The Supreme Court held that an undertaking by a promoter to arrange for infusion of funds to enable a borrower to comply with financial covenants does not constitute a 'contract of guarantee' under Section 126 of the Indian Contract Act, 1872. Furthermore, the approval of a resolution plan under the IBC does not ipso facto discharge the liability of third-party security providers. The rights of creditors against such parties, in relation to any portion of unsustainable debt secured or guaranteed by them, are preserved unless expressly extinguished by the plan.
(i) Whether Clause 2.2 of the Deed of Undertaking dated 27.07.2011 constitutes a contract of guarantee within the meaning of Section 126 of the Indian Contract Act, 1872?
(ii) Whether approval of the resolution plan of ESL resulted in extinguishment of entire debt, so as to bar any claim against ECL as a guarantor or third party surety?
(i) No - Clause 2.2 does not constitute a contract of guarantee. The undertaking by ECL to arrange for infusion of funds into ESL so that ESL could comply with financial covenants is not a promise to discharge ESL's liability to the creditor. It merely facilitates the borrower's compliance and does not satisfy the statutory requirements of Section 126 of the Indian Contract Act.
(ii) No - Approval of resolution plan does not extinguish debt against third parties. The resolution plan explicitly preserves rights against third-party security providers in relation to any portion of unsustainable debt secured or guaranteed by such third parties. The discharge of the corporate debtor's liability does not automatically discharge the liability of third-party security providers.
Sanction Letter: SREI sanctioned INR 500 crores to Electrosteel Steels Limited (ESL). No guarantee from Electrosteel Castings Limited (ECL) required.
Deed of Undertaking: ECL executed undertaking (Clause 2.2) to arrange for infusion of funds to enable ESL to comply with financial covenants.
CIRP Initiation: State Bank of India filed Section 7 application against ESL. NCLT admitted the application.
Resolution Plan Approval: NCLT approved Vedanta's resolution plan for ESL acquisition for INR 12,719.14 crores.
Assignment of Debt: SREI executed Deed of Assignment in favor of UV ARC for alleged residual debt.
NCLT Decision: NCLT dismissed UV ARC's Section 7 application, holding ECL was not a guarantor and debt stood extinguished.
NCLAT Decision: NCLAT affirmed NCLT order, holding undertaking was not a guarantee but resolution plan didn't extinguish debt against third parties.
Supreme Court Judgment: Undertaking ≠ guarantee; Resolution plan approval doesn't discharge third-party liability.
| Legal Provision | What It Means | Application in This Case |
|---|---|---|
| Section 126 Contract Act |
Defines contract of guarantee as promise to discharge third person's liability on their default | Undertaking to arrange funds doesn't meet these requirements |
| Section 31(1) IBC |
Resolution plan approved by NCLT binds all stakeholders | Doesn't automatically discharge third-party liabilities unless expressly stated |
| Clause 3.2(ix) Resolution Plan |
Preserves rights against third parties for unsustainable debt | Creditors can proceed against security providers despite plan approval |
| Section 62 IBC |
Appeal provision to Supreme Court against NCLAT orders | Both parties appealed different aspects of NCLAT order |
A contract to perform the promise or discharge the liability of a third person in case of their default. Requires: (a) existence of principal debt, (b) default by principal debtor, (c) promise by surety to discharge liability.
A promise to facilitate the borrower's compliance with financial covenants by arranging fund infusion. Does not involve direct promise to creditor or discharge of borrower's liability.
English common law concept where guarantor ensures principal debtor performs obligation. Not recognized under Section 126 of Indian Contract Act which requires direct discharge of liability.
Portion of debt that cannot be serviced by corporate debtor's cash flows, converted to equity or written down in resolution plan. Creditors take haircut on this portion.
"For an obligation to be construed as a guarantee under Section 126 of the Act, there must be a direct and unambiguous obligation of the surety to discharge the obligation of the principal debtor to the creditor. 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."
"It is well settled that approval of the Resolution Plan does not ipso facto discharge a security provider of her or his liabilities under the contract of security. Clause 3.2 (x) of the Resolution Plan explicitly reserves the rights of financial creditors against such third parties, including security providers/existing promoters, in relation to the unsustainable debt."
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