The code for determining which Vaults get liquidated lives within the vaultFactory. This code deals with ordering Vaults for liquidation, passing them to an auctioneer, burning IST raised for debt, and distributing additional penalties, proceeds, and/or shortfall to the reserve and/or to vault holders.
The Vault Manager distributes proceeds, penalties, and/or shortfall to the protocol reserve and possibly back to vault holders depending on the results of the specific liquidation. For more detail, see: