Contractual Nuance vs. Statutory Mandates: Interpreting Guarantees under the Indian Contract
The Supreme Court of India (‘Court’) in UV Asset Reconstruction Company Limited v. Electrosteel Castings Limited, Civil Appeal No. 9701/2024, has delivered a critical judgment clarifying the legal boundaries between a Deed of Undertaking and a Contract of Guarantee under Section 126 of the Indian Contract Act, 1872 (‘Act’). The Court’s decision underscores that mere commercial nomenclature and internal funding arrangements do not satisfy the rigorous legal requirements of a guarantee.
Factual Background
The dispute arose from a financial arrangement involving three primary parties: SREI Infrastructure Finance Limited (‘SREI’), Electrosteel Steels Limited (‘ESL’), and Electrosteel Castings Limited (‘ECL’), who functioned as the promoter and obligor . Vide a tripartite agreement and the foundational sanction letter dated 26.07.2011, SREI extended financial assistance of INR 500 crores to ESL . SREI was the original creditor, which subsequently assigned all its rights and interest in favour of UV Asset Reconstruction Company Limited (‘ARC’). Under the terms of this sanction letter, the primary security for the facility was restricted to a demand promissory note and post-dated cheques. The original sanction letter did not stipulate any requirement for a personal or corporate guarantee from ECL.
On the same date, SREI and ESL executed a Rupee Loan Agreement. Clause (d) (3) of Schedule 4 to the said loan agreement required ECL, as the promoter, to furnish an undertaking to arrange for the infusion of funds into the borrower to ensure compliance with stipulated financial covenants. In pursuance thereof, ECL executed a Deed of Undertaking, Warranty, and Indemnity dated 27.07.2011 (‘Undertaking’). Clause 2.2 of this Undertaking mandated that in the event the borrower was unable to comply with the financial covenants ECL would arrange for the infusion of funds into ESL to enable the borrower to meet its obligations. Subsequently, on 21.11.2011, ESL, ECL, and SREI entered into a supplementary agreement amending the facility agreement and the security package. Under the revised terms, ECL offered a first mortgage on its land situated at Elavur Village to SREI as security for the repayment and discharge of the financial assistance by ESL .
On 27.06.2017, State Bank of India filed an application for initiating corporate insolvency resolution process under Section 7 of the Insolvency and Bankruptcy Code, 2016 (‘Code’), against ESL before NCLT Kolkata. This application was admitted on 20.07.2017. Vide order dated 17.04.2018, the NCLT Kolkata approved the resolution plan submitted by Vedanta for the acquisition of ESL. The acquisition was executed for a total consideration of INR 12,719.14 crores, consisting of an upfront cash payment of INR 5,320.00 crores and the conversion of the remaining balance into equity shares . Upon implementation of the resolution plan, SREI issued an unconditional certificate to ESL confirming that the dues owned by ESL were fully discharged. However, SREI later claimed it had been allotted a reduced number of shares upon the conversion of the debt. On 30.06.2018, SREI executed a Deed of Assignment in favour of ARC.
ARC filed an application under Section 7 of the Code before NCLT Cuttack, asserting that a residual financial debt remained payable and that ECL had furnished a corporate guarantee . On 24.06.2022, the NCLT dismissed the petition, finding that ECL was not a guarantor and that the conversion of debt into equity extinguished the liability . Aggrieved by this dismissal ARC preferred an appeal before the NCLAT. In its judgment dated 24.01.2024, the NCLAT framed two specific issues: (a) whether ECL was a guarantor to SREI and (b) whether the approval of the resolution plan extinguished the entire debt so as to bar claims against ECL as a guarantor or third-party surety. The NCLAT resolved the first issue in the negative and that ECL could not be construed as a guarantor under Clause 2.2 of the Deed of Undertaking . Regarding the second issue, the NCLAT held that the resolution plan extinguished the debt specifically for the corporate debtor, ESL, alone. Extinguishment did not extend to third parties unless expressly provided in the plan. The appeal was dismissed on the primary finding that ECL was not a guarantor, which ultimately lead to the filing of the present appeal before the Supreme Court by ARC.
Arguments lead by the parties
Senior counsel for ARC contended that Clause 2.2 of the Undertaking satisfied the requirements of a contract of guarantee as defined under Section 126 of the Act. It was submitted that Clause 2.2 envisaged ECL discharging the obligation to infuse funds upon ESL’s default in complying with financial covenants. It was argued that this involved a two-step process: (a) funding ESL, and second and (b) eliminating the default breach. The agreement was characterised as a “See to it” guarantee, with reliance placed on precedents from the House of Lords inMoschi vs. Lep Air Services Ltd12 WLR 1175 along with the Court of Appeal in Associated British Ports vs. Ferryways2[2009] EWCA Civ. 189 and Shanghai Shipyard Co. Ltd. vs. Reignwood International Investment (Group) Co. Ltd.3[2021] EWCA Civ. 1147.
Senior counsel for ARC also pointed to letters dated 30.06.2017 and 20.07.2017 sent by ESL to SREI, which evidenced a payment of INR 38 crores by ECL to SREI. It was argued that this payment reinforced the existence of a guarantee obligation, as it demonstrated ECL actively discharging the borrower’s liability under the terms of the Undertaking. It was further argued that ECL had admitted its status as a guarantor in previous pleadings before the Madras High Court4CSD No. 18692 of 2019 and the Supreme Court5Civil Appeal No. 6669 of 2021, and was therefore stopped from taking a contrary stand based on Nagindas Ramdas vs. Dalpatram Ichharam and Ors.6(1974) 1 SCC 242 and Mumbai International Airport Pvt. Ltd. vs. Golden Chariot Airport and Ors7(2010) 10 SCC 422.
In response, ECL submitted that Clause 2.2 was confined to an obligation to facilitate fund infusion and could not be construed as a guarantee under Section 126 of the Act. It was argued that “See to it” guarantees find no place under the statutory framework or Indian common law. The payment of INR 38 crores was stated to have been made voluntarily by ECL as a promoter, and not in discharge of any contractual obligation. It was argued that pleadings are required to be read holistically and not in isolation. The pleading relied upon arose from proceedings for enforcement of the mortgage security furnished by ECL, in which any guarantee extended was expressly limited to the secured property and did not amount to a personal guarantee
Issues
1. Whether Clause 2.2 of the Undertaking constituted a valid Contract of Guarantee under Section 126 of the Act ?
Analysis
The Court analyzed the essential ingredients of a guarantee under Section 126 of the Indian Contract Act viz the existence of a principal debt, a default, and a promise by the surety to discharge the liability of the principal debtor to the creditor . The Court emphasized that a guarantee is a promise to answer for the payment of some debt in case of failure of another party who is primarily liable, relying on Conley (Re), ex p Trustee vs. Barclays Bank Ltd8(1938) 2 All ER 127. It requires a specific undertaking or unambiguous affirmation to discharge the liability of a third person.
The Court observed that Clause 2.2 contained a promise to the borrower to facilitate compliance, not a promise to the creditor to pay the debt upon default . An undertaking to infuse funds into a borrower cannot be equated with a promise to discharge the borrower’s liability to the creditor . The Court clarified that under Indian law, a “See to it” guarantee does not include an obligation to enable the principal debtor to perform its own obligation. Under English common law, a “see to it” guarantee imposes a duty on the guarantor to ensure that the principal debtor itself performs its obligation. Consequently, the guarantor’s liability arises immediately upon the principal debtor’s failure to perform, even though the guarantor is not required to perform the underlying obligation in place of the debtor.
The lack of intent to create a guarantee was reinforced by contemporaneous documents, including the sanction letter, which contained no requirement for a guarantee, and the Assignment Agreement, which explicitly reflected “Nil” against guarantor details. The Court also dismissed the argument that a payment of INR 38 crores by ECL evidenced a guarantee, noting it was made in its capacity as a promoter, not under a contractual obligation of guarantee. Regarding the admission of status in other pleadings, the Court found the reliance on Nagindas Ramdas vs. Dalpatram Ichharam9Supra 6, and Mumbai International Airport Pvt. Ltd. vs. Golden Chariot Airport10Supra 7, to be misconceived as they were inapplicable to the specific facts of this case.
Verdict
The Supreme Court affirmed the findings of the NCLT and NCLAT, concluding that Clause 2.2 of the Undertaking did not constitute a contract of guarantee and ECL could not be treated as a guarantor for the financial facilities. Finding no infirmity in the impugned judgment that would warrant interference, the Court dismissed the appeal with no order as to costs.
Conclusion
The judgment clearly holds that an undertaking by a promoter to arrange funds or support the borrower cannot be treated as a contract of guarantee unless there is a clear promise to the creditor to pay the debt on default. The Supreme Court has reaffirmed that liability as a guarantor must strictly satisfy the requirements of Section 126 of the Indian Contract Act and cannot be assumed from surrounding circumstances or later conduct. Considering the language of the documents and the security originally agreed upon, the Court has clarified that commercial support arrangements and contracts of guarantee are legally distinct and can create enforceable obligations only when this distinction is clearly and expressly made.
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