Promoter’s Undertaking to Infuse Funds Is Not a Guarantee under Section 126 Contract Act — Section 7 Application Rejected
- REEDLAW
- Jan 12
- 5 min read
REEDLAW Legal News Network reports: In a pivotal ruling clarifying the contours of financial liability under the Insolvency and Bankruptcy Code, the Supreme Court held that a promoter’s undertaking to arrange or facilitate infusion of funds into a Corporate Debtor, aimed at ensuring compliance with financial covenants, does not by itself amount to a contract of guarantee under Section 126 of the Indian Contract Act, and therefore cannot give rise to an enforceable financial debt under Section 7 of the Code in the absence of an express promise to discharge the debtor’s liability.
The Supreme Court Bench comprising Justice Sanjay Kumar and Justice Alok Aradhe, while adjudicating the Civil Appeal, held that an undertaking to arrange infusion of funds into a Corporate Debtor to maintain financial discipline or covenant compliance could not be equated with a guarantee as contemplated under Section 126 of the Indian Contract Act. The Court observed that unless there existed a clear and unequivocal promise by the undertaking party to discharge the liability of the Corporate Debtor in the event of default, no financial debt could be fastened upon such party, and consequently, a Section 7 application under the Insolvency and Bankruptcy Code was not maintainable against them.
The Supreme Court examined whether the Deed of Undertaking executed by the Respondent, in its capacity as promoter of the Corporate Debtor, constituted a contract of guarantee under Section 126 of the Indian Contract Act, 1872 so as to render the Respondent liable as a guarantor for the financial facilities availed by the Corporate Debtor. The Court reiterated that a contract of guarantee requires three essential elements, namely, the existence of a principal debt, default by the principal debtor, and an express and unambiguous promise by the surety to discharge the liability of the principal debtor in case of such default. Relying upon the principle stated in Conley (Re), ex parte Trustee v. Barclays Bank Ltd. (1938) 2 All ER 127, the Court reaffirmed that a guarantee is a promise to answer for the debt or obligation of another and operates as a security in the form of a right of action against a third party. It was further guided by the settled principles of construction of guarantees as laid down in Perrylease Ltd. v. Imecar AG (1987) 2 All ER 378, Raghunandan v. Kirtyanand (AIR 1932 PC 131), Eshelby v. Federated European Bank Ltd. (1932 1 KB 254), and Kamla Devi v. Thakhratmal Land (AIR 1964 SC 859), which establish that a guarantee, being a mercantile contract, must be construed to reflect the true intention of the parties as expressed in writing.
On analysing Clause 2.2 of the Deed of Undertaking, the Court held that it merely obligated the Respondent to arrange for infusion of funds into the Corporate Debtor to ensure compliance with financial covenants and did not contain any promise to the Financial Creditor to discharge the debt of the Corporate Debtor in the event of default. It was observed that an undertaking to assist the borrower in maintaining financial discipline or to enable compliance with covenants cannot be equated with a promise to satisfy the creditor’s claim. The Court distinguished the concept of a “see to it” guarantee, referred to in English decisions such as Moschi v. Lep Air Services Ltd. and Associated British Ports v. Ferryways NV and Shanghai Shipyard Co. Ltd. v. Reignwood International Investment (Group) Co. Ltd., by holding that even such guarantees presuppose a direct obligation to the creditor, whereas Clause 2.2 merely contemplated facilitating the borrower’s performance. It was clarified that Section 126 of the Contract Act mandates a direct promise to perform or discharge the liability of the principal debtor, and an obligation to enable the debtor to comply with its covenants does not satisfy this requirement.
The Court further found that contemporaneous documents, such as the sanction letter, which did not contemplate any personal or corporate guarantee, the information memorandum in the Corporate Debtor’s CIRP, the assignment deed showing “Nil” against guarantor details, and the audited financial statements of the Corporate Debtor, consistently demonstrated that no contract of guarantee was ever intended by the parties. It was also held that the payment made by the Respondent during the insolvency proceedings was voluntary in its capacity as promoter and not pursuant to any contractual obligation of guarantee, and therefore could not be relied upon to infer the existence of a guarantee.
The argument of estoppel based on alleged admissions in pleadings was rejected by relying on the settled principle that pleadings must be read as a whole and not selectively. The Court distinguished the decisions in Nagindas Ramdas v. Dalpatram Ichharam (1974) 1 SCC 242 and Mumbai International Airport Pvt. Ltd. v. Golden Chariot Airport (2010) 10 SCC 422 by holding that they deal with clear and unequivocal admissions under the Evidence Act, whereas the statements relied upon in the present case were made in a different context relating to enforcement of mortgage security and did not amount to an admission of a guarantee.
Accordingly, the Supreme Court concurred with the concurrent findings of the Adjudicating Authority and the Appellate Tribunal that Clause 2.2 of the Deed of Undertaking did not constitute a contract of guarantee under Section 126 of the Indian Contract Act. It was held that in the absence of an express promise to discharge the liability of the Corporate Debtor, no financial debt could be fastened upon the Respondent for the purposes of Section 7 of the Insolvency and Bankruptcy Code, and the dismissal of the Section 7 application was legally justified.
Mr. Mukul Rohatgi, Gopal Subramanium and Dhruv Mehta, Senior Advocates with Mr. Vikas Mehta, Mr. Pulkit Deora, Mr. Hemant Kothari, Mr. Kartikeya Sharma, Mr. Kartik Pandey, Ms. Nitika Grover, Mr. Nishant Anshul, and Mr. Sameer Rohatgi, Advocates, represented the Appellant.
Mr. Amit Sibal, Senior Advocate, with Mr. Dhruv Dewan, Mr. Rishabh Bhargava, Ms. Sanjukta Roy, and Mr. Dhruv Sethi, Advocates, appeared for the Respondent.
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