Injunction
against invocation of bank guarantee
PART-
II
The
issue of encashing bank guarantee in the backdrop of disputes between parties
is often a subject matter in the court dockets. The law has evolved in this
regard over the year and generally, any fetter is not permitted to the
encashment of bank guarantee. There are instances, however, when the restrain
order against invocation of bank guarantee could be passed. In the present
write up, endeavour shall be to reflect on the above issue. In fact, the present
article is a sequel to earlier article where law relating to encashment of bank
guarantee on merit i.e after trial was deliberated. However, unless, the issue
of interim restrain against invocation of bank guarantee and parameter under
which such order could be passed is also deliberated, a vital limb of the law
shall remain unattended. Therefore, by way of the present write up it is
endeavoured to analyze the law in respect of that and parameter under which
interim injunction against invocation of bank guarantee could be passed and
judicial precedents in this regard has accordingly been duly ventured on.
The
Law and judicial precedents : Analysis
If
a bank guarantee is invoked on fraudulent ground there may be a ground of
interim injunction. Thus it follows that if a party seeks to encash bank
guarantee, despite the pervasive fraud unleashed by it, then the same may
tantamount to reaping advantage of their own wrong. Whether the same could be
permitted is a question?
It
will be apposite to cull out various precedents relating to the principles
governing the bank guarantees and its encashment, and the parameter of probable
challenges that are permitted to be raised against invocation thereof.
As a general rule courts are loath to interfere
with irrevocable documentary credits and obligations assumed by the banks, like
Letters of Credit and Bank Guarantees, since internal and international Trade
and Commerce runs on the faith of their efficacy. How well established and
entrenched is the concept could be borne out from the scores of judicial
decisions. In Hamzeh Malas & Sons Vs. British Imex Industries Limited, (1958) 1 All ER 262, it
was held by the Queen’s bench that opening of a confirmed letter of credit
constitutes a contract between the bank and the vendor of goods which imposes
upon the banker an absolute obligation to pay, irrespective of any dispute
between the parties, as to whether the goods are up to
contract or not as an elaborate commercial system is built upon the
footing that banker’s credit is of that character and it would be wrong for a
court to interfere with the established practice.
In
Centex India Ltd. Versus Vinmar Impex
Inc, AIR 1986 SC 1924, it was held that a bank guarantee resembles and is
analogous to a letter of credit and the same considerations apply to it, which
apply to a letter of credit in the matter of its enforcement/ interference by
courts. This decision is noted at the outset for the reason that letters of
credit were in vogue earlier to the introduction of bank guarantees for
commercial purposes and the principles governing letters of credit in the
matter of interference by the courts were made applicable to bank guarantees as
well.
The Supreme Court in
the case of Tarapore & Company v. V.O. Tractors Export, (1969) 2
SCR 920, while citing with approval the aforesaid principle of Queens
bench was pleased to lay down the following principles :
(i)
an irrevocable letter of credit has a definite
implication;
(ii)
letter of credit is a contract between the
banker and the beneficiary and is
independent of and not qualified by the contract of sale or the
underlying transaction; and
(iii) letter
of credit, being a mechanism of great importance in the international trade,
its autonomy is entitled to protection. This being so courts do not interfere with their autonomy except
in very exceptional circumstances.
In yet another English
decision in R.D. Harbottle (Mercantile)
Limited Vs. National West Minister Bank Limited (1977) 3 W.L.R. 752, which
is largely quoted by the courts in the decisions involving letters of
credit and bank guarantees, it was held as follows:-
“It is only in exceptional cases that the
courts will interfere with the machinery of irrevocable obligations assumed by
the banks. They are the life and blood of international commerce.
Such obligations are recorded as collateral to the underlying rights and
obligations between the merchants at either end of the banking chain.
Except possibly in the clear cases of fraud of which the banks have notice the
courts will leave the merchants to settle their disputes under the contracts by
litigation or arbitration as available to them or stipulated in the contract.
The courts are not concerned with their difficulties to enforce such
claims. These are risks which the merchants take. In this case, the
plaintiffs took the risk of unconditional wording of the guarantees. The
machinery and commitments of banks are on a different level, they must be
allowed to be honoured, free from interferences by the courts otherwise trade
in international commerce could be irreparably damaged.”
The aforesaid
observations of Kerr J. were cited with approval in Edward Owen Engineering Limited
Vs. Barclays Bank International Ltd., (1978) 1 All ER 976 by Lord Denning, who
observed that “a bank which gives a performance guarantee must honour that
guarantee according to its terms. It is not in the least concerned with
the relations between the supplier and customer nor with the question whether
the supplier is at default or not. The bank must according to its guarantee
pay on demand, if so stipulated without proof of default. The only exception is when there is a clear
fraud of the beneficiary which the bank has notice.”
The Supreme Court in
the case of United Commercial bank vs. Bank of India, (1981) 3 SCR 300,
while relying upon various decision held that a letter of credit constitutes a
contract between the beneficiary and the bank issuing the letter of credit and
is independent of and unqualified by the underlying contract of
sale. In this regard it observed as follows:-
“The credit contract is independent of the
sales contract on which it is based, unless the sales contract is in some
measure incorporated…..The authorities are uniform to the effect that a letter
of credit constitutes the sole contract with the banker, and the bank issuing
the letter of credit has no concern with any question that may arise between
the seller and the purchaser of the goods, for the purchase price of which the
letter of credit was issued.”
The aforesaid decisions
were noticed and relied upon by the Supreme Court in U.P. Co-operative Federation
Limited Vs. Singh Consultants and Engineering Pvt. Ltd. , AIR
1988 SC 174. In that case it was held that in order to restrain
the operation of an irrevocable letter of credit or of a bank guarantee, there
should be a serious dispute, a prima
facie case of fraud and special equities in the form of preventing
irretrievable injustice between the parties, otherwise their very purpose would
be frustrated and the fabric of trading operations will get jeopardized. While
holding so, their lordships made reference to history, progress and growth of
the concept of letter of credit. Elucidating the concept it was
pointed out to the effect that:
(i)
The letter of credit was used in conjunction
with the sale transactions between the parties, separated geographically over
distances and was intended to facilitate the sale and purchase of goods between
unfamiliar buyers and sellers. It was difficult for the seller to rely
upon the credit of the buyer and similarly it was equally difficult for the
buyer to pay for the goods prior to their delivery. In order to bridge
the gap and to generate confidence in the parties to do business even with
total strangers, mechanism of letter of credit was created;
(ii)
In the case of such transactions when the
seller presents a demand as per terms of the documents, the banks must pay if
the documents are in order and the terms of credit are satisfied. To this
absolute rule that the banks must honour the commitments, there are two
exception in as much as in case there be fraud of the beneficiary and special equities in the form of preventing
irretrievable injustice between the parties, the
bank could refuse the demand.
The Supreme Court to
illustrate a case of fraud of the beneficiary of a bank guarantee in the above
decision, referred to the American case of Sztejn Vs. J. Heney Schroder Banking Corporation (1941) 31 NYS 2d
631. The facts of the case as noticed by
the Supreme Court were that one Mr. Sztejn wanted to buy certain quantity of
Bristles. He entered into deal with a overseas seller to sell to him a
particular quantity thereof. The Respondent bank issued a letter of
credit to the seller that provided that upon receipt of appropriate documents,
the bank would pay for the shipment. It was discovered by Sztejn that
the shipment did not consist of Bristles, but crates of worthless
material. He approached the bank which informed him that the letter of
credit was an independent undertaking of the bank and it must pay to the
seller, whereupon he sought an injunction from the Court. The collecting
bank which received the documents from the seller for collection applied for
dismissing the buyer’s claim for injunction on the ground that there was no cause
of action. It was a proceeding similar to a proceeding that is initiated by an
application under Order VII Rule 11 CPC. The allegations were taken to be true
and as they constituted fraud, the court issued injunction against the
demand of letter of credit. It was noticed by the Supreme Court in the
same decision- UP Co-operative Federation
(supra)] that it was perhaps, the first time that the said exception
of fraud to the rule of absolute independence of the letter of credit was
applied in aforesaid American case. The exception of fraud created in the
above case was codified in sections 5 – 114 of the US Uniform Commercial
Code. The Supreme Court also noticed that the exception was accepted by
the courts in England as reflected in the following cases:
i. Hamzeh Malas & Sons Vs. British Imex Industries Ltd. (supra).
ii. R.D. Harbottle (Mercantile) Limited Vs. National West Minister Bank
Limited (supra)
iii.
Edward Owen Engineering Limited Vs. Barclays Bank International
Ltd. (supra)
iv.
United City Merchants (Investments) Vs. Royal Bank of India (1982)
2 All. E.R. 720.
In the case of General Electric Technical Services Company
Inc. Vs. Punj Sons
(P) Ltd., (1991) 4 SCC 230, where as per the stipulations in the three
bank guarantees, the bank was required to pay on demand of the beneficiary
without demur and the beneficiary was to
be the sole judge as regards the loss or damage caused to it due to the alleged
breach of the other party to the underlying contract, the Supreme Court held
that the right of a contractor to recover certain amount under running bills
would have no relevance to the obligation of the bank to honour its commitment
under the guarantees given by it. At this stage, it may be worthwhile to quote
the exact observations of the court :
“The GETSCO has only sought to enforce the
bank guarantee for the balance amount of Rs. 1,06, 12,500 on a complaint that Respondent-1,
has failed to perform the contract as per the terms and conditions. The Bank
has undertaken to pay this sum of money and it is a commitment of the Bank. The
Bank must honour its commitment when demand is made. Indeed, the Bank was
prepared to pay and has in fact issued the Cashier's order as per demand from
GETSCO, but the Court has directed the Bank not to pay under the guarantee. The
question is whether the Court was justified in restraining the Bank from paying
to GETSCO under the bank guarantee at the instance of Respondent-1. The law as
to the contractual obligations under the bank guarantee has been well settled
in a catena of cases. Almost all such cases have been considered in a recent
judgment of this Court in U.P. Cooperative Federation Ltd. v.
Singh Consultants and Engineers (P) Ltd., [1988] 1 SCC 174 wherein
Sabyasachi Mukherji, J., as he then was, observed (at 189) 'that in order to
restrain the operation either of irrevocable letter of credit or of confirmed
letter of credit or of bank guarantee, there should be serious dispute and
there should be good prima facie case of fraud and special equities in the form
of preventing irretrievable injustice between the parties. Otherwise, the very
purpose of bank guarantees would be negatived and the fabric of trading
operations will get jeopardised'. It was further observed that the Bank must
honour the bank guarantee free from interference by the Courts. Otherwise,
trust in commerce internal and international would be irreparably damaged. It
is only in exceptional cases that is to say in case of fraud or in case of
irretrievable injustice, the Court should interfere. In the concurring opinion
one of us (K. Jagannatha Shetty, J.) has observed that whether it is a
traditional bond or performance guarantee, the obligation of the Bank appears
to be the same. If the documentary credits are irrevocable and independent, the
Bank must pay when demand is made. Since the Bank pledges its own credit
involving its reputation, it has no defence except in the case of fraud. The
Bank's obligations of course should not be extended to protest the unscrupulous
party, that is, the party who is responsible for the fraud. But the banker must
be sure of his ground before declining to pay. The nature of the fraud that the
courts talk about is fraud of an "egregious nature as to vitiate the
entire underlying transaction". It is fraud of the beneficiary, not the
fraud of somebody else.”
The High Court has observed that failure on the part
of GETSCO to make a reference to mobilisation advance in the letter seeking
encashment of the bank guarantee would tantamount to suppression of material
facts, in the sense that the mobilisation advance was, under the contract to be
recovered from the running bills. It was further observed that disclosure
of such facts would have put the bank to further inquiry as to what was the
amount covered by those bills and what was the corresponding amount of the
mobilisation advance and to what extent the amount covered by the bank
guarantee remained payable. In any event, the High Court said, that GETSCO
could not demand full amount of the bank guarantee on 17 April 1989. It seems
to us that the High Court has misconstrued the terms of the bank guarantee and
the nature of the inter-se rights of the parties under the contract. The
mobilisation advance is required to be recovered by GETSCO from the running
bills submitted by the Respondent. If the full mobilisation advance has not
been recovered, it would be to the advantage of the Respondent. Secondly, the
Bank is not concerned with the outstanding amount payable by GETSCO under the
running bills. The right to recover the amount under the running bills has no
relevance to the liability of the Bank under the guarantee. The liability of
the Bank remained intact irrespective of the recovery of mobilization advance
or the non-payment under the running bills. The failure on the part of GETSCO
to specify the remaining mobilisation advance in the letter for encashment of
bank guarantee is of little consequence to the liability of the Bank under the
guarantee. The demand by GETSCO is under the Bank guarantee and as per the
terms thereof. The Bank has to pay and the Bank was willing to pay as per the
undertaking. The Bank cannot be interdicted by the Court at the instance of Respondent-1
in the absence of fraud or special equities in the form of preventing irretrievable
injustice between the parties. The High Court in the absence of prima facie
case on such matters has committed an error in restraining the Bank from
honouring its commitment under the bank guarantee.”
Thus it is clear that notwithstanding the dispute
between the beneficiary and the party at whose instance the bank guarantee is
furnished, the bank is liable to discharge its liability in accordance with the
terms of the bank guarantee, subject to the two exceptions recognised by the
Supreme Court in its decision rendered in the case of UP Cooperative Federation
(supra).
In the State
Trading Corporation of India Ltd. Vs. Jainsons Clothing
Corporation and Anr., (1994) 6 SCC
597, the Supreme Court while referring to the
decision in U.P .Coop federation Ltd. case and various other decisions held as
follows:- “The grant of injunction is a discretionary
power in equity jurisdiction. The contract of guarantee is a trilateral
contract which the bank has undertaken to unconditionally and unequivocally
abide by the terms of the contract. It is an act of trust with full faith to
facilitate free flow of trade and commerce in internal or international trade
or business. It creates an irrevocable obligation to perform the contract in
terms thereof. On the occurrence of the events mentioned therein the bank
guarantee becomes enforceable. The subsequent disputes in the performance of
the contract does not give rise to a cause nor is the court justified on that
basis, to issue an injunction from enforcing the contract, i.e., bank
guarantee. The parties are not left with no remedy. In the event of the dispute
in the main contract ends in the party's favour, he/it is entitled to damages
or other consequential reliefs.”…
“It
is settled law that the court, before issuing the injunction under Order 39,
Rules 1 and 2, CPC should prima facie be satisfied that there is triable issue
strong prima facie case of fraud or irretrievable injury and balance of
convenience is in favour of issuing injunction to prevent irremediable injury.
The court should normally insist upon enforcement of the bank guarantee and the
court should not interfere with the enforcement of the contract of guarantee
unless there is a specific plea of fraud or special equities in favour of the
plaintiff. He must necessarily plead and produce all the necessary evidence in proof of the fraud in
execution-of the contract of the guarantee, but not the contract either of the
original contract or any of the subsequent events that may happen as a ground
for fraud.”
In Larsen
and Tubro Ltd. Vs. Maharastra State Electricity
Board, AIR 1996 SC 334, it was held to the effect that bank
guarantee furnished by the bank being irrevocable and unconditional one and as
the beneficiary was made the sole judge on the questions of breach of
performance of the contract and the extent of loss and damages, injunction
restraining the beneficiary from invoking the bank guarantee could not have
been granted.
In Hindustan
Steel Works Construction Ltd. Vs. Tarapore and Co. and
another, AIR 1996 SC 2268, the Supreme Court while quoting the observations of Mukherji, J.,
recorded in para 34 of his lordships judgment rendered in UP Cooperative
Federation case (supra), namely, “It is only in exceptional cases that is to
say in case of fraud or in case of
irretrievable injustice be done, the Courts should interfere,” clarified
that this being the ratio of the decision, fraud cannot be said to be the only
exception. Their Lordship went on to lay
down that where the party approaching the Court is able to establish that in
view of special equities in his
favour, if injunction as requested is not granted, then he would suffer an
irretrievable injustice, the court could and would interfere. It was further
observed that the fraud which is recognized as an exception is the fraud by one
of the parties to the under lying contract which has the effect of vitiating
the entire underlying transaction. It was also observed that the demand by the
beneficiary under the bank guarantee may become fraudulent, not because of any
fraud committed by the beneficiary executing the underlying contract but it may
become so because of subsequent events or circumstances. The court also
observed that there is no good reason that the court should not restrain a
person making such a fraudulent demand from enforcing a bank guarantee.
In Dwarikesh Sugar Industries
Ltd. vs Prem Heavy Engineering
Works Pvt. Ltd. & Anr. (1997) 6
SCC 450, the Supreme Court held as follows:-
“21. Numerous decisions of this Court
rendered over a span of a nearly two decades have laid down and reiterated the
principles which the Court must apply while considering question whether to
grant an injunction which has the effect of restraining the encashment of a
bank guarantee. We do not think it necessary to burden this judgment by
referring to all of them. Some of the most recent pronouncements on this
point where the earlier decisions have been considered and reiterated are; Svenska Handelsbanken Vs. Indian Charge
Chrome, (1994) 1 SCC 502; Larsen & Toubro Ltd. Vs. Maharashtra , (1995) 6 SCC 68; Hindustan Steel Workers Construction Ltd. Vs. G.S. Atwal & Co.
( Engineers ) (P). Ltd., (1995) 6 SCC 76 and U.P. State Sugar Corporation Ltd. Vs. Sumac International
Ltd. (1997) 1 SCC 568.”
The general principle
which has been laid down by this court has been summarized in case of U.P.
State Sugar Corporation as follows:-
“The law relating to invocation of such bank
guarantee is by now well settled. When in the course of commercial
dealings an unconditional bank guarantee is given or accepted, the beneficiary
is entitled to realize such a bank guarantee in terms thereof irrespective of
any pending dispute. The bank giving such guarantee is bound to
honour 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. Courts should, therefore, be slow in granting an injunction to
restrain the realisation 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
customers 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 guarantee and the adverse effect of such
injunction on commercial dealings in the country.”
Dealing with the question of fraud it has been held
that fraud has to be an established fraud. The following observation of sir
John Donaldson, M.R. in Bolivinter oil SA V. Chase Manhattan Bank (1984) 1 All
ER 351, are apposite:
"The wholly
exceptional case where an injunction may be granted is where it is proved
that the bank knows that any demand for payment already made or which may
thereafter be made will clearly be fraudulent. But the evidence must be clear
both as to the fact of fraud and as to the bank's knowledge. It would
certainly not normally be sufficient that rests on the uncorroborated statement
of the customer, for irreparable damage can be done to a bank's credit in the
relatively brief time which must elapse between the granting of such an
injunction and an application by the bank to have it charged."
(emphasis supplied)
The aforesaid passage
was approved and followed by this court in U.P. cooperative Federation Ltd. Vs.
Singh consultants and Engineers (P) Ltd. [(1988) 1 SCC 174].
The second exception
to the rule of granting injunction, i.e., the resulting of irretrievable injury, has to be such a circumstance which
would make it impossible for the guarantor to reimburse himself, if he
ultimately succeeds. This will have to be decisively established and it must be
proved to the satisfaction of the Court that there would be no possibility
whatsoever of the recovery of the amount from the beneficiary by way of
restitution. …….
…………..
27. …………..
28………
29. It is unfortunate that the High Court did
not consider it necessary to refer to various judicial pronouncements of this
Court in which the principles which have to be followed while examining an
application for grant of interim relief have been clearly laid down. The
observation of the High Court that reference to judicial decisions will not be
of much importance was clear a method adopted by it in avoiding to follow and
apply the law as laid down by this Court. Yet another serious error which was
committed by the High Court, in the present case, was not to examine the terms
of the bank guarantee and consider the letters of invocation which had been
written by the appellant…………
“It is held that when
a position, in law, is well settled as a result of judicial pronouncement of the
Supreme Court, it would amount to judicial impropriety
to say the least, for the subordinate courts including the High Courts to
ignore the settled decisions and then to
pass a judicial order which is clearly contrary to the settled legal position.
Such judicial adventurism cannot be
permitted and we strongly deprecate the tendency of the subordinate courts in
not applying the settled principles and in
passing whimsical orders which necessarily has the effect of granting wrongful
and unwarranted relief to one of the parties. It is time that this tendency
stops.”
In Federal Bank Ltd. Vs.
V.M. Jog Engineering Ltd. and Ors. (2001) 1 SCC 663, the
Supreme Court taking stock of the various judgments observed as under:-
“55. In several judgments
of this Court, it has been held that courts are not to grant injunction to
restrain encashment of bank guarantees or letter of credit. Two exceptions have
been mentioned- (i), Fraud, and (ii) Irretrievable damage. If the plaintiff is prima facie
able to establish that the case comes within these two exceptions, temporary
injunction, under order 39 rule 1 CPC can be issued. It has also been held that
the contract of bank guarantee or the letter of credit is independent of the
main contract between the seller and the buyer.
This is also clear from Article 3 and 4 of UCP (1983 Revision). In case of an irrevocable bank guarantee or
letter of credit the buyer cannot obtain injunction against the banker on the
ground that there was a breach of the contract by the seller. The bank is to honour the demand for
encashment if the seller prima facie complies with the terms of the bank
guarantee or the letter of credit, namely, if the seller produces the documents
enumerated in the bank guarantee or the letter of credit. If the bank is satisfied on the face of the
documents that they are in conformity with the list of documents mentioned in
the bank guarantee or the letter of credit and there is no discrepancy, it is
bound to honour the demand of the seller for encashment. While doing so it must take reasonable
care. It is not permissible for the bank
to refuse payment on the ground that the buyer is claiming that there is a breach
of contract. Nor can the bank try to
decide this question of breach at that stage and refuse payment to the
seller. Its obligation under the
documents having nothing to do with any dispute as to breach of contract
between the seller and the buyer. As to
its knowledge of fraud or forgery, we shall presently deal with it.”
The Supreme Court in the
aforesaid case also referred to the following observations in the case of Sztejn v. J.
Heney Schroder Banking Corpn. (1941) 31 NYS 2d. 631.
“where the seller's
fraud has been called to the bank's attention before the drafts and documents
have been presented for payment, the principle of the independence of the
bank's obligation under the Letter of Credit should not be extended to protect
the unscrupulous seller. …..”
“……No hardship will
be caused by permitting the bank to refuse payment where fraud is claimed,
where merchandise is not merely inferior in the quality but consists of
worthless rubbish, where the draft and the accompanying document are in the
hands of one who stands in the same position as the fraudulent seller, where
the bank has been given notice of fraud before being presented with the drafts
and documents for payment, and where the bank itself does not wish to pay
pending an adjudication of the rights and obligations of the other parties.”
In BSES
Ltd. (Now Reliance Energy Ltd.) Vs. Fenner India Ltd. and Anr. (2006) 2 SCC 728, it
was reiterated that there are two exceptions to the general rule that the bank
must pay according to the tenor of the guarantee: “when there is a clear fraud of beneficiary from which it seeks to
benefit and the bank has notice of the fraud; and the second exception is when
there are special equities in favour of injunction such as when irretrievable
injury and injustice would occur if such an injunction were not granted.”
In the
case of Samwoh Asphalt
Premix Pte. Ltd. Vs. Sum Cheong Piling Pte. Ltd.
(2002) 1 SLR 1, wherein the Singapore Court has gone so far as to say that the
unconscionable calling of a bank guarantee was an exception independent of
fraud. The Supreme Court, while repelling the aforesaid contention
advanced on behalf of one of the Respondents, refused to accept the proposition
of law laid down in the aforesaid judgment of the Singapore court in the face
of the law laid down in U.P. Coop. federation (supra) and numerous other
judgments. It was also observed that whatever may be the law as to the
encashment of the bank guarantees in other jurisdictions, when the law in India
is clear, settled and without any deviation whatsoever, there is no occasion to
rely upon the foreign case law.
28. In Hindustan Construction Company
Ltd. Vs. State of Bihar, AIR 1999 SC 3710, it was held that a bank
guarantee is the common mode of securing payment of money in commercial
dealings as a beneficiary under the guarantee is entitled to realise the whole
of the amount under the guarantee in terms thereof irrespective of any pending
dispute between the person on whose behalf the guarantee was given and the
beneficiary.
In Reliance
Salt Ltd. Vs. Cosmos Enterprises & Anr, (2006) 13 SCC
599, it was held that “breach of contract by reason
of supply of inferior quality tea or salt or delay in supply or a short supply
may render a party responsible for damages for commission of breach of
contract, but breach of contract alone does not lead to a conclusion that a
fraud had been committed thereby…..”. It was also held by the Supreme Court
that fraud which vitiates the contract must have a nexus with conduct of the
parties prior to entering into the contract but these observations are contrary
to the decision rendered by two judge bench in Hindustan Steel Works
Constructions Ltd. Vs. Tarapore and
Company (supra).
30. It is also well settled
that the Terms of the bank guarantee must be fulfilled before its invocation.
In M/s Harprasad and
Co. Vs. Sudharshan Steel
Mills, AIR 1980 Delhi 174, it was held that under the bank guarantee absolute
liability would arise only on the terms of the bank guarantee being fulfilled.
It will be appropriate to quote the following paragraphs from the
decision:
“In this connection we may point out that the
Punjab National Bank in this case, as every other bank issuing a bank
guarantee, has a duty to perform. The bank must not, take up the position that
it would be willing to pay the amount of the bank guarantee on a mere demand
simply because its customer who has got the bank guarantee issued in favor of
the other party to the contract has already secured the bank against any loss
that may be caused by the recovery of the amount of the bank guarantee from the
bank by the other party in the contract. The bank has itself a duty to satisfy
itself that the demand by the beneficiary under the bank guarantee is made in
accordance with the terms of the bank guarantee. For instance, if in the
present case the appellant has simply called upon the bank to pay the money
under the bank guarantee, such a notice in writing is not in accordance with
the terms of the bank guarantee. It is the duty of the bank to satisfy itself
that the demand is made on the ground that in the judgment of the appellant Respondent
No. 1 has failed to fulfill any of the obligations under the contract. Further,
the bank has to see that the judgment is exercised in respect of some definite
obligation to be performed by Respondent under the contract. It is not sufficient
for the appellant merely to reiterate parrot-like words of the bank guarantee.
The statement by the appellant in the notice in writing that Respondent No. 1
has failed 'to carry out and fulfill any of the obligations assumed under the
said contract' would simply be unintelligible 'Any of the obligations' are
meaningless words unless and until a reference is made to some particular
obligation to which Respondent No. 1 has failed to carry out in the judgment of
the appellant. The duty of the appellant in making the demand on the bank is
like the duty of the plaintiff to disclose the cause of action in the plaint.
Just as a plaint is liable to be rejected for non-disclosure of the cause of
action, a demand by the beneficiary of the bank guarantee is liable to be
rejected by the bank if it does not state the facts showing that the conditions
of the bank guarantee have been fulfilled. Just as the allegations in the
plaint have to be assumed to be true at the stage of plaint is to be
entertained, similarly the allegations in the demand would have to be assumed
to be true by the bank provided that the proper allegations are made just as a
proper pleadings has to be made in the plaint. The bank is not to enquire into
the truth of the allegations just as the court is not to enquire into the truth
of the pleadings at the stage of the filing of the plaint………
The argument of the appellant that the liability of the bank is absolute
even without showing whether the appellant has stated in the notice in writing
that in its judgment Respondent No. 1 has failed to fulfill an obligation under the contract after describing
some particular obligation there under would amount to saying that the effect
of the bank guarantee is to deliver the amount of money secured by the bank
guarantee to the beneficiary. This is not so, until the terms of the bank
guarantee are fulfilled the amount is not placed into the pockets of the beneficiary. It still
remains with the bank. It is no use for the beneficiary to say that the amount
under the bank guarantee is payable to the beneficiary on demand if the demand
must be preceded by a proper statement in the demand notice. ”
In Explore Computers Pvt. Ltd.
Vs. CALS Ltd. & Anr. 131 (2006) DLT 477,
it was held that the bank is obliged to verify that the cause of action for
invoking the bank guarantee has been made out as per the letter of
invocation. It was further held that the bank, however, is not required
to go into the merits of the controversy.
In V.V. Gupta Vs. New Delhi
Municipal Council & Anr., 129 (2006) DLT. 771, it
was held that if invocation of bank guarantee is not in terms of the bank
guarantee then the injunction can be granted restraining the encashment of the
bank guarantee.
In Hindustan Construction Company Ltd.
Vs. State of Bihar & Anr.
(supra), it was also held that
invocation must be in accordance
with the terms of the bank guarantee or else the invocation itself would be
void. In this regard it was observed as under:-
“What is important, therefore, is that the
bank guarantee should be in unequivocal terms, unconditional and recite
that the amount would be paid without demur or objection irrespective of any
dispute that might have much granted or might being pending between the
beneficiary under the bank guarantee or the person on whose behalf the
guarantee was furnished. The terms of the bank guarantee are, therefore,
extremely material. Since the bank guarantee represents an independent
contract between the bank and the beneficiary, both the parties would bound by
the terms thereof. The invocation, therefore, will have to be in
accordance with the terms of bank guarantee, or else, that invocation itself
would be bad.”
In National Highways
Authority of India Vs. Karnataka Enterprises & Anr.
(2003) 7 SCC 410, it was held that a contract of guarantee is a complete and
separate contract by itself. The law regarding enforcement of on demand
bank guarantee is very clear. If the enforcement is in terms of the
guarantee then courts must not interfere with the enforcement of bank
guarantee. The courts can only interfere with the invocation is against
the terms of the guarantee or if there is any fraud. Courts cannot
restrain the enforcement of on demand guarantee by looking at the terms of the
underlying contract.
The Supreme Court in Federal Bank vs. V.M. Jog Eng. Ltd. and Ors.
(supra) also laid down that the banks while dealing with the demand for
encashment of a bank guarantee must satisfy itself that the bank guarantee has
been invoked in accordance with the terms thereof. It also referred to uniform
customs and practices for documentary credits formulated by the international
chamber of commerce with a view to emphasize the duty and obligation of the
bank to apply reasonable care to ascertain whether on the face of the letter of
invocation, the banks credit has been invoked in terms and conditions thereof.
In this regard, it was observed as follows:
Summary
of the principles that flow from the aforesaid judicial pronouncements:
The
following principles emerge from the decisions cited above:-
a.
Irrevocable and
unconditional bank guarantee constitutes a contract between the bank and the
beneficiary, which is separate and independent of and unqualified by the
underlying contract between the person at whose instance the bank guarantee is
furnished and the beneficiary thereof.
b.
Bank Guarantee must
be invoked in terms thereof. The terms of the bank
guarantee are material and both the parties, namely, the bank and the
beneficiary are bound by them. This being so, the bank is required to honour
the demand for encashment of a bank guarantee only if the beneficiary complies
with the terms of the bank guarantee.
The bank has a duty to satisfy itself that the demand by the beneficiary
under the bank guarantee is made in accordance with the terms of the bank
guarantee. In case the invocation is not
in accordance with the terms of the bank guarantee, that invocation itself
would be void. Even under the Uniform
Customs and Practices for documentary credits (for short UCP), formulated by
the International Chamber of Commerce, it is provided that the bank must
examine all the documents with reasonable care to ascertain that they appear on
their face to be in accordance with the terms and conditions of the
credit. The invocation is to be
rejected, if it does not state the facts showing that the conditions of the
bank guarantee have been fulfilled.
c.
Where the irrevocable
and unconditional bank guarantee is invoked in terms thereof the bank is under
an obligation to honour its commitment irrespective of the pending disputes
between the parties emanating from the underlying transaction. However, there
are exceptions to the rule on the basis of which the invocation of bank
guarantee may not be entertained by the bank or encashment thereof be injuncted
by a court.
Exceptions:-
(i)
Prima-facie
established fraud of the beneficiary of an egregious nature so as to vitiate
the entire underlying transaction.
Explanation
(a)
The bank’s and courts
obligation to entertain invocation of bank guarantee, cannot be extended to
protect an unscrupulous party, who is responsible for the fraud as fraud
unravels all but prima facie evidence of fraud must be clear.
(b) The
bank must have knowledge of fraud in case it refuses to honour the invocation
of the bank guarantee. In Federal Bank Ltd. Vs. V.M. Jog Engineering Ltd.
(supra), the Supreme Court after taking stock of various judgements held that “not
only must fraud be clearly proved but as far as bank is concerned, it must also
prove that it had knowledge of the fraud.” In other words, in a case the party,
at whose instance the bank furnishes the guarantee, does not inform the bank
about the fraud of the beneficiary and the bank in ignorance thereof entertains
the invocation of the bank guarantee and encashes the same, the bank cannot be
faulted and made liable to him for refund or restitution of the amount realised
under the bank guarantee. A party that fails to give notice of fraud of the
beneficiary to the bank, loses his right to complain against the bank for accepting
the invocation. It is the risk which the party takes for his said failure. In a nutshell, it may be stated that where
the bank is urged not to entertain invocation, it must have notice of fraud. It
is however, different where matter is before the court under section 9 of
Arbitration & Conciliation Act, 1996 or before an arbitrator in proceedings
under Section 17 thereof and court or the arbitral tribunal, as the case may be
has to take a view in the matter regarding the allegation of fraud of the
beneficiary. It is in the former contingency and context that the bank must
have notice of fraud, in case it is to refuse invocation. In the latter
contingency of an arbitration between the parties to the underlying contract,
where the justifiability and legality of invocation of bank guarantee is in
question, the party who challenges invocation must prima-facie prove fraud of
the beneficiary. In such proceedings the bank has no role to play as the bank
not being a signatory to the arbitration agreement, cannot be a party to such
proceedings. The Supreme Court in Federal Bank Ltd. Vs. V.M. Jog Engineering
Ltd. (supra) also relied upon the decision in the case of United Trading Corp.
S.A. Vs. Allied Arab Bank, 1985 (2) Loyds Rep. 554, wherein it was stated that
there must be proof of knowledge of fraud on the part of the bank at any time
before payment is released. Therefore the person at whose instance bank
guarantee is furnished can give proof of the fraud of the beneficiary to the
bank before payment is released pursuant to invocation of bank guarantee by
him. In the instant case the Hon’ble High Court passed the interim order
restraining the bank from encashing the bank guarantee, before referring the
matter for arbitration, which must have posted the bank with knowledge of the
proceedings.
(c) The Supreme Court has not accepted the
proposition of law laid down by Singapore Court in the case of Samwoh Asphalt (supra)
that injunction ought to be granted when a performance guarantee is invoked for
an oblique purpose using it as an bargaining chip and as a deterrent. It also refused to go as far as the Singapore
Court which held that unconscionable calling of a bank guarantee was an
exception independent of fraud.
Therefore, in India the invocation of bank guarantee cannot be
restrained on the ground on which the Singapore Court interfered.
(d) There is a conflict on the question at what
stage the demand by the beneficiary under the bank guarantee may become
fraudulent. In Hindustan Steel Works
Pvt. Ltd. Vs. Tarapur & Co., (1996) SC 2268 Supra, it was held that demand
by the beneficiary under the bank guarantee may become fraudulent not because
of any fraud committed by the beneficiary executing the underlying contract but
it may become so because of subsequent events or circumstances. It was also held that there was no good
reason why the court should not restrain a person making such a fraudulent
demand from enforcing a bank guarantee. In State Trading Corporation of India
Ltd. Vs. Jainsons Clothing Corporation & Ors., (1994) 6 SCC 597 (supra),
the Supreme Court observed to the effect that the party must necessarily plead
and produce all the necessary evidence in proof of fraud, in execution of the
contract of guarantee, but not the contract either of the original transaction
or any of the subsequent events that may happen, as a ground for fraud. In other words it means that fraud in
execution of the contract of guarantee can be considered as an exception to the
rule and not the fraud which is practiced at the time of execution of the
original contract or at a point of time subsequent to the execution of the
contract of guarantee. In Reliance Salt
Ltd. Vs. Cosmos Enterprises & Anr. ,(2006) 13 SCC 599, it has been stated
that fraud which vitiates the contract must have a nexus with conduct of party
prior to entering into the contract.
In view of the conflicting
observations of the Supreme Court, there is no clarity on the question whether
the restraint order can be issued for the fraud committed by the beneficiary
before or subsequent to the execution of the bank guarantee or underlying
contract. It appears that the principle laid down by the Supreme Court in
Hindustan Steel Works Pvt. Ltd. Vs. Tarapur & Co., AIR 1996 SC 2268,
namely, the demand of the beneficiary may become fraudulent not because of
fraud committed by the beneficiary executing the underlying contract but it may
become so because of the subsequent supervening events, needs be adopted as
fraud of the beneficiary cannot be overlooked at any stage and point of time.
It is in keeping with the principles of fair play and justice not to allow a
party to reap the benefit of his fraudulent act or to take advantage of it. The
aforesaid decision in Hindustan steel was not noticed in Reliance Salt Ltd. Vs.
Cosmos Enterprises & Anr. ,(2006) 13 SCC 599.
(ii)
Where the party
approaching the court is able to prima-facie establish that in view of special
equities existing in his favour, if injunction is not granted, he would suffer
an irretrievable harm or injustice, the invocation of bank guarantee could be and
would be interfered with.
Explanation
Irretrievable injury must be such
as would make it impossible for the person on whose behalf the bank guarantee
is furnished to reimburse himself if he ultimately succeeds against the
beneficiary at the end of the trial. It must be prima-facie established that
there would be no possibility of recovery of the amount from the beneficiary by
way of restitution. The impossibility of restitution ought to be in the nature of
impossibility which was demonstrated in the case of Itek Corporation Vs. First
National Bank of Boston, 566 Fed. Supp 120. In that case an exporter in USA
entered into an agreement with the Imperial Government of Iran. It brought an
action for an order terminating its liability under the Letter of Credit issued
by an American Bank in favour of an Iranian Bank as part of the contract. The
action was sought in view of the situation created after the Iranian revolution
as a result of which the American Government cancelled the export licenses for
export of goods to Iran. The relations between the two countries had soured to such
an extent that Iranian Government forcibly took 52 American citizens as
hostages. The Government of United
States blocked all Iranian assets under its jurisdiction and also cancelled the
export contracts. In these circumstances the US Supreme Court upheld the
contention of the exporter that any claim for damages against the purchaser in
the event of being decreed by the American Courts, would not be executable in
Iran. In these circumstances, it was held that realisation of bank
guarantee/letter of credit would cause irreparable harm to the exporter.
CONCLUSION
The
conclusion that emanates from the aforesaid discussion are as under:-
General Rule: The
courts normally do not go behind the allegations made in the demand for realisation
of a bank guarantee and loathe to interfere at that stage but where the
demand/invocation falls in any of the following three exceptions, the general
rule yields and the party at whose instance the bank guarantee is furnished is
entitled to the grant of an order restraining the enforcement of the bank
guarantee:
First Exception:
Where fraud of the beneficiary is prima-facie established.
Second Exception: Where party at whose instance the bank
guarantee is furnished, is able to show that special equities exist in his
favour and in case injunction is not granted, he will suffer an irretrievable
injury.
Third Exception :
Where the beneficiary has invoked the bank guarantee without fulfilling and
satisfying the terms of the bank guarantee.
The
aforesaid principles are self contained and self explained and no further
elucidation may be necessary.
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Anil K Khaware
Founder & Senior Associate
Societylawandjustice.com
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