Does an obligation to arrange fund infusion in a deed of undertaking amount to a contract of guarantee under Section 126 of the Indian Contract Act?

Summary

Practical Impact

What’s New / What Lawyers Should Note

• Clarifies that an undertaking to arrange for infusion of funds into a borrower does not, by itself, constitute a contract of guarantee under Section 126.
• Affirms that a guarantee must be a direct promise to the creditor to discharge the debt on default, not merely a covenant to help the principal debtor comply.
• Emphasises the importance of contemporaneous security documents (sanction letter, information memorandum, audited accounts) in construing guarantee obligations.
• Confirms that voluntary payments by a promoter do not create a guarantee where none was contractually agreed.

Summary of Legal Reasoning

1. Statutory definition: Section 126 mandates a direct and unambiguous undertaking by the surety to the creditor to discharge the third party’s liability on default.
2. Contractual construction: Guarantees, though mercantile contracts, are construed to give effect to parties’ real intentions, not via technical semantics.
3. Clause analysis: Clause 2.2 obligates the promoter to arrange fund infusion for the borrower, with no obligation to pay the lender on default.
4. Contemporaneous documents: Sanction letter, loan agreement schedules, assignment agreement and audited statements confirm absence of any guarantee.
5. “See-to-it” distinction: English law’s “see-to-it” guarantee requires breach upon principal’s default, but still involves a promise to the creditor—absent here.
6. Voluntary payment: ₹38 crore paid by the promoter to the lender was discretionary and cannot create a statutory guarantee post-hoc.

Arguments by the Parties

Petitioner (Asset Reconstruction Company)

• Clause 2.2 meets Section 126: a two-step “see-to-it” guarantee obliging fund infusion and remedying default.
• Reliance on House of Lords and Court of Appeal authorities endorsing “see-to-it” guarantees.
• Promoter’s admissions in earlier litigations estop it from denying guarantee status.
• Letters evidencing payment of ₹38 crore reinforce guarantee obligation.
• NCLAT erred in treating sanction letter and information memorandum as conclusive.

Respondent (Promoter)

• Clause 2.2 is a mere covenant to arrange funding, not a promise to the lender to pay on default.
• Sanction letter did not require any corporate guarantee; contemporaneous documents confirm this.
• “See-to-it” guarantee is not recognized under Indian law.
• Payment of ₹38 crore was voluntary, in capacity as promoter, not under any contractual guarantee.
• Admissions in different contexts cannot be read in isolation or out of context.

Factual Background

In July 2011 a corporate borrower availed ₹500 crore from a financier, secured by a demand promissory note and cheques. Its promoter furnished a deed of undertaking (Clause 2.2) to arrange fund infusion for compliance with financial covenants but no guarantee was stipulated. The financier’s rights were later assigned to an asset reconstruction company, which invoked Section 7 of the Insolvency and Bankruptcy Code claiming corporate guarantee liability. Both NCLT and NCLAT held the promoter was not a guarantor; the Supreme Court dismissed the appeal.

Statutory Analysis

• Section 126, Indian Contract Act, 1872: defines “contract of guarantee” as a promise by a surety to perform or discharge a third party’s liability on default.
• Essential elements:
  • Existence of principal debt
  • Default by principal debtor
  • A promise to the creditor to discharge that debt
• Clause 2.2 lacks any direct promise to the creditor; it only obliges the promoter to infuse funds into the borrower to meet covenants.
• No “reading down” or “reading in” was applied; clause fails the statutory test as held by Supreme Court.

Alert Indicators

• ✔ Precedent Followed – Affirms established guarantee-construction principles under Section 126.