The Bombay High Court (HC) by its judgment dated 19 August 2020 (judgment) passed in LD-VC-IA NO. 01 of 2020 IN LD-VC-SUIT NO. 120 of 2020- Yes Bank Limited v Zee Entertainment Enterprises & Ors has held that a letter of comfort would constitute a guarantee only if its terms meet the conditions set out in Section 126 of the Indian Contract Act, 1872 (Contract Act).

FACTUAL BACKGROUND

  • The main dramatis personae in the matter are:

i) Yes Bank Limited (Yes Bank)

ii) Zee Entertainment Enterprises Limited (Zee), the flagship company of the Zee/Essel group of companies (Zee Group);

iii) Living Entertainment Limited (LEL), ATL Media Limited (ATL), Veria International Limited (Veria) and Living Entertainment Entreprises Pvt. Ltd. (LEEPL)- all wholly owned subsidiaries of Zee;

  • In January 2016, certain companies in the Zee Group, holding approximately 5% equity in Zee, subscribed to equity in Veria through LEL and LEEPL.
  • On 20 January 2016, LEL entered into a Put Option Agreement (POA) with ATL, whereunder LEL had the option of calling upon ATL to buy 64.38% of Veria’s equity. The POA was valid till 29 July 2026.  
  • To fund this exercise as well as to re-finance certain intercorporate deposits used towards this exercise, LEL availed a loan of USD 50 million (“loan”) from Yes Bank, which was inter alia governed by a Facility Letter and Addendum thereto dated 30 March 2016 ,a Facility Agreement dated 8 June 2016 and several security documents (“facility documents”). Axis Bank, Dubai International Finance Centre branch (Axis Bank) was appointed as the Security Trustee under some of the security documents. The facility documents provided several “events of default”. On the occurrence of an event of default, Yes Bank had the right to enforce the put option under the POA and call upon ATL to buy-out LEL’s holding in Veria at an “exercise price” within a “settlement date” so that with the funds so received, LEL could repay Yes Bank. One of the events of default was a fall in promoter shareholding in Zee beyond a certain threshold.
  • As one of thesecurity for the loan, Zee issued a Letter of Comfort dated 31 March 2016 (LOC) to Yes. This is the document at the centre of the dispute. Under the LOC, Zee inter alia undertook to “support [ATL] by infusing equity/debt for meeting all its working capital requirements, debt requirements, business expansion plans, honouring put options, take or pay agreements and guarantees”, “undertake all its overseas operations through ATL and its subsidiaries” and“to hold at-least 51% shares during the tenure of the facility”. The LOC would remain valid from date of release of facilities from Yes Bank to the date of its repayment.
  • On 2 August 2019, the promoters of Zee announced divestment of a part of their stake in Zee. In response, Yes Bank wrote to Zeesaying that the divestment had triggered an event of default and demanded repayment of the loan.
  • On 7 November 2019, Yes Bankissued enforcement notices to LEL and ATL liquidate its dues and a put-option notice to ATL in terms of the POA. LEL responded to the notice served upon it acknowledging its dues and requested time for repayment, which it failed to do. ATL, on its part, failed to buy-out the shares of Veria.
  • Thereafter, Yes Bank issued three letters to Zee on 21 November 2019, 9 January 2020 and 31 March 2020 respectively. While the LOC was alluded to in the letter dated 9 January 2020 whereby Zee was called upon to “support” ATL by infusing funds in terms of its obligations thereunder,it was only in the letter dated 31 March 2020, which was addressed to Zee, its directors and Key Managerial Personnel (KMP) that Yes Bank for the first time took the stand that the LOC was “absolute, irrevocable and unconditional guarantee” and called upon Zee to repay the loan. Zee, in response, issued a letter dated 11 June 2020 to Yes Bank, denying its liability as a guarantor ,stating that its only obligation under the LOC was to keep ATL in liquidityand asserting that there was no privity of contract between Yes Bank and Zee.
  • Aggrieved by the stand taken by Zee, Yes Bank filed the suit being LD-VC-SUIT NO. 120 of 2020 (suit) before the HC inter alia against Zee and its directors, LEL, Veria, ATL and LEEPL, praying inter-alia for a declarations that the LOC was in the nature of a guarantee and perpetual injunctions against Zee from alienating its assets till its repaid the loan with interest.. In the suit, Yes Bank filed an interlocutory application being LD-VC-IA NO. 01 of 2020 (application) praying for orders against Zee to secure the debt.

ISSUE FOR CONSIDERATION BEFORE THE HC

The HC sought to examine whether the LOC would constitute a guarantee under Section 126 of the Contract Act and consequently, whether Yes Bank was entitled to the reliefs sought for in the application.

JUDGMENT

  • The HC considered Section 126 of the Contract Act, which 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”. In this regard, it accepted Yes Bank’s contention that the form which the guarantee took was immaterial. In the same breadth, Zee’s contention that there was no privity between it and Yes Bank was rejected. The HC held that the question that was required to be answered was whether the privity was in the nature of a contract of guarantee.
  • In this regard, the HC held that a guarantee created a very specific obligation, whereunder a guarantor unequivocally undertakes and assures repayment of the debt of the principal debtor on its default
  • The HC went on to consider the wordings of the LOC in the instant case and the conduct of the parties in connection therewith, in line with the principles of contractual interpretation laid down by theSupreme Court in Godhra Electricity Company Limited & Anr v State of Gujarat & Anr [(1975) 1 SCC 199].
  • The HC arrived at a finding that under the LOC, Zee at best was under an obligation to infuse funds into ATL to enable it to meet its obligations under the POA and not to repay the debts owed by LEL to Yes Bank. Except the letter dated 31 March 2020, all other correspondences issued by Yes Bank to Zee revealed that Yes Bank itself understood the obligations of Zee under the LOC to be limited to infusing funds into ATL. This was also borne out of the pleadings in the plaint.
  • The HC considered the decision of the Delhi High Court (Delhi HC) in Lucent Technologies v ICICI Bank Ltd [2009 SCC OnLine Del 313] (Lucent) relied upon by Yes Bank. In Lucent had held the LOC involved in the case not to be a guarantee, it had recognised that parties had to be held to the bargain they had entered into in a commercial document and the promissory consequences of the same had to be given effect to. In this regard, the Delhi HC, inter alia, relied on the the decision of the Commercial Division of the Supreme Court of New South Wales, Australia in Banque Brussels Lambert SA v Australian National Industries Limited [(1989) 21 NSWLR 502] (Banque Brussels). The HC held that while it accepted the aforesaid proposition of law, in Banque Brussels, the Court was dealing with a claim for damages. While the court concerned held that the LOC in that case was not a guarantee, it went on to award damages to the plaintiff for the failure on the part of the defendant to perform its obligations under the said LOC. In the instant suit, no prayer for damages had been made.
  • The HC also considered the decision of the Karnataka High Court in United Breweries (Holding) Ltd v State Industrial Investment & Development Corporation Limited [AIR 2012 Kar 65], where a Division Bench of the Karnataka High Court had held the LOC involved in that case not to be a guarantee. In that case, it was held that a guarantor was liable only to the extent of his guarantee- no additional liability could be foisted upon him. In the instant case, it was clear from the terms of the LOC that Zee had only undertaken to infuse funds into ATL and not discharge its debt on its behalf. Therefore, the reliefs claimed in the application and prima facie, the suit, could not be granted.
  • In the aforesaid premise, the HC held that LOC would amount to a guarantee, if,upon reading its terms as a whole and considering the conduct of parties, the requirements under Section 126 of the Contract Act were met. The nomenclature of the document would be inconsequential. In the instant case, however, the LOC was found not to amount to a guarantee and the application was dismissed.

COMMENT

Although the view taken by the HC is a prima facie one, the judgment has important ramifications. LOCs are routinely caused to be issued by lenders as security for facilities extended by them. Although the LOC in the question in the instant case was found not to be a guarantee, the judgment affirms the possibility of an LOC amounting to a guarantee under Section 126 of the Contract if worded in a manner evincing the intention of the issuer to bind itself as a guarantor. This has to be ascertained from the terms of the LOC. Further, even assuming that a LOC is not a guarantee, the judgment has left room for a claim for damages to be maintained by a party aggrieved by the non-performance of obligations under an LOC by its issuer. This is in line with the decision in Banque Brussels. Further, a claim for specific performance of obligations under an LOC ( Zee infusing funds into ATL to enable ATL to honour the put option) may also be maintained. Be that as it may, the key takeaway from the judgment is that an LOC may not be a toothless security, as is commonly believed, and obligors thereunder may very well be held accountable in respect thereof.