RESTRAINING THE INVOCATION OF BANK GUARANTEE

[Mr. M. GOVINDARAJAN]

Bank guarantee

A bank guarantee is a type of financial backstop offered by a lending institution. The bank guarantee means that the lender will ensure that the liabilities of a debtor will be met. In other words, if the debtor fails to settle a debt, the bank will cover it. A bank guarantee enables the customer, or debtor, to acquire goods, buy equipment or draw down a loan.

Types

The following are the various types of bank guarantee-

• Performance Guarantee;
• Bid Bond Guarantee;
• Financial Guarantee;
• Advance Payment Guarantee;
• Foreign Bank Guarantee;
• Deferred Payment Guarantee.

Features of a bank guarantee

A contract of Bank Guarantee involves the following important features-

• Underlying contract between the applicant (i.e. the debtor) and the beneficiary (i.e. the creditor);
• Maximum amount can be claimed under the Bank Guarantee;
• Period of validity of the Bank Guarantee;
• Period within which claim must be made by the beneficiary.

Invocation of bank guarantee

The beneficiary needs to invoke the bank guarantee on or before the expiry date of the guarantee. If the Bank does not receive any claim on or before the validity period mentioned, the Bank is discharged from its liability.   A bank is obliged to honor any legitimate claim within the validity period of the guarantee. If the invocation is in order and there is no court prohibiting the payment, the bank is required to honor payment to the beneficiary.  Before making the payment to the beneficiary, bank informs the applicant about the invocation of the guarantee and asks him to arrange for funds for payment of claim amount.

Cancellation of bank guarantee

After the expiry of the bank guarantee the same is to be returned to the bank for cancellation.  Otherwise the bank will send a registered notice to the beneficiary of the guarantee with direction to return the bank guarantee immediately.  If the beneficiary does not give any reply to the said notice or the original guarantee is not surrendered for cancellation, the bank can cancel the bank guarantee after waiting for a reasonable time.

Restraining the invocation

The law relating to courts’ interference by injunction restraining invocation of the bank guarantee has been settled by the various decisions of the Supreme Court and other courts. 

In RACHITA BUILDERS AND FINANCIERS PVT. LTD. VERSUS CHETAK CONSTRUCTION LIMITED AND ANOTHER [1990 (5) TMI 249 - MADHYA PRADESH HIGH COURT], the Madhya Pradesh High Court held that the courts will not interfere with enforcement of bank guarantees or letters of credit unless a case of fraud or a case of apprehension of irretrievable injustice has been made out so that either there should be a good prima facie case of fraud or of special equities in the form of preventing irretrievable injustice between the parties.

In  UNITED COMMERCIAL BANK VERSUS BANK OF INDIA [1981 (3) TMI 249 - SUPREME COURT] it has been held that courts should refrain from granting injunctions restraining performance of contractual obligations arising out of a letter of credit or a bank guarantee between one bank and another. In that case, the order passed by the High Court granting a temporary injunction restraining the appellant-bank from recalling a payment made ‘under reserve’ from respondent No. 1, was set aside on a finding that it was difficult to say on the material on record that the plaintiffs had a prima facie case and that the plaintiffs had failed to establish that they would be put to irreparable loss unless an interim injunction was granted and that the balance of convenience clearly lay in allowing the normal banking transaction to go forward.

In M/S. TECHTRANS CONSTRUCTION INDIA PVT. LTD., KSHEERAABD CONSTRUCTIONS PVT. LTD., JOINT VENTURE VERSUS M/S. RELIANCE UTILITY ENGINEERS LIMITED (FORMERLY KNOWN AS M/S. UTILITY ENERGYTECH AND ENGINEERS PVT. LTD.,) & ANOTHER [2014 (9) TMI 1252 - ANDHRA PRADESH HIGH COURT] the petitioner sought direction restraining the 1^st    respondent not to en-cash the bank guarantees invoked by it issued by the 2^nd respondent and also restraining the 2^nd respondent from honoring/disbursing the guarantee amount under both bank guarantees shown in the schedule furnished by the bank to the 1^st  respondent.

The Supreme Court in HIMADRI CHEMICALS INDUSTRIES LTD VERSUS COAL TAR REFINING COMPANY  [2007 (8) TMI 704 - SUPREME COURT] lays down the following principles in the matter of injunction to restrain the encashment of bank guarantee as below-

• While dealing with an application for injunction in the course of commercial dealings, and when an unconditional bank guarantee or letter of credit is given or accepted, the beneficiary is entitled to realize such a bank guarantee or a letter of credit in terms thereof irrespective of any pending disputes relating to the terms of the contract.
• The bank giving such guarantee is bound to honor it as per its terms irrespective of any dispute raised by its customer.
• The courts should be slow in granting an order of injunction to restrain the realization of a bank guarantee or a letter of credit.
• Since a bank guarantee or a letter of credit is an independent and a separate contract and is absolute in nature, the existence of any dispute between the parties to the contract is not a ground for issuing an order of injunction to restrain enforcement of bank guarantees or letters of credit.

In UP. STATE SUGAR CORPN. VERSUS SUMAC INTERNATIONAL LTD. [1996 (12) TMI 294 - SUPREME COURT]  the Supreme Court held that the bank giving a guarantee is bound to honor it as per its terms irrespective of any dispute raised by its customer. The very purpose of giving such a bank guarantee would otherwise be defeated. The courts should, therefore, be slow in granting an injunction to restrain the realization of such a bank guarantee. The courts have carved out only two exceptions. A fraud in connection with such a bank guarantee would vitiate the very foundation of such a bank guarantee. Hence if there is such a fraud of which the beneficiary seeks to take advantage, he can be restrained from doing so. The second exception relates to cases where allowing the encashment of an unconditional bank guarantee would result in irretrievable harm or injustice to one of the parties concerned. Since in most cases payment of money under such a bank guarantee would adversely affect the bank and its customer at whose instance the guarantee is given, the harm or injustice contemplated under this head must be of such an exceptional and irretrievable nature as would override the terms of the guarantee and the adverse effect of such an injunction on commercial dealings in the country. The two grounds are not necessarily connected, though both may co-exist in some cases.

In M/S. KSE ELECTRICALS PVT. LTD. VERSUS THE PROJECT DIRECTOR, BANGLADESH RURAL ELECTRIFICATION BOARD AND ANR. [2021 (12) TMI 1105 - CALCUTTA HIGH COURT],  the petitioner was awarded a contract for supply of conductor and related accessories to the respondent No. 1 pursuant to a global tender floated by the latter. The contract dated 15.11.2-15 was a Carriage and Insurance Paid contract for a price of USD 830,290 + BDT 371,000. The petitioner was required to furnish a performance security for an amount of USD 83,505 for a period of 24 months under the relevant clause of the General Conditions of Contract.  By an order dated 10.05.2021 a learned Single Judge restrained the respondent No. 2 from making any payment under a bank guarantee invoked by the respondent No. 1. The said order was modified on 18.05.2021 by another Learned Judge confirming the interim order of injunction and further restraining the respondent No. 1 from encashing the bank guarantee.

The High Court observed that the petitioner has satisfied two of the three ingredients, namely special equity and the invocation not being in terms of the guarantee. The clauses in the contract and more particularly the General Conditions Contract clearly demonstrate that the bank guarantee was furnished towards performance security. There can be no issue with regard to performance since the petitioner has already received 90% of the contract price. The invocation letter also demonstrates that there cannot be any performance issue with regard to the supplies effected by the petitioner. The invocation letter does not contain any allegation of a breach of performance obligations by the petitioner. The special equity also stands satisfied by reason of the petitioner facing an immediate and irreversible financial loss if the payment is made by Citibank NA, Dhaka to the respondent No. 1 in terms of the Letter of Invocation. If Citibank NA, Dhaka has the temerity to frustrate the orders of injunction passed against the respondents, it must also bear the risk and consequence of such action.

The interim orders passed by learned judges on 10.05.2021 and modified on 18.05.2021 were on a particular set of facts before filing of affidavits. The court may have considered altering or further modifying the orders of injunction at the instance of the respondent No. 2 having compelling facts disclosed subsequently on affidavits. Apart from territorial jurisdiction, no other grounds have been pleaded or shown which would warrant varying the orders when all relevant facts were taken into consideration by the learned Judges. It is also significant that the respondent no. 1 has not appeared or contested these proceedings and respondent no. 2 has taken to ‘shadow boxing’ on behalf of the absentee wrongdoer.

The High Court confirmed the order dated 10.05.2021 as modified by the order dated 18.05.2021  and made absolute.