Section 126 of the Indian Contract Act, 1872 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 person who gives the guarantee is called the 'surety'; the person in respect of whose default the guarantee is given is called the 'principal debtor', and the person to whom the guarantee is given is called the 'creditor'. In a bank guarantee, the bank stands as the surety and promises to pay the amount secured to the creditor in situations of default of the principal debtor.
Bank Guarantees are instruments primarily used by business entities to strengthen and/or secure an obligation under their contract. The party who requests that the guarantee is to be issued applies to its bank for a bank guarantee to be issued in favor of the beneficiary, i.e, the party who will receive the guarantee. Bank guarantees provide better negotiating position in business conclusions and helps in securing own claims and performance of the other party to the transaction. Generally, bank guarantees can be classified into two types; a conditional bank guarantee and an unconditional bank guarantee. For invoking a conditional bank guarantee, it is mandatory that the conditions specified for invocation of such a guarantee are met and only then the guarantee can be encashed.
On the other hand, for invocation of unconditional guarantee no specific conditions are required to be satisfied. As long as the invocation itself is legal (as per the format given in the guarantee), the bank is bound to honour such an invocation. Courts generally do not interfere with the invocation and encashment of bank guarantees, unless the aggrieved party has a very good case for such injunction.
Grounds of Injunction of Unconditional Bank Guarantees
The Apex Court in the case of Himadri Chemicals Industries Ltd. vs. Coal Tar Refining Company1 has collated principles developed over time with respect to granting of injunction against invocation of bank guarantees as follows:
- 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 beneficiary is entitled to realize such Bank Guarantee irrespective of any pending dispute between the parties relating to the terms of the contract.
- The bank giving such guarantee is bound to honour 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.
- Fraud of an egregious nature which would vitiate the very foundation of such a Bank Guarantee or Letter of Credit and the beneficiary seeks to take advantage of the situation.
- Allowing encashment of an unconditional Bank Guarantee or a Letter of Credit would result in irretrievable harm or injustice to one of the parties concerned.
In addition to fraud and irretrievable harm, the Supreme Court, in the landmark judgment of Hindustan Construction vs State of Bihar2 further stated that an unconditional bank guarantee could also be injuncted when –
- . If the unconditional bank guarantee itself imposed specific conditions on the party invoking the bank guarantee, by making reference to the principal contract, then these conditions would have to be fulfilled before the unconditional bank guarantee could be invoked.
- Unconditional bank guarantees being independent contracts in themselves, would have to be invoked in accordance with the terms of the Bank Guarantee. In the present matter, the Guarantee terms stated that the guarantee could be invoked by the Chief Engineer, and an invocation of the same by the Executive Engineer was held to be unlawful.
Recent developments on restrains based on Principal Contracts
The Hon'ble High Court of Delhi is presently dealing with the interesting question of whether a party can be injuncted from invoking an unconditional bank guarantee, if restrains are placed on it by the Principal Contract, pursuant to the terms of which the bank guarantees were given.
Larsen and Toubro Ltd (L&T) was employed by Experion Developers Private Limited (Experion) to construct a Group Housing Project by the name of "Windchants" in Sector 112, Manesar Urban Complex, Gurgaon, Haryana. Under the said contract a number of bank guarantees were given, including – An advance bank guarantee for Rs. 3.8Cr; three retention bank guarantees worth Rs 13.84 Cr, Rs 13.84Cr and Rs. 1.6Cr respectively; and, a performance bank guarantee for Rs. 31.68Cr. Certain disputes arose between the parties following which Experion invoked the aforementioned retention bank guarantees and the performance bank guarantee.
Aggrieved, L&T filed an Application under Section 93 of the Arbitration and Conciliation Act, 1996 before the High Court of Delhi. Hon'ble Justice Navin Chawla vide his judgment dated 03.07.2019 granted an injunction on the encashment of the bank guarantees. Hon'ble Justice Chawla took note of the grounds of fraud and irretrievable injustice and held that the same was not shown by L&T. Justice Chawla however noted the presence of certain clauses in the principal contract, which expressly prevented Experion from invoking the bank guarantees, unless the conditions therein were followed. Justice Chawla noted that as per Clause 4.2, Experion was entitled to invoke the bank guarantees if L&T – failed to pay amounts due, either agreed upon or determined under Sub-Clause 2.5 of Clause 20 within 42 days; failed to remedy a default within 42 days after receiving notice from the Employer requiring the default to be remedied; or where circumstances existed entitling the Employer to terminate the agreement under Sub-Clause 15.2.
Justice Chawla held that Clause 4.2 was in the nature of a negative covenant, which restrained Experion from invoking the bank guarantees. He noted that such clauses were enforceable under Section 42 of the Specific Relied Act, 1963. Admittedly, the procedure under Clause 4.2 was not followed. Based on the same, Justice Chawla injuncted Experion from encashing the guarantees, granting leave to Experion to invoke the guarantees as per Clause 4.2.
Subsequent to this judgment, Experion did two things – First, it challenged the order dated 03.07.2019;4 and second, it terminated the contract agreement on 15.07.2019 and on 22.07.2019 sent fresh letters notices invoking the same bank guarantees, without any notice to the Petitioner. Aggrieved, L&T made yet another Application under Section 95 of the Arbitration and Conciliation Act, 1996 inter alia praying that an injunction be granted on the invoked bank guarantees. The matter was listed before Hon'ble Justice Jyoti Singh who framed the following issues –
"A. Whether the BGs in question are unconditional and if so whether their invocation/encashment can be restrained? B. Whether the judgment of the Co-ordinate Bench in OMP (I) (COMM) 200/2019, between the same parties is binding on this Court and the effect of the said judgment on a second invocation between the same parties."
After considering extensive arguments by both parties, Hon'ble Justice Singh held as under –
- As per the terms of the bank guarantees in question, the same were unconditional guarantees. In such a situation, the existing dispute between the parties are immaterial and as fraud or irretrievable injustice was not pleaded or set up by L&T, the encashment of the bank guarantees could not be injuncted.
- In case there are conflicting judgments of a bench of same strength, the judgments given by larger benches and the Apex Court prevail. As the law of bank guarantees was decided by the Supreme Court, the position of law taken by the Supreme Court would apply.
- Justice Singh also dealt with the contention of L&T stating that Experion could not invoke the bank guarantees without following the procedure laid in Clause 4.2 of the principal contract. She rejected this contention, relying on the Supreme Court Judgment of Gujarat Maritime Board vs Larsen and Toubro Infrastructure Development Projects Limited6 , wherein it was held that disputes pertaining to bank guarantees have to be resolved dehors the terms of the main contract between the parties or disputes relatable to the main contract between the parties.
- With respect to submissions on res judicata, Justice Singh held that res judicata would not apply, first, as the order dated 03.07.2019 was not a final adjudication on the issue of the bank guarantees and the order itself had given leave to Experion to invoke the bank guarantees again; and second, in cases where questions of law are involved, res judicata cannot apply.
- The effect of restraining the Respondent from encashing the bank guarantee had the same effect as granting an injunction on the bank guarantee. In light of the settled laws pertaining to injunction of encashment of bank guarantee, one could not be permitted to do indirectly, what one cannot do directly.
Thus it can be seen that two judgments, given by two different Judges of the Hon'ble Delhi High Court, arising from the issue of invocation of the same bank guarantees have relied on very different positions of law and resulted in two very different outcomes. As mentioned above, Experion had challenged the order dated 03.07.2019. Justice Jyoti Singh's judgment dated 03.12.2019 has also been challenged by L&T under Section 37 of the Arbitration and Conciliation Act, 1996 and the same is pending before the Hon'ble High Court of Delhi. It would be interesting to see the opinion of the Hon'ble Division Bench comprising Hon'ble Justice Hima Kohli and Hon'ble Justice Asha Menon on the matter.
2. (1998) 8 SCC 436
3. Larsen and Toubro Limited vs Experion Developers Pvt Ltd and Ors O.M.P.(I) (COMM.) 200/2019
4. Experion Developers Pvt Ltd vs Larsen and Toubro Limited FAO(OS) (COMM) 177/2019
5. Larsen and Toubro Limited vs Experion Developers Pvt Ltd and Ors O.M.P.(I) (COMM.) 234/2019
6. (2016) 10 SCC 46
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.