Corporate Restructuring, Valuation and Insolvency · Winding-up by Tribunal under the Companies Act, 2013

Preferential Payments, Insolvency Rules and Priority of Debts in Winding Up

Updated 11 October 2026 · Fact-checked

In winding up by the Tribunal, section 326 puts workmen's dues first. Within them, wages, salary, Industrial Disputes Act compensation and holiday remuneration for two years (or other prescribed period) rank above secured creditors. Section 327 then pays government dues and employee claims, ahead of floating-charge debentures. Sections 326 and 327 do not apply to IBC liquidation.

Understand Preferential Payments, Insolvency Rules and Priority of Debts

When a company is wound up, its assets are rarely enough to pay everyone. The law therefore decides who is paid first. Knowing this order is the core of the topic.

Section 325 used to apply insolvency rules to winding up of insolvent companies. It has been omitted by the Insolvency and Bankruptcy Code, 2016 with effect from 15-11-2016. So do not write that insolvency rules apply through section 325. Say it is omitted, and that insolvent companies now go through the Code.

Section 326 is headed overriding preferential payments. In winding up under the Companies Act, workmen's dues, and the secured creditor's shortfall where applicable, are paid in priority to all other debts. Part of the workmen's dues gets a special top rank under the proviso. These are the sums in Explanation clause (b)(i) and (ii): wages or salary (including commission) and compensation under the Industrial Disputes Act, 1947, and accrued holiday remuneration. They count if payable for two years preceding the winding up order, or such other period as may be prescribed. They are paid in priority to all other debts, including debts due to secured creditors. They are paid within thirty days of sale of assets and are subject to the prescribed charge over the security of secured creditors.

Under section 326(2), these proviso sums are paid in full before any payment is made to secured creditors. The proviso sums are part of workmen's dues, not a separate group. After they are paid, the balance of the workmen's dues is paid pari passu with the secured creditor's shortfall or workmen's portion. These are paid in full. If the assets are insufficient, they abate in equal proportions.

A secured creditor who has realised his security but could not recover everything ranks pari passu with workmen's dues. His claim is limited to the unrealised amount or the workmen's portion in his security, whichever is less.

Section 327 lists the ordinary preferential payments. These are:

taxes, revenues, cesses and rates due to the Government or a local authority, which became due within twelve months before the relevant date;
wages or salary of employees, due for not more than four months within those twelve months;
accrued holiday remuneration of employees;
ESI and similar employer contributions for twelve months;
compensation dues under the Workmen's Compensation Act, 1923 for death or disablement of an employee;
sums due to employees from the provident, pension, gratuity or welfare funds;
investigation expenses.

The Explanation says an employee does not include a workman. So the wage, holiday remuneration, compensation and fund items in section 327 cover employees other than workmen. The workmen's equivalents are in section 326 and its Explanation clause (b).

Section 327 debts rank subject to section 326. Under section 327(3)(b), they have priority over debenture holders under a floating charge if the assets available for general creditors are insufficient. This priority is not given over secured creditors holding a fixed charge.

Section 324 supports this by allowing all debts and claims, present or future, certain or contingent, to be proved. A just estimate is made of contingent claims or claims sounding only in damages. Finally, section 327(7) says sections 326 and 327 do not apply to liquidation under the IBC, which has its own waterfall.

Key rules to remember

Workmen's portion of security: Workmen's portion = Value of security × Workmen's dues ÷ (Workmen's dues + Debts due to secured creditors); This is the proportion in the Explanation to section 326. Illustration: ₹1,00,000 × 1,00,000 ÷ 4,00,000 = ₹25,000.
Secured creditor's pari passu claim: Claim = lesser of (unrealised secured debt) and (workmen's portion in his security); Applies under section 326(1)(b) where the secured creditor has realised the secured asset. It ranks pari passu with workmen's dues.
Order of payment under section 326: Step 1: proviso sums (part of workmen's dues under Explanation clause (b)(i) and (ii), payable for two years, or such other prescribed period, preceding the winding up order) are paid in full in priority to all other debts, including secured creditors, subject to the prescribed charge over secured creditors' security → Step 2: the balance of workmen's dues and the secured creditor's shortfall or workmen's portion (whichever is less) are paid pari passu in full; Section 326(1) proviso and 326(2). The proviso sums are wages or salary (including commission) and compensation under the Industrial Disputes Act, 1947, and accrued holiday remuneration, all due to workmen. They are paid within thirty days of sale of assets and before any payment to secured creditors. If assets are insufficient for the Step 2 debts, they abate in equal proportions.
Section 327 debts among themselves: Rank equally; paid in full, else abate in equal proportions; Section 327(3)(a). Under section 327(3)(b), they also rank ahead of debentures under a floating charge if the assets for general creditors are insufficient. They do not rank ahead of fixed-charge secured creditors.
Relevant date: Date of appointment (or first appointment) of a provisional liquidator; if none, date of winding up order; Section 327 Explanation (c). Used to count the twelve-month and four-month periods.
Scope limit: Sections 326 and 327 do not apply to liquidation under the IBC; Section 327(7). Section 325 stands omitted.

How to solve Preferential Payments, Insolvency Rules and Priority of Debts questions

Use this sequence for any problem or theory question on priority of payments in winding up by the Tribunal.

1Identify the mode: winding up by the Tribunal under the Companies Act, or liquidation under the IBC. If IBC, state that sections 326 and 327 do not apply.
2Note that section 325 is omitted and insolvent companies are dealt with under the Code.
3List every claim: workmen's dues, secured creditors (fixed or floating charge), government taxes, employee wages, other funds, unsecured creditors. Separate workmen from other employees.
4Fix the relevant date and check the time limits, such as taxes due within twelve months and employee wages for not more than four months within those twelve months.
5Apply section 326 first: pay the proviso sums (workmen's wages or salary and Industrial Disputes Act compensation, and accrued holiday remuneration, payable for two years preceding the winding up order or such other prescribed period) ahead of secured creditors. Then pay the balance of workmen's dues and the secured creditor's shortfall or workmen's portion, whichever is less, pari passu.
6Then apply section 327 for the other preferential debts, ranking them equally and abating proportionately if short. Remember they rank ahead of floating-charge debenture holders only, not fixed-charge secured creditors.
7Pay general creditors from what remains, and compute any abatement in proportion.
8Write a conclusion stating who is paid, how much, and why.

Quickest way: Three-tier ladder

When to use it: Use this when the question lists many creditors and gives little time.

Tier 1: section 326. Proviso sums (part of workmen's dues, for two years or other prescribed period) first, even above secured creditors. Then the balance of workmen's dues plus the secured creditor's shortfall, pari passu.
Tier 2: section 327 debts, equal among themselves, subject to tier 1. They beat floating-charge debenture holders only (section 327(3)(b)), not fixed-charge secured creditors.
Tier 3: everyone else.
Keep fixed-charge secured creditors outside tiers 2 and 3. They stand on their own security, subject to the section 326 proviso charge.
Compute workmen's portion with the ratio formula only if a secured creditor has realised security.
Close by naming the section for each tier.

Common mistakes in Preferential Payments, Insolvency Rules and Priority of Debts

Saying section 325 applies insolvency rules to winding up of insolvent companies.
Older books and the section heading still show the old rule.
Fix: State that section 325 is omitted by the IBC, 2016 with effect from 15-11-2016.
Applying sections 326 and 327 to IBC liquidation.
Students mix the Companies Act and Code waterfalls.
Fix: Quote section 327(7): these sections do not apply to liquidation under the IBC.
Giving the secured creditor his whole unpaid debt pari passu with workmen.
The words 'whichever is less' are missed.
Fix: Take the lesser of the unrealised debt and the workmen's portion in his security.
Treating workmen and employees as the same under section 327.
Both words appear in the section.
Fix: Remember the Explanation: employee does not include a workman. Workmen's wages, holiday remuneration, compensation and fund dues are dealt with under section 326 and its Explanation. Section 327 items (b), (c), (e) and (f) cover employees other than workmen.
Ignoring time limits and the relevant date.
Students focus only on the list of debts.
Fix: Check that taxes became due within twelve months and employee wages relate to not more than four months within the twelve months before the relevant date.

Worked examples

Example 1

A secured creditor holds security worth ₹1,00,000. Workmen's dues are ₹1,00,000. Debts due to secured creditors total ₹3,00,000. Find the workmen's portion in this security.

Show the solution

Aggregate of workmen's dues and secured debts = 1,00,000 + 3,00,000 = ₹4,00,000.
Proportion = 1,00,000 ÷ 4,00,000 = one-fourth.
Workmen's portion = ₹1,00,000 × 1/4 = ₹25,000.

Answer: The workmen's portion is ₹25,000, as in the illustration under section 326.

Example 2

Aarav Textiles Ltd is being wound up by the Tribunal. Can its liquidator rely on section 325 to apply insolvency rules, and who is paid first?

Show the solution

Section 325 has been omitted by the IBC, 2016 w.e.f. 15-11-2016, so it cannot be relied on.
Under section 326, workmen's dues are paid in priority to all other debts, with the secured creditor's shortfall pari passu where applicable.
Next, section 327 debts such as taxes due within twelve months, employee wages and fund dues are paid, ranking equally.
Remaining assets go to other creditors.
If the winding up were an IBC liquidation, sections 326 and 327 would not apply.

Answer: Section 325 cannot be relied on. Workmen's dues rank first under section 326, then section 327 debts, then other creditors.

Exam tips

Open with the fact that section 325 is omitted. It shows the examiner you know the current law.
Draw the ladder in your answer: section 326, section 327, then others.
Quote the illustration figures of ₹1,00,000, ₹3,00,000 and ₹25,000 only as an example.
Always link the answer to section 327(7) when a question mentions IBC.
Write the conclusion in one clear line naming the order.

Practice questions from Winding-up by Tribunal under the Companies Act, 2013

Preferential Payments, Insolvency Rules and Priority of Debts: frequently asked questions

Is section 325 of the Companies Act, 2013 still in force?

No. Section 325 is omitted by the Insolvency and Bankruptcy Code, 2016 with effect from 15-11-2016. Insolvent companies are dealt with under the Code.

What does section 326 give priority to?

It gives overriding priority to workmen's dues in winding up under the Act. A secured creditor who realised his security ranks pari passu for the lesser of his unrealised debt and the workmen's portion.

Do sections 326 and 327 apply in IBC liquidation?

No. Section 327(7) says they do not apply in liquidation under the Insolvency and Bankruptcy Code, 2016.

How do preferential debts rank under section 327?

They rank equally among themselves and are paid in full. If assets are insufficient, they abate in equal proportions.