Line of Difference: Letter of Comfort and Contract of Guarantee

Yash Tripathi, Associate at Pioneer Legal, Mumbai

Concepts

In an event of default in repayment of the debt, invoking a guarantee is always the priority of the lenders. However, it should also be looked thoroughly whether a document serves as a contract of guarantee or not. In the recent decision of Yes Bank Ltd. v. Zee Entertainment Enterprises Ltd. &Ors.[1], Bombay HC draws the line of difference between a letter of comfort (“LOC”) and a contract of guarantee.

Contract of Guarantee:

Section 126 of the Indian Contract Act, 1872 defines ‘contract of guarantee’ to mean a contract to perform the promise, or discharge the liability, of a third person in case of his default. It further states that the person who gives the guarantee is called the ‘surety’; the person in respect of whose default the guarantee is given is called the ‘principle debtor’ and, the person to whom the guarantee is given is called the ‘creditor’. Additionally, a guarantee may be either oral or written.

LOC:

Although, there is no statutory definition for LOC, P Ramanatha Aiyar’s Advanced Law Lexicon provides that LOC is a document that indicates one party’s intention to try to ensure that another party complies with the terms of a financial transaction without guaranteeing performance in the event of default.

Additionally, Chitty on Contract in its 26th Edition, while acknowledging the statutory void vis-à-vis a settled definition of LOC, states that where the language of such a document does not negative contractual intention, it is open to courts to hold the parties bound by the document, and they will, in particular, be inclined to do so where the parties have acted on the document for a long period of time or have expended considerable sums of money in reliance on it.

FACTS

In the instant case of Yes Bank Ltd. v. Zee Entertainment Enterprises Ltd. &Ors., the transaction which took place is as follows:

Yes Bank Ltd. (“Yes Bank”) provided a loan (“Facility”)to Living Entertainment Ltd.[2] (“LELM”) for purchasing stock of Veria International Ltd.[3] (“Veria”). A put option agreement[4] (“Agreement”) as entered into between LELM and ATL Media Ltd.[5] (“ATL”) was provided as a security for the Facility. Therefore, in an event of default Yes Bank could enforce the Agreement in order to compel ATL to buy out LELM’s equity holding in Veria, putting LELM in funds with which it would repay Yes Bank.

With respect to the above, on May 31, 2016 a LOC was issued by Zee Entertainment Enterprises Ltd. (“Zee”) to Yes Bank which states as follows:

“We confirm that we shall support ATL Media Ltd. (hereinafter referred as ‘ATL’) by infusing equity/debt for meeting all its working capital requirements, debt requirements business expansion plans, honouring put option, take or pay agreement and guarantees;”

Subsequently an event of default occurred, and Yes Bank called upon Zee to honour its obligations as stated in the LOC issued on May 31, 2016. In this regard, the main contention of Yes Bank was that the LOC was in a nature of an absolute, irrevocable and unconditional guarantee.

Rival contention from Zee was that the LOC was only meant to keep ATL in liquidity, and that this does not mean there existed any ‘privity of contract’ between Yes Bank and Zee vis-à-vis LELM’s debt obligations towards Yes Bank.

BOMBAY HC’s Approach

The Bombay High Court while recognizing that conduct of the parties is always a guide to the construction of contracts[6], stated that Yes Bank seems to make Zee liable for more than what it undertook under the LOC. The LOC in question clearly states that Zee would support ATL in sufficient funds for the Agreement to work. However, there is no liability on part of Zee directly to Yes Bank to pay off LELM’s loan debt.

The court relied on the principles as laid down in United Breweries (Holding) Ltd v. Karnataka State Industrial Investment & Development Corporation Ltd.[7] wherein, it was held that whether the deed in question is a deed of guarantee or not depends upon the terms under which the guarantor binds himself. Under law he cannot be made liable for more than what he has undertaken. Additionally, the Bombay HC also noted that under Indian law a guarantee provides a commitment or the assurance of obligation to pay off the debt of another upon default. The guarantor stands surety for the repayment of the debt. If the debtor fails to repay, the creditor need look no further than the surety or guarantor. In the instant case Zee hasn’t given any commitment vis-à-vis LELM’s debt obligations towards Yes Bank. Zee has an obligation to put ATL in sufficient funds for the Agreement to work. Henceforth, the two obligations are entirely different and the LOC does not qualify as a contract of guarantee between Zee and Yes Bank.

Bombay HC also laid down certain propositions coming out from the instant case which inter alia include

  1. In a given case, a LOC may indeed amount to a guarantee. Not every LOC is ipso factoa guarantee. The nomenclature is unimportant, as is the absence of the word ‘guarantee’;
  2.   Conformity to provisions of Section 126 of Indian Contract Act, 1872 is a must to qualify as a ‘guarantee’;
  3. A court will look to the nature of the bargain struck and the role that each of the parties played, and when, in what manner, and to what extent while executing a commercial document. 

CONCLUSION

In view of the propositions as laid down in the instant case by the Bombay High Court, the fact which gets highlighted critically is that every document in a commercial transaction is required to be worded carefully. It is also pertinent to note that from a lender’s perspective documentation is required to be thoroughly checked and legal satisfaction to the utmost possible extent vis-à-vis wording of such documentation should be done. For a contract of guarantee to exist between a surety and a creditor, pre-requisites of Section 126 of the Indian Contract Act, 1872 are required to be satisfied. Therefore, these principles become more critical as it is a settled fact that you cannot hold a person liable for more than what he has undertaken.


[1]     LD-VC-SUIT No. 120 of 2020 (To be renumbered subsequently).

[2]     An entity held by the promoters, or promoter’s family, of Zee Entertainment Enterprises Ltd. 

[3]     An entity held by the promoters, or promoter’s family, of Zee Entertainment Enterprises Ltd. 

[4]     An agreement through which LELM could compel ATL to take up LELM’s holding in Veria.

[5]     A wholly owned subsidiary of Zee Entertainment Enterprises Ltd.

[6]     Godhra Electricity Co Ltd &Anr v State of Gujarat &Anr (1975) 1 SCC 199.

[7]     2011 SCC Online Kar 4012.

Disclaimer: This article is meant for informational purposes only and does not purport to be advice or opinion, legal or otherwise, whatsoever. Views expressed in this article are personal views of the author

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