Promoter's Undertaking to Infuse Funds

Source: Supreme Court 

Why in News? 

The bench of Justices Sanjay Kumar and Alok Aradhe in the case of UV Asset Reconstruction Company Limited v. Electrosteel Castings Limited (2025) held that a contractual clause obligating a promoter to arrange infusion of funds into a borrower to meet financial covenants does not amount to a contract of guarantee under Section 126 of the Indian Contract Act, 1872. 

What was the Background of UV Asset Reconstruction Company Limited v. Electrosteel Castings Limited (2025) Case? 

• Electrosteel Limited (ESL) availed financial assistance of Rs. 500 crores from SREI Infrastructure Finance Limited (SREI), vide sanction letter dated 26.07.2011. 
• Electrosteel Castings Limited (ECL), being ESL's promoter, was required to furnish an undertaking to arrange for the infusion of funds to enable ESL to comply with financial covenants. 
• When SREI and ESL executed a Loan Agreement, a clause was incorporated to that effect. 
• ECL executed a Deed of Undertaking dated 27.07.2011, undertaking a limited obligation to arrange for infusion of funds into ESL. 
• In 2017-18, ESL underwent corporate insolvency resolution process under the Insolvency and Bankruptcy Code, 2016. 
• A resolution plan was approved and implemented for ESL. 
• SREI issued an unconditional 'no due certificate' to ESL. 
• Subsequently, SREI claimed that it had been allotted a reduced amount of equity shares upon conversion of balance debt. 
• SREI later assigned its rights on the alleged residual debt in favour of UV Asset Reconstruction Company Limited (the appellant). 
• Claiming residual debt, the appellant approached NCLT, Cuttack with a petition under Section 7 of IBC. 

Proceedings before NCLT and NCLAT: 

• The NCLT dismissed the petition on two grounds: (i) ECL was not a guarantor in respect of financial facilities availed by ESL and, therefore, no financial debt was owed by ECL, and (ii) the conversion of ESL's debt into equity under resolution plan resulted in extinguishment of any liability of ECL. 
• In appeal, the NCLAT held that ECL was not a guarantor for financial facilities availed by ESL. 
• However, NCLAT also observed that approval of the resolution plan extinguished debts only qua ESL, and not third-parties, unless specifically provided. 
• The appeal was dismissed on the ground that ECL was not ESL's guarantor. 
• Aggrieved by the findings, both parties approached the Supreme Court. 

What were the Court's Observations? 

• The Court stated "The clause neither records an undertaking to discharge the debt owed to the creditor nor does it contemplate payment to the lender in the event of the default. The clause contains a promise, not to the creditor to pay the debt upon default, but to the borrower to facilitate compliance with Financial Covenants." 
• The Court emphasized "An undertaking to infuse funds into a borrower, so that it may meet its obligations cannot, by itself be equated with the promise to discharge the borrower's liability to the creditor. A mere Covenant to ensure financial discipline or infusion of funds does not satisfy the statutory requirements of Section 126 of the Act." 
• The Court referred to other documents as well, including the sanction letter, to note that there was no "guarantee" furnished by ECL. 
• The Court concurred with the findings of NCLT and NCLAT that Clause 2.2 of the Deed of Undertaking did not constitute a contract of guarantee and that ECL could not be treated as guarantor for the financial facilities availed by ESL. 
• Accordingly, the appeal was dismissed. 
• In a connected appeal filed by ECL, the Court observed that the Resolution Plan did not provide the financial creditors, including SREI, with the full value of unsustainable debt of ESL. 
• The Court held that the approval of the Resolution Plan of ESL did not result in extinguishment of entire debt, so as to bar any claim against the ECL as a security provider/third-party surety. 
• Accordingly, ECL's appeal qua NCLAT's finding was dismissed. 

What is Section 126 of the Indian Contract Act, 1872? 

About:  

• Section 126 of the Indian Contract Act, 1872 provides that a "contract of guarantee" is a contract to perform the promise, or discharge the liability, of a third person in case of his default. 
  • Guarantee means to give surety or assume responsibility. It is an agreement to answer for the debt of another in case he makes default. 
• Three parties are involved in the contract of guarantee.  
  • Surety: The person who gives the guarantee is called the surety. The liability of the surety is secondary, i.e., he has to pay only if the principal debtor fails to discharge his obligation to pay. 
  • Principal debtor: The person in respect of whose default the guarantee is given is the principal debtor. 
  • Creditor: The person to whom the guarantee is given called the creditor. 
• A guarantee is either in the format of writing or of oral.   
• This contract lets the principal debtor to avail employment, loan or goods on credit and the surety would ensure repayment in case of any default in the part of the debtor. 
• Example 
  • Mohan takes loan of Rs. 5 lakhs from the UCO Bank of Lucknow University Branch. Sohan promises to UCO Bank that if Mohan fails to rupee the loan timely then, Mohan will pay. This is a contract of guarantee and Mohan is Principal debtor UCO Bank is creditor and Sohan is surety. 

Essentials of Contract of Guarantee: 

1. The contract can be either oral or in writing. Nevertheless, the assurance contract can only be in writing in English law. 
2. The guarantee contract presumes a principal liability or a discharge duty on the part of the principal debtor. Even if there is no such principal liability, one party agrees to pay another under such situations, and the enforcement of this obligation is not contingent on anyone else's default, it is an indemnity contract. 
3. Sufficient consideration is to support the principal debtor. It is not necessary to have clear consideration between the creditor and the assurance that it is appropriate that the creditor has done anything for the good of the principal debtor. 
4. Assurance consent cannot be obtained by misrepresentation or cover of any material information relating to the transaction.

Section 128 of the ICA:

• Section 128 of the Indian Contracts Act, 1872 states the liability of the surety is co-extensive with that of principal debtor, unless it is otherwise provided by the contract. 
• Surety's liability is the same as that of the principal debtor.  
• A creditor can move directly against the surety.  
• Without suing the principal debtor, a creditor may sue the surety directly.  
• Surety is liable to make payment immediately after the default of any payment by the principal debtor. 
• Primary responsibility for making payment, however, is from the principal debtor, and the responsibility of the surety is secondary. In fact, if the principal debtor cannot be held liable for any payment due to any document error, then surety is not responsible for such payment as well.  

Continuing Guarantee 

• Section 129 of the ICA deals with continuing Guarantee 
• One form of guarantee that extends to a series of transactions is a continuing guarantee.  
• A continuing guarantee extends to all transactions that the principal debtor enters into before the surety revokes it.  
• A continuing guarantee for future transactions may be withdrawn at any time by notice to the creditors. However, the responsibility of a surety for transactions completed prior to such revocation of guarantee is not diminished.