be rejected if it does not pay government dues at par with secured creditors.

Impact: This judgment completely inverted hierarchy - made Crown Dues = Secured Creditors, contrary to legislative intent that government dues are at 53(1)(e) - 5th rank.

Correction:

• Paschimanchal Vidyut Vitran Nigam Ltd v. Raman Ispat (2023) 10 SCC 461 - SC observed Rainbow Papers did not notice Section 53 and Section 36(4) properly.
• Insolvency and Bankruptcy Code (Amendment) Act, 2026 - Added Explanation to Section 3(31) and 53: Any charge created by operation of any law - i.e. statutory charge - is not Security Interest. Overrules Rainbow Papers. Restores hierarchy - Government dues back to 53(1)(e).

Case 2: Committee of Creditors of Essar Steel India Ltd v. Satish Kumar Gupta - (2020) 8 SCC 531 - SC

Facts: NCLAT had held that CoC cannot differentiate between Financial Creditors and Operational Creditors, must pay similar percentage.

Held: SC reversed NCLAT. CoC has commercial wisdom, but Section 30(2)(b) mandates that Operational Creditors must get at least liquidation value as per Section 53 priority. CoC cannot secure its own dues at cost of statutory dues or operational creditors. NCLAT cannot rewrite waterfall. However CoC can give more than liquidation value to OCs if it wants, but minimum is Section 53 hierarchy.

Case 3: Technology Development Board v. Anil Goel - NCLAT - 2021

Issue: Inter-se priority among secured creditors who relinquish security.
NCLAT held: Once secured creditors relinquish security under Section 52(1)(a) to liquidation estate, they all fall under Section 53(1)(b)(i) and share pari passu. No priority based on date of charge creation or inter-creditor agreement. Section 53 does not recognize inter-se ranking.

Case 4: PTC India Financial Services Ltd v. Vikas Prakash Gupta & Ors - NCLT Hyderabad - 2022 & Indo Unique Flame Ltd - Same Bench

Two judgments. Petitioners argued: They had first charge, second chargeholder should get only after first is paid fully.

NCLT Hyderabad held:

Waterfall mechanism under Section 53(1) does not recognise any inter-se ranking of charges among financial creditors which was agreed prior to initiation of insolvency. All secured creditors who relinquish rank equally under 53(1)(b)(i).

Rejects contractual subordination in liquidation.

Case 5: Times Innovative Media Ltd v. Pawan Kumar Aggarwal (Liquidator) - NCLAT New Delhi - 19 Sep 2024 - [2024] 167 taxmann.com 240

Facts: Operational Creditor (Times Innovative) filed application that Liquidator wrongly placed unsecured Financial Creditor (related party) ahead of Operational Creditor. Claimed priority.

Held: NCLAT dismissed. On plain reading of Section 53(1), financial debts owed to unsecured creditors ranked higher than debt of operational creditor.

Order:

• 53(1)(c) - Unsecured Financial Creditors = 3rd in waterfall after workmen/secured
• 53(1)(d) - Operational Creditors clubbed with Government dues = 4th
  Appellant cannot claim priority. Liquidator right in placing Unsecured FC ahead of Operational Creditor. Relies on Swiss Ribbons Pvt Ltd v. Union of India (2019) 4 SCC 17 which upheld constitutional validity of Section 53 and distinction between FC and OC.

Case 6: Swiss Ribbons Pvt Ltd v. Union of India - (2019) 4 SCC 17

Challenge to Section 53 as discriminatory against Operational Creditors.

SC upheld hierarchy: Financial Creditors lend money with time value, they take risk, they are part of CoC, they have superior position. Operational Creditors provide goods/services. Classification under Section 53 is intelligible and not violative of Article 14. Failure to maintain this distinction is failure of IBC's objective.

3. Consequences of Failure to Prioritize

• Resolution Plan liable to be rejected under Section 31(2) - NCLT can reject if not compliant with 30(2)(b) + 53
• Liquidator personally liable for breach of duty - Section 66 (fraudulent transaction) and Section 60(5) application by aggrieved creditor
• CoC decision can be set aside for material irregularity