Is an Undertaking to Infuse Funds a Guarantee under Section 126 of the Contract Act?

In modern financing arrangements, particularly in project finance and infrastructure lending, promoters are frequently required to give comfort to lenders through undertakings, letters of support, or commitments to infuse funds into the borrowing entity. These instruments are often drafted as alternatives to formal guarantees, especially where promoters seek to avoid direct personal or corporate liability for the borrower’s debt.

A recurring legal question arising from such arrangements is whether an undertaking by a promoter to infuse funds into a borrower, in the event of financial stress or breach of covenants, can be construed as a “contract of guarantee” within the meaning of Section 126 of the Indian Contract Act, 1872. The distinction is not merely semantic. If such an undertaking amounts to a guarantee, the promoter becomes a surety and can be proceeded against directly by the creditor. If it does not, the lender’s remedies are confined to the borrower and the securities expressly created.

This issue was conclusively examined by the Supreme Court of India in UV Asset Reconstruction Company Limited v. Electrosteel Castings Limited, decided on 6 January 2026, where the Court held that a mere undertaking to infuse funds does not constitute a contract of guarantee under Section 126.

The judgment provides authoritative clarity on the legal boundary between promoter undertakings and guarantees, with significant implications for insolvency law, corporate finance, and contract drafting.

Statutory Framework: Section 126 of the Indian Contract Act, 1872

Section 126 of the 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.”

The provision contemplates three distinct parties:

1. Principal debtor – the person whose obligation is guaranteed;
2. Creditor – the person to whom the guarantee is given; and
3. Surety – the person who undertakes to discharge the liability upon default.

From the statutory language and settled jurisprudence, three essential elements emerge:

• the existence of a principal debt or obligation;
• a default by the principal debtor; and
• a promise by the surety to the creditor to perform or discharge that liability upon such default.

A guarantee is thus a secondary obligation, triggered only upon the failure of the principal debtor. It creates a direct enforceable right in favour of the creditor against the surety.

Factual Background of the Electrosteel Dispute

Electrosteel Steels Limited (ESL) availed financial assistance of ₹500 crores from SREI Infrastructure Finance Limited. The sanction letter did not require any personal or corporate guarantee from Electrosteel Castings Limited (ECL), the promoter of ESL. Instead, ECL was required to furnish an undertaking to arrange for the infusion of funds into ESL so that the borrower could comply with stipulated financial covenants.

Pursuant to this requirement, ECL executed a Deed of Undertaking, Warranty, and Indemnity dated 27 July 2011. Clause 2.2 of the deed obligated ECL to arrange for infusion of funds into ESL if ESL was unable to comply with its financial covenants.

Subsequently, ESL entered insolvency proceedings under the Insolvency and Bankruptcy Code, 2016. After approval and implementation of a resolution plan, the lender’s rights were assigned to UV Asset Reconstruction Company Limited, which initiated proceedings against ECL, contending that Clause 2.2 constituted a corporate guarantee, thereby making ECL liable as a guarantor.

Both the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT) rejected this contention. The matter ultimately reached the Supreme Court.

Issue

• Whether Clause 2.2 of the Deed of Undertaking, which required the promoter to arrange the infusion of funds into the borrower to enable compliance with financial covenants, amounted to a contract of guarantee under Section 126.

Supreme Court’s Interpretation of “Guarantee”

The Supreme Court reiterated that a guarantee must involve an unambiguous promise by the surety to the creditor to discharge the liability of the principal debtor in the event of default. The Court emphasised that the substance of the obligation, not its label, is determinative.

The Court observed that Clause 2.2:

• did not require ECL to pay the lender directly;
• did not contemplate discharge of ESL’s debt to the creditor; and
• merely required ECL to arrange funds so that ESL could comply with financial covenants.

Such an obligation, the Court held, operates between the promoter and the borrower, not between the promoter and the lender.

An undertaking to support the borrower financially so that it may itself meet its obligations cannot be equated with a promise to the creditor to answer for the borrower’s default. Consequently, the statutory ingredients of Section 126 were not satisfied.

Distinction Between Fund Infusion and Debt Discharge

A key contribution of the judgment lies in its clear doctrinal distinction between:

• infusing funds into the borrower, and
• discharging the borrower’s liability to the creditor.

In a contract of guarantee, the surety undertakes to step into the shoes of the debtor upon default. In contrast, a fund infusion obligation merely strengthens the borrower’s balance sheet, enabling it to perform its obligations independently. The creditor has no direct right to demand payment from the promoter under such an arrangement.

The Court categorically held that financial discipline covenants or support undertakings, without a promise to the creditor, do not transform into guarantees merely because they are triggered upon default.

Rejection of the “See to It” Guarantee Argument

The appellant relied on English authorities recognising “see to it” guarantees, where the guarantor undertakes to ensure performance by the principal debtor. The Supreme Court declined to import this doctrine wholesale into Indian law.

It clarified that even under common law, a “see to it” guarantee requires a promise to the creditor that the obligation will be performed, failing which the guarantor becomes liable. However, an obligation merely to enable or facilitate performance does not satisfy Section 126.

Indian contract law, the Court noted, requires a direct promise to discharge liability, not an indirect commitment to assist performance.

Role of Contemporaneous Documents

The Court also placed considerable reliance on contemporaneous documentation, including:

• the original sanction letter, which did not require a guarantee;
• the information memorandum in the insolvency process, which recorded no guarantee;
• the assignment deed, which showed “nil” guarantors; and
• the audited financial statements, which reflected no guarantee obligation.

These documents reinforced the conclusion that the parties never intended to create a contract of guarantee.

Effect of Promoter Payments and Pleadings

The appellant argued that ECL’s payment of ₹38 crores and certain pleadings referring to “guarantee” amounted to an admission. The Court rejected this contention, holding that:

• voluntary payments by promoters do not create contractual liability; and
• pleadings must be read as a whole and in context.

Admissions relating to limited security interests could not be elevated into proof of a guarantee where none existed contractually.

Conclusion

The Supreme Court’s ruling in UV Asset Reconstruction Co. Ltd. v. Electrosteel Castings Ltd. settles an important and long-contested issue in Indian contract and insolvency law. An undertaking by a promoter to infuse funds into a borrower, even if triggered upon breach of financial covenants, does not amount to a contract of guarantee under Section 126 of the Indian Contract Act unless it contains a clear promise to the creditor to discharge the borrower’s liability upon default.

By reaffirming the strict statutory requirements of a guarantee, the Court has drawn a principled boundary between promoter support arrangements and suretyship. The judgment enhances legal certainty, aligns contractual liability with commercial intent, and underscores the need for careful drafting in complex financing transactions.

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