Promoter’s Undertaking to Infuse Funds Does Not Amount to a Contract of Guarantee Under Section 126 of the Indian Contract Act: A Critical Analysis of the Supreme Court’s Ruling

Introduction

The Supreme Court of India recently delivered a significant judgment that clarifies the legal distinction between a promoter’s undertaking to arrange funds for a borrowing company and a formal contract of guarantee under Section 126 of the Indian Contract Act, 1872. In the matter of UV Asset Reconstruction Company Limited v. Electrosteel Castings Limited[1], the Apex Court 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. This judgment, delivered by a Bench comprising Justice Sanjay Kumar and Justice Alok Aradhe, has far-reaching implications for the interpretation of guarantee obligations in corporate financing arrangements and insolvency proceedings under the Insolvency and Bankruptcy Code, 2016.

The Court observed that an undertaking to infuse funds into a borrower, enabling it to meet its obligations, cannot be equated with a promise to discharge the borrower’s liability to the creditor directly. This distinction is critical in understanding the nature of obligations undertaken by promoters in financing transactions and their potential liability under insolvency proceedings. The judgment also addressed the question of whether approval of a resolution plan under the Insolvency and Bankruptcy Code automatically extinguishes the liability of third-party guarantors, thereby providing clarity on multiple fronts of commercial law.

Understanding Contract of guarantee under Section 126 of the Indian Contract Act, 1872

Section 126 of the Indian Contract Act, 1872 defines a contract of guarantee with precision and establishes the foundational framework for understanding the tripartite relationship between the surety, principal debtor, and creditor. The provision states: “A ‘contract of guarantee’ is a contract to perform the promise, or discharge the liability, of a third person in case of his default. The person who gives the guarantee is called the ‘surety’; the person in respect of whose default the guarantee is given is called the ‘principal debtor’, and the person to whom the guarantee is given is called the ‘creditor’. A guarantee may be either oral or written.”

This statutory definition establishes several essential elements that must be present for an obligation to constitute a valid contract of guarantee. The first essential element is the existence of a principal debt owed by the principal debtor to the creditor. Without an underlying obligation, there can be no guarantee, as the surety’s promise is contingent upon the default of the principal debtor in discharging an existing liability. The second element is the occurrence of default by the principal debor in fulfilling their primary obligation to the creditor. The guarantee becomes operative only upon such default, making it a secondary or contingent obligation rather than a primary one.

The third and most critical element, as emphasized repeatedly by Indian courts, is an unambiguous and direct promise by the surety to discharge the liability of the principal debtor to the creditor upon default. This promise must be explicit and must contemplate the surety stepping into the shoes of the principal debtor to satisfy the creditor’s claim. The mere undertaking to enable the principal debtor to perform does not satisfy this requirement, as it does not create a direct obligation from the surety to the creditor. The contractual privity in a guarantee exists between the surety and the creditor, with the surety promising to answer for the debt of the principal debtor in the event of default.

The Principle of Coextensive Liability Under Section 128

Section 128 of the Indian Contract Act, 1872 establishes the extent of a surety’s liability in unequivocal terms. The provision states: “The liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract.” This principle of coextensive liability means that the surety’s obligation mirrors that of the principal debtor in both quantum and nature, subject to any express limitations contained in the guarantee agreement itself.

The coextensive nature of surety liability has been consistently upheld by Indian courts as a fundamental principle governing contracts of guarantee. In Bank of Bihar Ltd v. Damodar Prasad and Another[2], the Supreme Court emphasized that when the principal debtor defaults on payment obligations, the surety becomes immediately liable for the entire amount due, including interest and charges. The Court clarified that the sole condition required for the implementation of the bond was a demand for payment pertaining to the principal debtor’s liability, and upon fulfillment of this condition, both the principal debtor and the surety were obligated to discharge the debt.

The principle of coextensive liability, however, is not absolute and admits of modification through express contractual stipulation. A surety may limit the extent of liability by clearly specifying in the guarantee agreement the maximum amount for which they can be held responsible, or by imposing conditions precedent to the invocation of the guarantee. The burden of proving such limitation rests squarely on the surety, and courts will not read restrictions into a guarantee unless they are expressly and unambiguously stated in the contract. This flexibility allows parties to tailor guarantee arrangements to their specific commercial needs while maintaining clarity about the scope of the surety’s obligations.

The Factual Matrix of the Electrosteel Castings Case

The dispute in UV Asset Reconstruction Company Limited v. Electrosteel Castings Limited arose from a complex financing arrangement involving multiple corporate entities. Electrosteel Steels Limited, the principal borrower, obtained financial assistance of Rs. 500 crores from SREI Infrastructure Finance Limited pursuant to a sanction letter dated July 26, 2011. The sanction letter explicitly did not stipulate any personal or corporate guarantee from Electrosteel Castings Limited, which was the promoter of the borrowing company. Instead, the securities for the facility were confined to a demand promissory note and post-dated cheques.

As part of the overall financing structure, Electrosteel Castings Limited executed a deed of undertaking in favor of the lender. Clause 2.2 of this deed imposed an obligation on the promoter to arrange for infusion of funds into Electrosteel Steels Limited at the end of each financial year in the event the borrower failed to comply with stipulated financial covenants. The clause specifically obligated the promoter to arrange such infusion in a form and manner acceptable to the lender, thereby ensuring the borrower’s continued compliance with the agreed-upon financial parameters.

Electrosteel Steels Limited subsequently committed default in repaying the financial facilities in 2013. Following restructuring efforts, the borrower underwent a corporate insolvency resolution process under the Insolvency and Bankruptcy Code, 2016, when the Kolkata bench of the National Company Law Tribunal admitted an application by State Bank of India to initiate insolvency proceedings. During the insolvency process, SREI Infrastructure Finance Limited filed its claim of Rs. 5.78 billion, which was duly admitted by the resolution professional. In 2018, the National Company Law Tribunal approved Vedanta Limited’s resolution plan for Electrosteel Steels Limited, and SREI issued a no-objection certificate confirming receipt of Rs. 2.42 billion for its dues along with allotment of equity shares.

Subsequently, SREI executed an assignment deed in favor of UV Asset Reconstruction Company Limited, assigning the loans and related rights under the financing documents. UV Asset Reconstruction then filed an application under Section 7 of the Insolvency and Bankruptcy Code, 2016, before the National Company Law Tribunal, Cuttack, seeking initiation of corporate insolvency resolution proceedings against Electrosteel Castings Limited. The appellant contended that the deed of undertaking executed by the promoter constituted a corporate guarantee, thereby creating a financial debt that could be enforced through insolvency proceedings. The National Company Law Tribunal dismissed this application, holding that Electrosteel Castings Limited was not a guarantor for the facilities availed by Electrosteel Steels Limited. This finding was subsequently affirmed by the National Company Law Appellate Tribunal, leading to the appeal before the Supreme Court.

Supreme Court’s Analysis and Interpretation

The Supreme Court undertook a detailed and methodical analysis of the legal principles governing contracts of guarantee while examining the specific terms of the deed of undertaking executed by Electrosteel Castings Limited. The Court began by reiterating that a guarantee, being a mercantile contract, must be construed in a manner that reflects the real intention and understanding of the parties as expressed in writing, rather than by applying merely technical rules of interpretation. The Court emphasized that the construction of guarantee contracts must give effect to the commercial purpose underlying the arrangement while remaining faithful to the language actually employed by the parties.

In analyzing Clause 2.2 of the deed of undertaking, the Supreme Court noted several critical aspects of its language and structure. The clause obligated the promoter to arrange for infusion of funds into the borrower company to enable compliance with financial covenants. Significantly, the Court observed that the clause did not contain any undertaking by the promoter to discharge the debt owed by the borrower to the creditor, nor did it contemplate direct payment to the lender in the event of default. The obligation under the clause was characterized as a promise by the promoter to the borrower to facilitate compliance with financial covenants, rather than a promise to the creditor to discharge the borrower’s liability upon default.

The Court held that for an obligation to be construed as a guarantee under Section 126 of the Indian Contract Act, there must be a direct and unambiguous obligation of the surety to discharge the obligation of the principal debtor to the creditor. The absence of such direct obligation was fatal to the characterization of the deed of undertaking as a guarantee. The Supreme Court further noted that the original sanction letter did not envisage any personal or corporate guarantee and expressly identified specific securities for the facility, thereby reinforcing the conclusion that the parties did not intend to create a guarantee relationship.

The Concept of ‘See to It’ Guarantee

UV Asset Reconstruction Company Limited argued that Clause 2.2 of the deed of undertaking constituted what is known in English common law as a ‘see to it’ guarantee. This form of guarantee involves a two-step process wherein the surety undertakes to ensure that the principal debtor performs its obligations, and if the principal debtor fails to perform, the surety itself must perform those obligations. The appellant relied on English precedents, particularly the decision in Moschi v. Lep Air Services Ltd.[3], to support the contention that such undertakings constitute valid guarantees even though they are framed in terms of ensuring performance rather than directly promising to pay upon default.

The Supreme Court, while acknowledging that ‘see to it’ guarantees are recognized in English common law, drew a careful distinction between such guarantees and mere undertakings to enable performance by the principal debtor. The Court held that a ‘see to it’ guarantee does not include an obligation merely to enable the principal debtor to perform its own obligation; rather, it contemplates that the surety will itself step in to perform if the principal debtor fails to do so. The Court observed that such an arrangement would constitute a guarantee under English law principles, but emphasized that the language of Clause 2.2 did not rise to this level of commitment.

The Supreme Court concluded that the obligation to arrange for infusion of funds into the borrower was fundamentally different from an obligation to ensure performance or to perform in the event of default. Arranging for funds is an enabling activity that facilitates the borrower’s own performance, whereas a guarantee contemplates that the surety will discharge the creditor’s claim directly if the borrower defaults. This distinction was critical to the Court’s ultimate conclusion that the deed of undertaking did not create a guarantee relationship within the meaning of Section 126 of the Indian Contract Act, and that such an arrangement would not constitute a guarantee under Indian contract law principles.

Voluntary Payments and Admissions in Pleadings

During the course of arguments, UV Asset Reconstruction Company Limited sought to rely on two additional circumstances to support its contention that Electrosteel Castings Limited was a guarantor. First, the appellant pointed to certain payments made by the promoter during the insolvency proceedings of the borrower company as evidence of acknowledgment of guarantee liability. Second, the appellant relied on statements made by Electrosteel Castings Limited in pleadings before other courts, arguing that these statements amounted to judicial admissions of guarantor status.

The Supreme Court rejected both these contentions with clear reasoning rooted in established principles of contract law and evidence. Regarding the payments made during the insolvency proceedings, the Court held that voluntary payments made in the capacity of a promoter, in the absence of a contractual obligation to make such payments, do not give rise to a contract of guarantee. The Court observed that a promoter may have various commercial and strategic reasons for making payments on behalf of a borrowing company, including preserving its investment, maintaining relationships with creditors, or protecting the corporate group’s reputation. Such payments cannot, by themselves, transform the nature of the legal relationship between the parties or create contractual obligations that did not previously exist.

With respect to the reliance on statements in pleadings, the Supreme Court reiterated the fundamental principle that pleadings must be read as a whole and in their proper context. The Court held that selective reliance on portions of pleadings to infer admissions of liability, where none exist when the pleadings are read holistically, is impermissible. The Court emphasized that statements made in pleadings must be interpreted in light of the entire factual and legal contentions advanced by the party, and that isolated phrases or sentences cannot be divorced from their context to manufacture admissions. This approach ensures that parties are not penalized for making factual statements or advancing alternative arguments in the course of litigation, and that the true nature of their legal position is assessed comprehensively rather than selectively.

Impact on Resolution Plans Under the Insolvency and Bankruptcy Code

The second appeal before the Supreme Court raised the important question of whether approval of a resolution plan under the Insolvency and Bankruptcy Code automatically extinguishes the liability of third-party security providers or guarantors. This question has significant implications for the rights of creditors who have taken guarantees or other security from third parties in addition to the corporate debtor that undergoes insolvency resolution. The resolution plan approved for Electrosteel Steels Limited contained a clause that stated: “all rights/remedies of the creditors shall stand permanently extinguished except any rights against any third party (including the Existing promoter) in relation to any portion of Unsustainable Debt secured or guaranteed by third parties.”

The Supreme Court unequivocally held that the approval of a resolution plan does not ipso facto discharge a security provider of their liabilities under the contract of security. The Court emphasized that it is well-settled law that the approval and implementation of a resolution plan for a corporate debtor does not automatically absolve guarantors or security providers of their contractual obligations to the creditors. The Court noted that the resolution plan in this case explicitly reserved the rights of creditors against third-party security providers, thereby making it clear that such rights were not intended to be extinguished through the resolution process.

This aspect of the judgment reinforces the principle established in the landmark case of Lalit Kumar Jain v. Union of India[4], where the Supreme Court held that the sanction of a resolution plan and the finality imparted to it by Section 31 of the Insolvency and Bankruptcy Code does not per se operate as a discharge of the guarantor’s liability. The Court in that case explained that as to the nature and extent of the liability, much would depend on the terms of the guarantee itself, and that an involuntary act of the principal debtor leading to loss of security would not absolve a guarantor of its liability. The principle underlying these judgments is that the insolvency resolution of the principal debtor is an involuntary process imposed by statute, and guarantors cannot escape their contractual obligations merely because the principal debtor has undergone insolvency proceedings.

Regulatory Framework Governing Guarantees and Insolvency Proceedings

The legal framework governing guarantees in India is primarily contained in Chapter VIII of the Indian Contract Act, 1872, which deals with indemnity and guarantee. Sections 126 to 147 of the Act provide a complete code governing various aspects of guarantee contracts, including the definition of guarantee, the extent of surety’s liability, circumstances under which a surety is discharged from liability, and the rights of sureties against principal debtors and co-sureties. This statutory framework has been supplemented by extensive judicial interpretation over more than a century, creating a rich body of case law that guides the application of these principles to diverse commercial situations.

The Insolvency and Bankruptcy Code, 2016 represents a paradigm shift in India’s approach to insolvency resolution, replacing the earlier fragmented legislative framework with a unified and time-bound process for addressing corporate distress. The Code establishes distinct mechanisms for different categories of stakeholders to initiate insolvency proceedings. Section 7 of the Code enables financial creditors to file applications for initiation of Corporate Insolvency Resolution Process before the National Company Law Tribunal when a default has occurred. The definition of financial creditor and financial debt under Sections 5(7) and 5(8) of the Code is critical, as only those who fall within these definitions can invoke the Section 7 mechanism.

The interaction between the Indian Contract Act and the Insolvency and Bankruptcy Code in the context of guarantees has been the subject of significant judicial consideration. The Supreme Court has clarified that while the insolvency resolution of a corporate debtor may result in a haircut to the claims of creditors through an approved resolution plan, this does not automatically extinguish the liability of guarantors who have provided independent security for the corporate debtor’s obligations. The guarantor’s liability continues to subsist, though it may be revised to reflect the amount that remains unpaid after implementation of the resolution plan. This principle ensures that creditors are not left without recourse simply because they agreed to a resolution plan that provided for less than full recovery from the corporate debtor, particularly when they had the foresight to obtain additional security from guarantors.

Practical Implications for Corporate Financing and Promoter Obligations

The Supreme Court’s judgment in UV Asset Reconstruction Company Limited v. Electrosteel Castings Limited has significant practical implications for the structuring of corporate financing transactions and the drafting of promoter undertakings. Financial institutions and other lenders must now be extremely careful in distinguishing between genuine guarantee arrangements and mere undertakings by promoters to facilitate the borrower’s performance. If lenders wish to hold promoters personally or corporately liable for the borrower’s defaults, they must ensure that the documentation clearly and unambiguously creates a direct obligation from the promoter to the lender to discharge the borrower’s liability upon default.

The judgment also provides important guidance on what does not constitute a guarantee. Undertakings to infuse funds into a borrowing company, to ensure compliance with financial covenants, to maintain certain financial ratios, or to take other enabling actions do not, by themselves, create guarantee liability. These undertakings create obligations from the promoter to the borrower, rather than from the promoter to the lender. While such undertakings may have commercial value in ensuring that the borrower remains financially healthy and capable of servicing its debts, they do not provide lenders with the same legal remedies available under a contract of guarantee Under Section 126, including the right to proceed directly against the promoter for recovery of the borrower’s debts.

The distinction drawn by the Supreme Court between different types of promoter commitments is particularly significant in the context of insolvency proceedings under the Insolvency and Bankruptcy Code. The right to initiate Corporate Insolvency Resolution Process under Section 7 of the Code is available only to financial creditors who are owed a financial debt. A guarantor who has executed a valid guarantee can be treated as having a contingent financial debt relationship with the corporate debtor, thereby potentially bringing them within the ambit of insolvency proceedings. However, a promoter who has merely undertaken to facilitate the borrower’s performance does not stand in the position of a debtor to the creditor and cannot be subjected to insolvency proceedings on the basis of such undertaking alone.

Comparative Analysis with English Common Law Principles

The Supreme Court’s discussion of the ‘see to it’ guarantee concept and its rejection in the Indian context highlights important differences between English common law approaches and Indian statutory principles governing guarantees. English law recognizes various forms of secondary obligations, including guarantees framed as undertakings to see to it that the principal performs. The leading authority on this point is the House of Lords decision in Moschi v. Lep Air Services Ltd., where it was held that a covenant to ensure that another person performs an obligation is enforceable as a guarantee even if not framed in traditional guarantee language.

The Indian approach, as clarified by the Supreme Court in the Electrosteel Castings case, is more formalistic and requires adherence to the statutory definition contained in Section 126 of the Indian Contract Act. The Court’s emphasis on the need for a direct and unambiguous obligation to discharge the principal debtor’s liability to the creditor reflects a stricter interpretation of what constitutes a guarantee. This approach provides greater certainty and predictability in determining when a guarantee relationship exists, but it also places greater responsibility on lenders to ensure that their documentation explicitly creates the intended legal relationship.

The divergence between English and Indian approaches can be attributed to differences in the underlying legal frameworks. England follows a common law system where contractual principles have evolved through judicial decisions over centuries, allowing for greater flexibility in recognizing different forms of contractual obligations based on the parties’ intentions as discerned from the agreement as a whole. India, while drawing inspiration from English common law, has a comprehensive statutory code governing contracts, including specific provisions defining guarantees. Indian courts must interpret contracts in light of these statutory definitions, which constrains the ability to recognize novel forms of guarantee arrangements that do not fit within the statutory framework.

Conclusion

The Supreme Court’s judgment in UV Asset Reconstruction Company Limited v. Electrosteel Castings Limited represents a significant contribution to the jurisprudence on contracts of guarantee and their intersection with insolvency law. The Court has clarified that a promoter’s undertaking to arrange for infusion of funds into a borrowing company, while commercially significant, does not constitute a contract of guarantee within the meaning of Section 126 of the Indian Contract Act unless it creates a direct and unambiguous obligation to discharge the borrower’s liability to the creditor upon default. This distinction is critical for determining the rights and remedies available to creditors when borrowers default on their obligations.

The judgment also reinforces the principle that approval of a resolution plan under the Insolvency and Bankruptcy Code does not automatically extinguish the liability of guarantors and security providers who are third parties to the corporate debtor. This ensures that creditors can continue to pursue their rights against such third parties even after the corporate debtor has undergone insolvency resolution, subject to the specific terms of the resolution plan and any express provisions regarding the treatment of third-party obligations. The preservation of creditor rights against guarantors highlights the continuing relevance of a well-drafted contract of guarantee under Section 126, ensuring that such guarantees retain their enforceability and value as security instruments.

For practitioners, this judgment underscores the critical importance of precise drafting when creating a contract of guarantee under Section 126. Lenders who wish to hold promoters or other parties liable as guarantors must ensure that the documentation establishes an explicit and unambiguous obligation to discharge the borrower’s liability to the lender upon default, rather than merely undertaking to facilitate the borrower’s own performance. Conversely, promoters and other parties providing comfort to lenders must carefully review the language of any undertakings they provide to ensure they understand the full extent of the obligations they are assuming and whether those obligations could give rise to liability under a contract of guarantee under Section 126.

References

[1] UV Asset Reconstruction Company Limited v. Electrosteel Castings Limited, 2026 INSC 14, available at: https://www.verdictum.in/court-updates/supreme-court/uv-asset-reconstruction-company-limited-v-electrosteel-castings-limited-2026-insc-14-1603910 

[2] Bank of Bihar Ltd. v. Damodar Prasad and Another, (1969) 1 SCC 620, available at: https://indiankanoon.org/doc/1377136/ 

[3] Moschi v. Lep Air Services Ltd., [1973] AC 331 (House of Lords)

[4] Lalit Kumar Jain v. Union of India, (2021) 9 SCC 321, available at: https://www.amsshardul.com/insight/liability-of-guarantors-after-landmark-india-verdict/ 

[5] Section 126 of the Indian Contract Act, 1872, available at: https://indiankanoon.org/doc/53550/ 

[6] Section 128 of the Indian Contract Act, 1872, available at: https://indiankanoon.org/doc/1377136/ 

[7] Section 7 of the Insolvency and Bankruptcy Code, 2016, available at: https://ibclaw.in/section-7-initiation-of-corporate-insolvency-resolution-process-by-financial-creditor-chapter-ii-corporate-insolvency-resolution-processcirp-part-ii-insolvency-resolution-and-liquidation-for-corpor/