Supreme Court: Scope Of Guarantees And Third-Party Rights Under The Insolvency And Bankruptcy Code, 2016

The Supreme Court of India (“SC”) in UV Asset Reconstruction Company Limited v. Electrosteel Castings Limited, 2026 INSC 14, held that an undertaking by a promoter to infuse funds into a borrower to ensure its compliance with financial covenants under the loan agreement does not constitute a contract of guarantee under Section 126 of the Indian Contract Act, 1872 (“Indian Contract Act”), and that approval of a resolution plan under the Insolvency and Bankruptcy Code, 2016 (“IBC”) does not, by itself, extinguish a financial creditor's rights against third-party security providers where such rights are expressly preserved in the resolution plan.

Factual Background

Electrosteel Steels Limited (“ESL”) availed financial assistance of INR 500,00,00,000 (Indian Rupees five hundred crore) (“Loan”) from SREI Infrastructure Finance Limited (“SREI”) pursuant to a sanction letter and addendum to the sanction letter dated July 26, 2011 (“Sanction Letter”). Under the Sanction Letter, the security for the Loan comprised a demand promissory note, post-dated cheques, and additional security in the form of subservient charge over movable and project assets of ESL. A rupee loan agreement was also executed between SREI and ESL on July 26, 2011 (“Loan Agreement”). Clause (d)(3) of Schedule 4 to the Loan Agreement required ECL to furnish an undertaking to infuse funds into ESL to enable ESL to comply with financial covenants under the Loan Agreement and other financing documents pertaining to the Loan.

Pursuant thereto, ECL executed a deed of undertaking, warranty and indemnity dated July 27, 2011, whereby it undertook a limited obligation to arrange for infusion of funds into ESL (“Deed of Undertaking”). Clause 2.2 of the Deed of Undertaking provided as follows:

“2.2. In the event the Borrower is not in a position to comply with the Financial Covenants in the Financing Documents, or has breached such Financial Covenants, the Obligors will arrange for the infusion of such amount of fund into the Borrower such that the Borrower is in a position to comply with the abovementioned Financial Covenants.”

Subsequently, on November 21, 2011, ESL, ECL and SREI entered into a supplementary agreement amending the Loan Agreement and security package, under which ECL created an equitable mortgage by deposit of title deeds (in favour of SREI) over its land and factory building, together with all benefits and advantages accruing thereon, situated at Tamil Nadu, to secure repayment of the Loan availed by ESL.

On July 20, 2017, an application under Section 7 of the IBC was admitted against ESL and vide  an order dated April 17, 2018, the National Company Law Tribunal (“NCLT”) approved a resolution plan submitted by Vedanta Limited (“Resolution Plan”) for acquisition of ESL.

Upon implementation of the Resolution Plan, SREI issued an unconditional no-dues certificate to ESL. Thereafter, SREI claimed that it had been allotted a reduced number of shares upon conversion of the balance debt and, accordingly, on June 30, 2018, executed a deed of assignment in favour of UV Asset Reconstruction Company Limited (“UV ARC”) to assign the alleged residual debt, pursuant to which UV ARC became the lender in respect of such amount.

UV ARC thereafter filed an application under Section 7 of the IBC before the NCLT, Cuttack, asserting that (a) a residual financial debt remained payable by ESL; and (b) ECL had furnished a corporate guarantee for the debt of ESL.

The NCLT dismissed such section 7 application vide  an order dated June 24, 2022, holding that the conversion of ESL's debt into equity under the Resolution Plan resulted in extinguishment of any liability, and that ECL was not a guarantor to SREI for the Loan.

UV ARC thus preferred an appeal before the National Company Law Appellate Tribunal (“NCLAT”). The NCLAT, in its judgment dated January 24, 2024, framed two issues: (i) whether ECL was a guarantor to SREI for the Loan; and (ii) whether approval of the Resolution Plan resulted in extinguishment of the entire debt so as to bar any claim against ECL. The NCLAT answered the first issue in the negative, and held that although extinguishment of debt operated only qua ESL, the appeal failed since ECL was not a ‘guarantor' under Section 126 of the Indian Contract Act.

The present appeal was preferred against the abovementioned judgment of the NCLAT in the SC.

Decision

Issue I: Whether ECL was a ‘Guarantor' for the Loan.

The SC noted that Section 126 of the Indian Contract Act 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.” Therefore, essential ingredients of a ‘guarantee' under Section 126 of the Indian Contract Act are: (a) existence of a principal debt; (b) default by the principal debtor; and (c) a promise by the surety to discharge the liability upon such default. Accordingly, in order to constitute a guarantee, there has to be a specific undertaking or unambiguous affirmation to discharge the liability of a third person in case of their default.

Clause 2.2 of the Deed of Undertaking merely obligated ECL to arrange infusion of funds into ESL to enable compliance with financial covenants, but did not contain any undertaking to pay the creditor or discharge the borrower's debt. The Court held:

“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.”

The Court also referred to the sanction letter, information memorandum, assignment agreement, and audited financial statements, all of which reflected ‘Nil' under the category of guarantors.

Accordingly, it was held that Clause 2.2 of the Deed of Undertaking did not constitute a contract of guarantee.

Issue II: Whether the approval of a resolution plan extinguishes claims against third parties.

The SC proceeded to consider the treatment of the admitted financial debt under the Resolution Plan. Out of a total admitted debt of INR 13395,25,00,000 (Indian Rupees thirteen thousand three hundred ninety-five crore twenty-five lac), INR 5320,00,00,000 (Indian Rupees five thousand three hundred twenty crore) was treated as sustainable debt, while INR 7619,24,00,000 (Indian Rupees seven thousand six hundred nineteen crore twenty-four lac) was treated as unsustainable debt and converted into equity. After face value reduction and consolidation, financial creditors ultimately received shares worth only INR 152,38,00,000 (Indian Rupees one hundred fifty-two crore thirty-eight lac).

The SC therefore noted that the Resolution Plan resulted in substantial diminution of value of unsustainable debt to the financial creditors, including SREI.

The SC further observed that clause 3.2(ix) of the Resolution Plan expressly preserves the rights of financial creditors against any third party, including a security provider or existing promoter, in relation to any portion of the unsustainable debt that is secured or guaranteed by such third parties, and clarifies that such rights shall not be extinguished by approval of the Resolution Plan. The clause further provides that, where any third-party security provider (including a promoter), who has guaranteed or secured any portion of the debt availed by ESL prior to the insolvency commencement date, makes any claim against ESL, Vedanta Limited or the special purpose vehicle on account of invocation or enforcement of such security or guarantee, such claim shall be settled at ‘Nil' value, i.e, such third party security provider shall not have a right of subrogation against ESL, Vedanta Limited or the special purpose vehicle.

The SC reaffirmed that it has already been held in Lalit Kumar Jain v. Union of India  (2021) (SCC OnLine SC 396) that the approval of a resolution plan does not ipso facto discharge a security provider's liabilities where the plan preserves such rights.

Accordingly, the SC held that the approval of the Resolution Plan did not result in extinguishment of the entire debt so as to bar any claim against ECL in its capacity as a security provider or third-party surety.

Conclusion

This decision clearly delineates the contractual boundaries between support undertakings in the nature of equity infusion commitments and guarantees. It underscores that, unlike a mere undertaking to infuse equity or provide financial support, a guarantee must contain a specific and unequivocal promise to discharge the liability of a third party in the event of its default, in absence of which the arrangement cannot be characterised as a guarantee in law.

Please find attached a copy of the judgement,  here.

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