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– Roopa Somasundaran & Misthi Sharma, MRP Advisory

Introduction

The construction industry operates on a complex web of performance-linked contracts, where risk allocation is primarily managed through contractual security mechanisms such as retention money, performance bank guarantees, and advance payment guarantees. These instruments are intended to safeguard employers against delay, defective workmanship, and non-performance. However, when a construction entity enters insolvency under the Insolvency and Bankruptcy Code, 2016 (“IBC”), these performance securities assume a far more contentious role.

What were once mechanisms of contractual discipline are increasingly repurposed as insolvency tools—shaping asset pools, creditor hierarchies, and recovery outcomes. This raises fundamental legal questions: Does a moratorium under section 14 of the IBC restrain the invocation of performance guarantees? Does retention money form part of the insolvency estate, or is it held in trust for the employer? Can retention money be treated as a “security interest” under the IBC, and if so, in whose favour?

This article critically examines these issues through statutory interpretation and judicial precedent, including Anuj Jain v Axis Bank, State Bank of India v Ramakrishnan, and Gangavaram Port Ltd v Satyam Cement. It argues that the IBC, designed primarily with financial creditors and lending transactions in mind, inadequately accommodates the relational and performance-driven architecture of construction contracts. The result is doctrinal ambiguity, commercial imbalance, and inconsistent outcomes for both employers and contractors.

The Role of Security Mechanisms in Construction Contracts

Retention money—typically ranging between 5% and 10% of the contract value—is withheld from periodic payments to the contractor and released only upon satisfactory completion and defect rectification. In parallel, employers routinely insist on performance and advance payment guarantees to protect against contractor default.

These mechanisms are not merely financial safeguards; they are intrinsic to project execution and risk management in construction. However, the introduction of the IBC’s collective insolvency regime—centred on value maximisation and equitable distribution—has disrupted this equilibrium. While the Code prioritises financial debt resolution, it offers limited guidance on how performance-based securities should be treated during insolvency, creating friction between insolvency law and contract law. 

Performance Bank Guarantees and the Moratorium

Section 14 of the IBC imposes a moratorium on proceedings against the corporate debtor upon commencement of insolvency. However, bank guarantees occupy a unique legal position: they are independent contracts between the issuing bank and the beneficiary.

In State Bank of India v Ramakrishnan, the Supreme Court clarified that the moratorium does not extend to guarantors. By extension, courts have consistently permitted the invocation of performance bank guarantees during insolvency proceedings. From an employer’s perspective, this preserves contractual rights and provides immediate financial protection. From an insolvency standpoint, however, it risks undermining the collective process by depleting value that might otherwise have been preserved for resolution or distribution among creditors.

Thus, while legally defensible, unrestricted invocation of guarantees during moratorium exposes a structural tension between individual contractual enforcement and collective insolvency objectives. 

Retention Money and the Insolvency Estate

Sections 18 and 36 of the IBC distinguish between assets belonging to the corporate debtor and assets held in trust. Retention money, by its very nature, is withheld and contingent upon satisfactory performance. In Gangavaram Port Ltd v Satyam Cement, the NCLAT recognised that retention money is conditional and not immediately payable, suggesting that it may not constitute a straightforward asset of the contractor.

Despite this, the legal status of retention money remains unresolved. It is neither expressly excluded from the insolvency estate nor clearly recognised as trust property. This ambiguity creates practical difficulties: treating retention money as estate property benefits creditors but undermines contractual risk allocation, while treating it as trust property protects employers but may weaken the prospects of resolution.

Can Retention Money Qualify as a Security Interest?

Under sections 3(30) and 3(31) of the IBC, a secured creditor must hold a legally recognised security interest. Retention money undeniably performs a security function, yet it lacks formal classification or statutory recognition.

In Anuj Jain v Axis Bank, the Supreme Court emphasised substance over form when identifying security arrangements. Applying this reasoning, retention money exhibits characteristics akin to a security interest. However, in the absence of explicit statutory recognition, employers are denied secured creditor status, while contractors are left without clarity on entitlement. This doctrinal gap leaves both parties commercially exposed and fuels litigation. 

Structural Tensions and Commercial Consequences

The analysis reveals a deeper structural conflict between insolvency law and construction contracts. Instruments designed to ensure performance are transformed into tools of insolvency risk allocation. Permitting invocation of guarantees during moratorium protects employers but erodes the insolvency estate. Including retention money within the estate favours creditors but compromises contractual fairness.

The creditor-centric framework of the IBC, with its emphasis on financial debt, fails to account for performance-based obligations. This leads to strategic behaviour, discourages timely project completion, disadvantages subcontractors and operational creditors, and increases legal uncertainty and disputes.

Conclusion

The current insolvency framework does not provide balanced or predictable protection to either employers or contractors in respect of retention money and performance securities. The absence of statutory clarity and inconsistent judicial treatment result in inequitable outcomes and commercial instability.

There is a compelling case for targeted reform: recognising construction-specific security mechanisms, clarifying the treatment of retention money, and better aligning insolvency objectives with the realities of performance-based contracts. Without such recalibration, the IBC will continue to strain against the operational and commercial logic of the construction sector, to the detriment of all stakeholders.

References

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