Director Salary Priority in Liquidation: Section 53 IBC Waterfall Explained
- reetika72
- 20 hours ago
- 5 min read
In most pre-funded private companies in India, especially startups and early-stage ventures, the shareholders are often the same individuals who serve as Directors. These founder-directors not only manage strategic decisions but also work full-time in various operational roles — from product development to finance and business growth.
To formalise this working relationship, they typically draw a salary under an Employment Agreement, making them both Directors and Employees of the company.
But what happens when such a company unfortunately faces liquidation — whether voluntary or involuntary?
Under the Insolvency and Bankruptcy Code, 2016 (IBC), Section 53 provides a clear waterfall mechanism that determines the order in which the proceeds from the sale of company assets are distributed.
Let’s explore where such director-employees fall in this hierarchy.
The Waterfall Mechanism under Section 53 of the IBC
When a company goes into liquidation, the liquidator distributes the proceeds from asset realisation in a fixed order of priority known as the waterfall mechanism:
Insolvency resolution process and liquidation costs (includes fees of insolvency professionals, legal costs, and other administrative expenses)
Workmen’s dues for the 24 months preceding the liquidation commencement date and debts owed to secured creditors who have relinquished their security interest.
Wages and unpaid dues owed to employees (other than workmen) for the 12 months preceding the liquidation commencement date.
Financial debts owed to unsecured creditors
Amounts due to the Central and State Governments (for the 2 years preceding liquidation) and remaining secured creditors (if any)
Remaining debts and dues
Preference shareholder
Equity shareholders or partners
Where Do Directors Who Are Also Employees Fall?
The key question here is: If a Director is also an Employee — with a valid employment contract and monthly salary — where do their dues fit in the waterfall under Section 53?
The answer depends on the nature of their role and remuneration:
1. Director as a Bona Fide Employee (Executive Director/Managing Director)
If the director holds a full-time executive position and has an employment agreement defining their salary, benefits, and working conditions, their unpaid salary for the 12 months preceding liquidation will fall under:
Section 53(1)(c) — “Wages and unpaid dues owed to employees other than workmen.”
This means:
They are treated at par with other employees (except workmen, who have slightly higher priority).
Their salary dues are paid before unsecured creditors and government dues.
However, only the last 12 months of unpaid salary are covered under this category. Any dues beyond that period may fall lower in the order of payment.
Why Managing Directors and Whole-Time Directors Fall Under Section 53(1)(c) — Not 53(1)(b)
It’s important to understand why an MD or WTD is categorised under employees other than workmen and not under workmen’s dues.
The term “workman” is defined under Section 2(s) of the Industrial Disputes Act, 1947, which includes persons employed to do manual, unskilled, skilled, technical, operational, clerical, or supervisory work, but explicitly excludes individuals employed in managerial or administrative capacities.
Since Managing Directors and Whole-Time Directors perform managerial and decision-making functions, they do not fall within the definition of ‘workman’.
Therefore, their dues are not covered by Section 53(1)(b) (which gives priority to workmen’s dues for 24 months), but instead fall under Section 53(1)(c) (which covers employees other than workmen and limits dues to 12 months preceding liquidation).
This distinction adds legal precision to the classification and directly explains why WTDs and MDs enjoy only 12 months’ protection, not 24 months like workmen.
Severance Pay and Compensation for Loss of Office: Where Do They Fit?
Another common issue arises when Directors or Employees claim compensation for loss of office, severance pay, or future notice pay after termination.
Such claims — though contractually valid — do not qualify as ‘employee dues’ for priority under Section 53(1)(b) or (c).This is because they do not represent unpaid wages or salary for services already rendered, but rather compensation for future loss of employment.
As a result:
Severance or notice pay claims are treated as ordinary unsecured debts under Section 53(1)(f) — “remaining debts and dues.”
They rank much lower in the waterfall, below financial and operational creditors.
This distinction is critical for directors and employees to understand: Routine salary and wages (earned) receive preferential treatment, but compensation for loss of office or severance (unearned) does not.
2. Non-Executive or Independent Directors
For non-executive or independent directors, who are not on the company payroll and only receive remuneration or sitting fees, the scenario is different.
They are not considered employees, and therefore, their unpaid remuneration does not qualify as employee dues. Their claims will fall under:
Section 53(1)(f) — “Any remaining debts and dues.”
This is much lower in the waterfall, ranking after unsecured creditors and government dues.
Judicial Perspective
Indian courts and tribunals have recognised this distinction between executive and non-executive directors.
The National Company Law Tribunal (NCLT) and National Company Law Appellate Tribunal (NCLAT) have consistently held that:
A Managing Director or Whole-time Director can be treated as an employee if there is evidence of an employer-employee relationship — such as appointment letters, salary slips, or tax deductions at source (TDS) under the head “salary.”
Independent or non-executive directors are not employees and hence cannot claim priority under Section 53(1)(c).
Severance or loss-of-office compensation is not part of “employee dues” and must be treated as an ordinary unsecured claim.
Key reference cases include:
Vijay Kumar Jain v. Standard Chartered Bank & Ors. (2019) — emphasising role-based classification.
Ghanashyam Mishra & Sons Pvt. Ltd. v. Edelweiss ARC (2021) — clarifying the scope of admitted claims under IBC.
Implication for Startups and Private Companies
For startups and privately held companies in India — where founders wear multiple hats as shareholders, directors, and employees — this distinction has real financial implications during insolvency.
If liquidation occurs:
Founders who are executive directors with valid employment contracts will stand higher in priority (under Section 53(1)(c)).
Founders acting purely as directors/shareholders without employment contracts will rank much lower and are unlikely to recover dues after creditors are paid.
Any severance or compensation for loss of office will rank even lower, as an ordinary unsecured claim.
Thus, it’s prudent for founders to formalise their employment relationships with the company through proper agreements, payroll, and statutory compliances. This not only ensures legal clarity but also provides some degree of protection in case of liquidation.
Conclusion
Under Section 53 of the IBC, a Director who is also an employee falls within the “employee” category for the purpose of liquidation distribution — but only if they can prove a legitimate employer-employee relationship.
Further, since Managing Directors and Whole-Time Directors perform managerial functions, they are not “workmen” under the Industrial Disputes Act, 1947 — hence their dues fall under Section 53(1)(c) (employees other than workmen, for 12 months), not under Section 53(1)(b) (workmen’s dues for 24 months).
Additionally, claims for compensation for loss of office or severance pay are not treated as employee dues; they are ordinary unsecured debts under Section 53(1)(f) and rank much lower in the liquidation priority.
As liquidation scenarios continue to surface across India’s startup ecosystem, understanding where Directors-Employees stand in the IBC waterfall is critical for founders, investors, and insolvency professionals alike.