Brief Overview:
Undertaking by a promoter to infuse funds into a borrower company, cannot be treated as a contract of guarantee and thus does not amount to financial debt under the IBC.
Technical Details:
The Borrower, i.e., Electrosteel Steels Limited (“Borrower”), had availed certain credit facilities, pursuant to which Electrosteel Castings Limited, the promoter (“Promoter”), executed a Deed of Undertaking (“DoU”) to arrange infusion of funds if the Borrower failed to meet financial covenants.
On the basis of the said DoU, UV Asset Reconstruction Company Ltd. (“UVARCL”) initiated proceedings under Section 7 of the Insolvency and Bankruptcy Code, 2016 (“IBC”) against the Promoter for the residual debt on the premise that the DoU amounted to a corporate guarantee.
The Apex Court, while dealing with the said issue, held that an undertaking to infuse funds into the Borrower by a Promoter would not constitute a contract of guarantee under Section 126 of the Indian Contract Act, 1872 (“ICA”), further elaborated as below:
1) Section 126 of the ICA mandates a guarantor to ‘perform a promise’ or ‘discharge the liability’ of a third person which necessarily implies a direct performance or discharge.
2) Clause requiring the Promoter to arrange infusion of funds does not obligate it to pay the lender or discharge the debt. The obligation was to assist the Borrower, not to answer directly to the creditor. Therefore, it did not fulfil the statutory ingredients of a contract of guarantee.
3) ‘See-to-it guarantee’ concepts from English law cannot override Section 126 of ICA in the absence of an express promise to pay. Guarantees, holding that Indian law requires an express and unambiguous promise to discharge another’s liability, which was absent here.
JC takeaway:
The Promoter’s commitment to arrange funding support for a borrower cannot be substituted for a guarantee, and insolvency proceedings cannot be invoked unless there is a clear contractual promise to discharge the borrower’s debt, as in a contract of guarantee.
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