No Contract of Guarantee Arises from Promoter’s Undertaking to Infuse Funds: Supreme Court

Introduction

In UV Asset Reconstruction Company Limited v. Electrosteel Castings Limited¹, the Supreme Court examined whether a promoter’s undertaking to arrange or infuse funds for a borrower constitutes a contract of guarantee within the meaning of Section 126 of the Indian Contract Act, 1872. The Court also considered the effect of approval of a resolution plan under Section 31 of the Insolvency and Bankruptcy Code, 2016 (“IBC”) on liabilities of third parties.

The Court held that a contractual undertaking by a promoter to arrange infusion of funds for a borrower does not, by itself, amount to a guarantee unless the instrument contains a clear and unequivocal promise to discharge the borrower’s debt to the creditor in the event of default. The Court further reiterated that approval of a resolution plan under Section 31 binds the corporate debtor but does not automatically extinguish liabilities of third-party security providers unless the resolution plan expressly provides for such extinguishment.

Facts

Electrosteel Limited obtained financial assistance of ₹500 crores from SREI Infrastructure Finance Limited pursuant to a sanction letter dated 26 July 2011. Electrosteel Castings Limited, the promoter of the borrower, executed a Deed of Undertaking dated 27 July 2011 containing Clause 2.2, under which the promoter undertook to arrange infusion of funds to ensure that the borrower complied with specified financial covenants.

Subsequently, Electrosteel Limited underwent corporate insolvency resolution proceedings under the IBC. A resolution plan was approved by the adjudicating authority under Section 31 of the Code and implemented. During the course of these events, the financial creditor issued a “no dues” certificate and later assigned certain alleged residual claims to UV Asset Reconstruction Company Limited (“UV ARC”).

UV ARC initiated proceedings under Section 7 of the IBC against Electrosteel Castings Limited, asserting that the promoter’s undertaking constituted a guarantee and that the promoter was therefore liable as a surety for the borrower’s debt.

Both the National Company Law Tribunal (“NCLT”) and the National Company Law Appellate Tribunal (“NCLAT”) held that the promoter’s undertaking did not constitute a guarantee within the meaning of Section 126 of the Contract Act. The matter was carried in appeal before the Supreme Court.

Issues

1. Whether Clause 2.2 of the Deed of Undertaking constituted a contract of guarantee within the meaning of Section 126 of the Indian Contract Act, 1872.
2. Whether approval of the resolution plan under Section 31 of the Insolvency and Bankruptcy Code, 2016 had the effect of extinguishing any liability of the promoter as a third-party security provider.

Arguments

The appellant contended that the promoter’s undertaking to arrange infusion of funds effectively operated as a “see to it” guarantee, whereby the promoter assumed responsibility to ensure that the borrower complied with its financial obligations. According to the appellant, the obligation satisfied the essential elements of a contract of guarantee under Section 126 of the Contract Act. The appellant also argued that the borrower’s debt stood satisfied through the resolution process and restructuring of the debt under the approved resolution plan.

The respondent promoter argued that Section 126 requires a clear promise by the surety to perform or discharge the liability of the principal debtor in the event of default. Clause 2.2 of the Deed of Undertaking merely required the promoter to arrange funds so that the borrower could comply with financial covenants and did not contain any promise to pay the creditor in case of default. The respondent further submitted that approval of a resolution plan under Section 31 of the IBC binds the corporate debtor but does not automatically extinguish liabilities of third parties unless the plan expressly provides for such extinguishment.

Judgment

The Supreme Court dismissed the appeal and affirmed the findings of the NCLT and NCLAT.

The Court observed that Section 126 of the Indian Contract Act, 1872 defines a contract of guarantee as a promise to perform the promise, or discharge the liability, of a third person in case of default. Such a contract necessarily involves three parties: the creditor, the principal debtor, and the surety. For a guarantee to arise, there must be a clear and unequivocal promise by the surety to discharge the debtor’s liability to the creditor upon default.

Upon examining Clause 2.2 of the Deed of Undertaking, the Court held that the clause merely required the promoter to arrange infusion of funds so that the borrower could comply with financial covenants. The clause did not contain any promise by the promoter to pay the lender in the event of default. The undertaking was therefore directed at supporting the borrower’s performance rather than assuming liability to the creditor.

The Court held that such a contractual obligation cannot be construed as a guarantee within the meaning of Section 126, as the essential element of a promise to discharge the creditor’s claim in the event of default was absent.

In addressing the argument based on “see to it” guarantees recognised in English law, the Court observed that the statutory framework under the Contract Act requires a clear undertaking to discharge the debtor’s liability. An obligation merely to arrange funds or facilitate performance does not satisfy this requirement.

With respect to the insolvency proceedings, the Court reiterated that approval of a resolution plan under Section 31 of the IBC renders the plan binding on the corporate debtor and its stakeholders. However, such approval does not automatically discharge or extinguish independent liabilities of third-party security providers or guarantors unless the resolution plan expressly provides for such release.

Analysis

The judgment highlights the importance of precise drafting in financial and security documentation. The Court adopted a strict textual interpretation of Section 126, emphasising that guarantees cannot be inferred merely from commercial context or from support undertakings that lack an explicit promise to discharge the creditor’s claim.

Promoter undertakings to arrange funds are frequently included in loan documentation as a mechanism to ensure liquidity support and covenant compliance by the borrower. However, such undertakings operate primarily as internal support arrangements and do not, in themselves, create liability in favour of the lender unless the instrument expressly provides for a guarantee.

The decision therefore reinforces two important principles for lending and insolvency practice.

First, lenders intending to secure promoter liability must ensure that the documentation clearly creates a guarantee consistent with Section 126 of the Contract Act. Clauses requiring promoters to arrange funds, maintain financial ratios, or support the borrower’s operations will not be treated as guarantees unless they contain an explicit undertaking to discharge the borrower’s debt upon default.

Second, the ruling reiterates the established position under the IBC that approval of a resolution plan does not automatically extinguish liabilities of third-party guarantors or security providers. While resolution plans often address the treatment of guarantees and third-party security interests, such liabilities continue to subsist unless the plan expressly provides for their release or modification.

From a practical perspective, the judgment highlights the need for committees of creditors and resolution applicants to clearly address the treatment of third-party guarantees and security arrangements within the resolution plan in order to minimise the risk of subsequent litigation.

Conclusion

The Supreme Court’s decision clarifies that a promoter’s undertaking to arrange or infuse funds for a borrower does not, by itself, constitute a contract of guarantee under Section 126 of the Indian Contract Act, 1872. A guarantee arises only where the instrument contains a clear and unequivocal promise by the surety to discharge the debtor’s liability to the creditor upon default.

The Court also reiterated that approval of a resolution plan under Section 31 of the Insolvency and Bankruptcy Code, 2016 binds the corporate debtor but does not automatically extinguish independent liabilities of third-party guarantors or security providers unless the resolution plan expressly provides for such extinguishment.

The ruling therefore reinforces the importance of precise drafting in loan documentation and highlights the need for explicit treatment of third-party liabilities in insolvency resolution plans.

1. Civil Appeal No. 9701 of 2024. ↩︎