Introduction
In a significant ruling clarifying the scope of contracts of guarantee under Section 126 of the Indian Contract Act, 1872, the Supreme Court has held that a promoter’s undertaking to arrange or infuse funds into a borrower company does not amount to a contract of guarantee. The Court further clarified that approval of a resolution plan under the Insolvency and Bankruptcy Code, 2016 (IBC) does not automatically extinguish unsustainable debt against third-party security providers or sureties, unless the resolution plan expressly provides for such extinguishment.
The judgment, delivered in UV Asset Reconstruction Company Limited v. Electrosteel Castings Limited (Civil Appeal No. 9701/2024), has far-reaching implications for financial creditors, promoters, asset reconstruction companies, and insolvency practitioners, particularly in distinguishing between financial covenants and contracts of guarantee.
Background of the Case
Electrosteel Limited (ESL) availed financial assistance of ₹500 crores from SREI Infrastructure Finance Limited through a sanction letter dated 26 July 2011. Electrosteel Castings Limited (ECL), the promoter of ESL, executed a Deed of Undertaking whereby it agreed to arrange infusion of funds into ESL to enable compliance with certain financial covenants under the loan agreement.
Notably, ECL did not execute a formal deed of guarantee in favour of the lender. Instead, its obligation was limited to ensuring financial discipline by facilitating infusion of funds into the borrower company.
In 2017–18, ESL underwent Corporate Insolvency Resolution Process (CIRP) under the IBC. A resolution plan was approved, and SREI issued an unconditional “no dues certificate” to ESL. Subsequently, SREI assigned its alleged residual debt to UV Asset Reconstruction Company Limited, which initiated proceedings against ECL, claiming it to be a guarantor.
Proceedings Before NCLT and NCLAT
The National Company Law Tribunal (NCLT), Cuttack dismissed the application under Section 7 of the IBC on two grounds:
- ECL was not a guarantor under Section 126 of the Indian Contract Act, and
- The approval of the resolution plan resulted in extinguishment of liability.
On appeal, the NCLAT agreed that ECL was not a guarantor, but clarified that approval of a resolution plan does not automatically extinguish liabilities of third parties, unless specifically stated. Both parties approached the Supreme Court, leading to the present judgment.
Issues Before the Supreme Court
The Supreme Court framed two central issues:
- Whether ECL could be treated as a guarantor for the financial facilities availed by ESL under Section 126 of the Indian Contract Act?
- Whether conversion of ESL’s debt into equity under the resolution plan extinguished any liability of ECL, assuming it was a third-party security provider?
Interpretation of Section 126 of the Indian Contract Act
Section 126 defines a contract of guarantee as a contract to perform the promise, or discharge the liability, of a third person in case of his default. The Court emphasised that the essence of a guarantee is a clear, direct, and unambiguous obligation on the part of the surety to discharge the debt of the principal debtor.
The Court observed that merely agreeing to arrange funds or enable the borrower to meet its obligations does not amount to a promise to pay the creditor upon default.
“See to It” Guarantee Explained
The Supreme Court drew a distinction between a “see to it” guarantee under English common law and the statutory requirement under Section 126. It held:
A “see to it” guarantee obligates the guarantor to ensure that the principal debtor performs its obligation. However, it does not include an obligation to enable the debtor to perform, and therefore does not qualify as a guarantee under Section 126.
Thus, an undertaking that merely facilitates compliance with financial covenants falls short of a statutory guarantee.
Court’s Key Observations
After analysing the Deed of Undertaking, sanction letter, and loan agreement, the Court concluded:
- The clause in question did not record any undertaking to discharge the debt owed by ESL.
- There was no promise to pay the lender in the event of default.
- The obligation was towards the borrower, not the creditor.
- A covenant to infuse funds or maintain financial discipline does not satisfy the ingredients of a contract of guarantee.
The Court categorically held:
“An undertaking to infuse funds into a borrower, so that it may meet its obligations, cannot be equated with a promise to discharge the borrower’s liability to the creditor.”
Effect of Resolution Plan on Third-Party Liability
In the connected appeal, the Supreme Court clarified an important aspect of insolvency law. It held that approval of a resolution plan under the IBC does not automatically extinguish unsustainable debt against third-party security providers or sureties, unless the plan explicitly provides for such extinguishment.
However, since ECL was not a guarantor at all, this principle did not assist the appellant. The Court therefore dismissed both appeals.
Final Decision
The Supreme Court upheld the findings of the NCLT and NCLAT and held that:
- Promoter’s undertaking to infuse funds is not a guarantee under Section 126 of the Indian Contract Act.
- ECL cannot be treated as a guarantor for the financial facilities availed by ESL.
- Resolution plans do not automatically extinguish third-party liabilities, unless expressly stated.
Accordingly, all appeals were dismissed.
Significance of the Judgment
This judgment is crucial for:
- Promoters, who often provide comfort undertakings without intending to assume personal liability;
- Financial creditors and ARCs, who must carefully distinguish between guarantees and covenants;
- Insolvency professionals, in assessing claims against third parties post-resolution.
The ruling reinforces that guarantee obligations cannot be implied and must strictly comply with the statutory requirements of Section 126.
Conclusion
The Supreme Court’s decision in UV Asset Reconstruction Company Ltd. v. Electrosteel Castings Ltd. brings much-needed clarity to the law on contracts of guarantee and the effect of resolution plans on third-party liabilities. By drawing a clear line between financial covenants and guarantees, the Court has strengthened contractual certainty and prevented unwarranted extension of liability on promoters without explicit consent.
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