Interference of Court in Encashment of Bank Guarantees

Banking Law

CIA-3

Aditya Agrawal 1750404

Arjun Kamath 1750411

Samkeet Surana 1750434

Vijay Tarshit 1750439

7 BBA LLB ‘A’

Introduction:

The following judgements relating to bank guarantees reveal that the Courts of law have
confirmed and relied upon the settled principle of law laid down earlier by several state High
Courts and the Supreme Court of India to the effect that except in the case of fraud and
irretrievable injustice proved beyond reasonable doubt, it will not be in order for the Court to
interfere and no order of injunction restraining the encashment of bank guarantee can be passed.
The judgements are discussed below in brief highlighting the issue raised, the essence of
reasoning and the decision of Court.

Case Laws:

1. THE STATE TRADING CORPORATION OF INDIA LTD. VS. JAINSONS

CLOTHING CORPORATION AND ORS.1

Facts:

The appellant had entered into a contract with Abu Dhabi Municipality, Abu Dhabi for
supply of 7,500 M.T. of 'B' Grade Basmati Rice. It in turn had entered into an agreement
with the respondent on April 20, 1985 for supply of 3000 M.T. and in case of necessity
another 1500 M.T. at the option of the STC, for shipment, of the B-Grade Basmati rice
to foreign buyer M/s. Abu Dhabi Municipality, Abu Dhabi. In order to furnish security
against the same a Performance Bank Guarantee was issued in that regard. On June 15,
1986 the Officer of the S.T.C. in terms of the guarantee had issued a certificate that the
respondent had committed default in the performance of the contract and called upon
the Bank to pay the sum of Rs. 11,70,000 contracted under the bank guarantee.

Issues:

Whether there is any fraud committed by the respondent as regards the contract of
guarantee which the appellant was entitled to invoke?

Whether under Section 126 of the Indian Contact Act 1872 a contract of guarantee is a
distinct separate contract to discharge the liability of a third person in case of his
default?

1
The State Trading Corporation of India Ltd. vs. Jainsons Clothing Corporation and Ors., AIR 1994 SC 2778.
Laws Involved:

• Indian Contract Act, 1872 - Section 126

• Indian Contract Act, 1872 - Section 17

Arguments Advanced:

It is settled law that the Court, before issuing the injunction under Order 39, Rules 1
and 2, CPC should prime face 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.

Conclusion:

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 abides 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.
 2. NEW INDIA ASSURANCE COMPANY LTD. V. KUSUMANCHI
KAMESHWARA RAO AND ANR.2

Facts:

The Plaintiff filed a suit for recovery of Rs. 1,25,000/- against both the Defendants in
the Court of Subordinate Judge, Kakinada, East Godavari District in the State of Andhra
Pradesh. The Plaintiff's case is that by a Deed dated 23rd April 1971 (Annexure A-2)
entered into between the Plaintiff and Defendant No. 2, the 2nd Defendant agreed and
undertook to pay to the Plaintiff a sum of Rs. 168,499.32 being the amount settled to
be due to the Plaintiff.

Accordingly at the request of the 2nd Defendant the 1st Defendant agreed to execute a
guarantee bond in favour of the Plaintiff for the said amount of Rs. 1,25,000/-. The 1st
Defendant executed a guarantee bond dated 26th April 1971 (Annexure A-1) in favour
of the Plaintiff by and under which the 1st Defendant agreed and undertook to pay to
the Plaintiff at Kakinada the said sum of Rs. 1,25,000/- or such lesser amount as may
be demanded by the Plaintiff on failure of the 2nd Defendant to fulfil the terms of the
agreement dated 23rd April 1971.

Issues:

As to whether Defendant No. 1 insurance company's predecessor insurance company,

had entered into any agreement of guarantee for covering the liability of Defendant No.
2 arising out of the suit agreement dated 23rd April 1971 ?

Whether the express written terms of the surety bond will have to be a bank guarantee
is given the bank which gives the guarantee is given the bank which gives the guarantee
would be liable to fulfil its obligations flowing from the terms of the guarantee and the
court would not interfere with such obligations flowing from the bank guarantee
executed by the concerned guarantor?

Laws:

• Constitution of India - Article 136

• Indian Evidence Act, 1872 - Section 91

2
New India Assurance Company Ltd. v. Kusumanchi Kameshwara Rao and Anr. (1997) 9 SCC 179.
 • Indian Evidence Act, 1872 - Section 92

Arguments Advanced:

The Appellant-Defendant No. 1 insurance company took the stand upon which the
learned Trial Judge framed relevant issued and came to the conclusion that the Plaintiff
claim could succeed only against Defendant No. 2 who had not contested the suit, but
so far as Defendant No. 1, was concerned as it had not executed any guarantee in favour
of the Plaintiff in connection with the agreement or Dissolution Deed dated 23rd April
1971 Annexure A-2, the suit was liable to fail against Defendant No. 1- insurance
company.

The Plaintiff carried the matter in appeal and by the impugned judgment a Division
Bench of the High Court took the view that in substance the surety bond sought to cover
the liability undertaken by the Dissolution Deed dated 23rd April 1971 and as that
liability was not discharged by Defendant No. 2 the Plaintiff was entitled to decree also
against Defendant No. 1 the guarantor insurance company and accordingly decreed the
suit also against Defendant No. 1.

Conclusion:

Whether the express terms of the guarantee bond give rise to the contract of guarantee
sought to be enforced will be the only limited enquiry which could be gone into by the
courts while deciding the rights and obligations flowing from such contract of guarantee
which is a tripartite contract between the creditor, principal debtor and the surety. Once
such suretyship agreement is established on the clear terms of the bond then as laid
down by the aforesaid decisions of this court no latitude can be given to the contracting
party, namely the surety or even the principal debtor to enable them to get out of the
obligations of the suretyship agreement flowing from such contract, except in
exceptional circumstances as indicated in these decisions.
 3. M/S. GEO TECH CONSTRUCTION COMPANY PRIVATE LTD. VS. M/S.
HINDUSTAN STEEL WORKS CONSTRUCTION LTD., COCHIN &
ANOTHER3

Facts:

The 1st Defendant/1st Respondent (H.S.C.L.) was the contractor for the work of "Pile
Foundation" "Pile caps" "site development works", etc., in respect of International
Stadium, Cochin owned by the Greater Cochin Development Authority. As per the
memorandum of understanding arrived at between the H.S.C.L. and Geo-Tech, the
latter was entrusted with the work as per letter of intent dated 7th April 1994. The
contract work was successfully completed by the Geo-Tech on 16th April 1996 and the
defect liability period was over on 30th November 1996 and security deposit was
released to the Geo-Tech by H.S.C.L. Consequently H.S.C.L. released the retention
amount when the Geo-Tech executed three Bank guarantees for Rs. 5 Lakhs each. Since
the contract work was successfully completed and the deficit liability period was over
the Geo-Tech wrote several letters to H.S.C.L. to release the Bank guarantee. However
the H.S.C.L. was taking effective steps to invoke the Bank guarantee alleging that Geo-
Tech had defaulted in remitting Rs. 14.20 lakhs towards the dues under the Kerala
Construction Workers Welfare Fund Act.

Issues:

The questions to be decided were whether interim relief against enforcement of bank
guarantee could be granted and whether during pendency of arbitration proceedings
relating to the disputed matter, the order of injunction granted by the lower court could
be interfered with.

Laws Involved:

• Code of Civil Procedure, 1908 (CPC) - Order XXXIX Rule 1

• Indian Contract Act, 1872 - Section 2, Section 2(g), Section 8, Section 9,
Section 17 & Section 126

3
M/s. Geo Tech Construction Company Private Ltd. vs. M/s. Hindustan Steel Works Construction Ltd., Cochin
& Another, AIR 1999 Kerala 72.
 • Indian Evidence Act, 1872 - Section 91 & Section 92.

Arguments Advanced:

The Bank of Baroda had furnished a bank guarantee undertaking to pay a specified
amount to the appellant at the request of M/s. Rana Builders, contractor against any loss
or damage caused to or suffered by appellant by reason of any breach by the said
contractor of any of the terms and conditions of the agreement. The High Court of
Calcutta observed that the learned single judge was in error in assuming that this matter
was not to be decided strictly on principles of injunction in relation to bank guarantee
but general principles of injunction on lenders would be applicable and on that basis
had proceeded to decide the matter.

The contention of the respondent that the entire dispute was pending before arbitration
and until the same was adjudicated upon, the injunction order under appeal which had
provided adequate safeguard to both the parties could not be set aside, had to be
rejected. The Court relied upon the judgement of the Supreme Court of India in
Hindustan Steel Works Construction Ltd. vs. GS Atwal and Company (AIR 1966
SC131) in which the Supreme Court did not accept the reasoning of the High Court that
before invoking the performance guarantee the appellant should assess the quantum of
loss and damages and mention the ascertained figure. The Court further observed that
the letter of invocation in respect of the bank guarantee cannot be equated with
documents that are required to be tendered under letters of credit. The bank guarantee
can be invoked in a commercial manner and it is sufficient if the bank is satisfied that
the guarantee is being invoked in accordance with its terms.

Conclusion:

The Court held that the respondent had failed to show prima facie case of fraud or
irretrievable injury and the order of the learned single judge restraining the enforcement
of bank guarantee was set aside. The appeal was allowed.
 4. DLF Cement Ltd. vs. Inspector of Police, Hyderabad and Others4

Facts:

The petitioner is a company incorporated under the Companies Act, 1956 having Head Office
in New Delhi. The Company has set up a large cement plant in technical collaboration with
Messrs Nihon Cement Company Ltd., Japan. The respondent No. 1 is the Sub-Inspector of
Police, Panjagutta. The respondents 2 and 3 are the nationalised banks. The fourth respondent
is the company to whom the two contracts were entrusted. It is to be understood that there were
several contracts that needed to be completed in a stipulated period of time but the said
contracts were not completed within the stipulated time. The petitioner paid a mobilisation
advance of Rs. 16,53,750/- to the fourth respondent in the second contract on submission of
bank guarantee of Rs.14,17,500/-. The fourth respondent submitted two bank guarantees, one
for the performance of the contract and the other advance bank guarantee for the second
contract. The petitioner had sought the encashment of the both bank guarantees. The fourth
respondent had entered into a contract and had agreed to complete the work within the
stipulated time and failed to perform in spite of several letters and reminders made by the
petitioner company. The fourth respondent also failed to rectify the defects pointed out by the
petitioner in the work that was carried out by the fourth respondent. The second respondent
stopped at no position of law bank guarantees. Apart from stopping the encashment of bank
guarantees the first respondent at the instance of the fourth respondent seized the original bank
guarantees. Hence this petition.

Issues:

The question to be decided was whether the second and third respondents which are
nationalised banks could be restrained by an order of injunction from honouring the bank
guarantee?

Laws Involved:

• Section 126 of Contract Act, 1872

• Indian Penal Code 1860, (IPC) - Section 406; Indian Penal Code 1860, (IPC) - Section
511

4
DLF Cement Ltd. vs. Inspector of Police, Hyderabad and Others, AIR 1999 AP 359
 • Arbitration and Conciliation Act, 1996 - Section 8

Arguments by the Appellant:

The counsel on behalf of the appellant states that the petitioner had made demand to the
respondent’s bank, the said banks suggested it to surrender the original bank guarantee if it
wants to encash the bank guarantees. The same was complied with, but the said guarantees
were allowed to be stopped and seized by the police. Tin's is the result of connivance on the
part of the respondents. According to the counsel, the bank guarantees offered were
unconditional, irrevocable and payable on demand by the petitioner. The undertaking given by
the second respondent bank is as under5: The counsel states that the case of the writ petitioner
is that the acts of the respondents is illegal and contrary to the terms of the contract. The banks
once agreed to abide by the terms of the contract and agreed to honour the bank guarantees on
demand, they should not have been influenced by the fourth respondent. The act of the first
respondent in directing the banks to stop payment of the bank guarantees amount and later
seizing the original records is not proper. The trial Court when accepted the contentions raised
by the respondent and when there is dispute the same shall be referred to the arbitrator and any
proceedings initiated by the civil Court without resorting to arbitration proceedings are liable
to be stayed.

Arguments by the Respondent:

The counsel on behalf of the respondent states that whatever acts that have been done by them
are purely pursuant to the registering of the above said crime. The counsel also took a stand
that the first respondent has nothing to do with the internal quarrels between the petitioner and
the other respondents. The respondent has admitted the entrustment of the work and execution
of the bank guarantees. According to the fourth respondent, the petitioner played fraud and
fraudulently invoked bank guarantees. As such the fourth respondent was constrained to file a
private complaint before the V Metropolitan Magistrate Court for the offences under Sections
406 and 511 IPC and a notice was ordered to the first respondent to take up investigation as
this respondent doubted about the bona fides on the part of the petitioner. The counsel on behalf

5
"We bank of Baroda, Maredpalli branch, Secunderabad branch hereby irrevocably and unconditionally undertake
to pay the purchaser on demand without of demur and without recourse to the Supplier upto an amount of
Rs.25,00,000/- (Rupees Twenty Five lakhs only) within 2 days from the date of receipt of the first written demand
from the purchaser, stating that the equipment supplied under the contract has failed to perform and/or the
performance of the equipment is not in accordance with the stipulation of the contract and/or deficiency. This
performance guarantee expires on the expiry of the warranty period and issue of final acceptance certificate by
the purchaser."
of the respondent has submitted that his client would not revoke the bank guarantee. But in the
order the word 'invoke' was written instead of the word 'revoke'. The learned Counsel for the
respondent also submitted that all the papers were submitted to the bank and the bank had
already extended the time by six months and produce the order by tomorrow. Accordingly, the
case is taken up for orders today. Today the learned Counsel for the respondent submits that
though the respondent as submitted earlier furnished papers to the bank and the bank already
passed order, but thinking whether to issue the order, since the matter is subjudiced.

Analysis of the Court:

The Court of the learned City Civil Judge had allowed the application under section 8 of the
Arbitration and Conciliation Act for reference of dispute between the petitioner and the first
respondent to arbitration and passed a direction to the respondent banks to maintain status quo
pending arbitration proceedings in respect of release of the bank guarantee. The petitioner had
filed this revision petition before the High Court of Andhra Pradesh against the part of the said
order directing the banks to maintain status quo. The Court observed that from the facts it is
clear that there is no dispute regarding the entrustment of the contract to the fourth respondent
and that there was delay in execution of the contractual work. In the event of any dispute
between the petitioner and fourth respondent it was provided that the same should be referred
to the arbitrator. It is not the duty of the Court to investigate the internal disputes between the
parties who are entering into agreement. The banks which have issued guarantees are bound to
honour the same when demand is made unless fraud is established. The Court referred to and
relied upon the decisions in NTPC Ltd. vs. Hind Galvanising & Engineering Company Ltd.6;
NTPC Ltd. vs. Flowmore Private Ltd.7 and Svenska Handelsbanken Ltd. vs. M/s. Indian
Charge Chrome8. In the light of the said decisions, the Court observed that the rule is well
established that a bank issuing guarantee is not concerned with the underlying contract between
the parties to the contract and if the documents are in order, the bank giving the guarantee must
honour the same and make payment. Hence the Court was of the view that when the dispute
had been made out, while referring the dispute to arbitration the lower Court had erred in
restraining the bank from making payment.

6
NTPC Ltd. vs. Hind Galvanising & Engineering Company Ltd, AIR 1990 Calcutta 421
7
NTPC Ltd. vs. Flowmore Private Ltd, AIR 1996 SC 445
8
Svenska Handelsbanken Ltd. vs. M/s. Indian Charge Chrome, AIR 1994 SC 626
Judgment:

The Court set aside the order of the lower Court directing the bank to stop payment till the
pendency of the proceedings before the arbitrator. The revision petition was allowed.

5. Hindustan Steel Works Construction Ltd. v. Tarapore and Co. and

Ors9

Facts:

The HSCL instructed a contractor for construction of civil works in its Visakhapatnam Steel
Plant. The contractor was not able to complete the work within the stipulated time and at its
request the time for completion of the work was extended till 31.3.87. Even during this
extended period, the contractor could not complete the work. The dispute began to arise
between the contractor and appellant. In amidst of the same, Bank of India gave 14 guarantees
in favour of HSCL at the instance of the Contractor. On the very day on which the appellant
rescinded the contract, the appellant called upon the bank to pay to the appellant the said sum
without any demur or protest in the instance of the contractor. The contractor, filed two
petitions for granting injunctions with respect to the same dispute, but the court finding that the
bank guarantees are unconditional refused to grant injunction and dismissed both the petitions
by a common judgment. Further on, a revision petition has been filed before the Andhra
Pradesh High Court, reversed the judgment of the lower court. Hence this petition.

Issues:

a) What are the grounds to constitute a case under banking fraud as special equities or fall
under special circumstances?
b) Whether these encashments could be restrained and was the High court just in doing
so?
c) Whether there were special equities or special circumstances justifying granting of an
injunction?
d) Whether High Court was right in restraining the appellant from enforcing the bank
guarantees?

9
Hindustan Steel Works Construction Ltd. v. Tarapore and Co. and Ors., AIR 1996 SC 2268,
Laws Involved:

• Arbitration and Conciliation Act, 1996

• Indian Contract Act, 1872

Arguments by the Appellant:

The counsel on behalf of the appellant stated that The High Court has not stated nor applied the
law correctly. He submitted that in the matter of encashment of a bank guarantee the Court
should not as a rule interfere unless it is a clear case of fraud and is likely to result in
irretrievable injustice. The counsel relied upon certain judgments which pertain to and state that
The law is so declared, according to him, by the decisions of this Court in United Commercial
Bank v. Bank of India10, Centax (India) Ltd. v. Vinmar Impex Inc11, Cooperative federation
Ltd. v. Singh Consultants and Engineers (P) Ltd.12. The counsel also stated that In U.P.
Cooperative Federation Ltd. (supra) also Mukherji, J. in paragraph 21 of his judgment has
observed as under:

“An irrevocable commitment either in the form of confirmed bank guarantee or irrevocable
letter of credit cannot be interfered with except in case of fraud or in case of question of
apprehension of irretrievable injustice has been made out. This is the well settled principle of
the law in England. This is also a well settled principle of law in India”.

The counsel also stated that The High Court also committed a grave error in restraining the
appellant from invoking bank guarantees on the ground that in India only a reasonable amount
can be awarded by way of damages even when the parties to the contract have provided for
liquidated damages.

Arguments by the Respondent:

The learned Counsel for the respondents, on the other hand, contended that though fraud is an
established exception to the general rule regarding interference with the autonomy of
irrevocable letter of credit or a bank guarantee that is not the only exception and the Court can

10
United Commercial Bank v. Bank of India, 1981 3 SCR 300
11
Centax (India) Ltd. v. Vinmar Impex Inc. AIR 1986 SC 1924
12
Cooperative federation Ltd. v. Singh Consultants and Engineers (P) Ltd. [1988] SCC 174
and should interfere where special circumstances or special equities exist and they are likely to
result in irretrievable injustice.

In United Commercial Bank v. Bank of India13 this Court again emphasized that obligation of a
bank in such a case is absolute, as 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. Therein the following passage from the judgment of
Kerr. J. in R.D. Horbottle (Mercantile) Ltd. v. National Westminster Bank Ltd14 was quoted
as a correct statement of law on the point: It is only in exceptional cases that the courts will
interfere with the machinery of irrevocable obligations assumed by banks. They are the
lifeblood of international commerce. The counsel on behalf of the respondent submitted that
the position of law with respect to liquidated damages in our country and observed that "Hence
there cannot be any agreement in regard to the amount that has to be allowed except the upper
limit that can be fixed, in case of breach". Relying upon the decision of this Court in

Union of India v. Raman Iron Factory15, the High Court held that any term in the agreement
that one of the parties shall be the sole judge to quantify the same has to be held as invalid.

Analysis of the Court:

“We are therefore of the opinion that the correct position of law is that commitment of banks
must be honoured free from interference by the Courts and it is only in exceptional cases, that
is to say, in case of fraud or in a case where irretrievable injustice would be done if bank
guarantee is allowed to be encashed, the Court should interfere. In this case fraud has not been
pleaded and the relief for injunction was sought by the contractor/ respondent No. 1 on the
ground that special equities or the special circumstances of the case required it. The special
circumstances and/or special equities which have been pleaded in this case are that there is a
serious dispute on the question as to who has committed breach of the contract, that the
contractor has a counter claim against the appellant that the disputes between the parties have
been referred to the arbitrators and that no amount can be said to be due and payable by the
contractor to the Appellant till the arbitrators declare their award. In our opinion, these factors
are not sufficient to make this case an exceptional case justifying interference by restraining

13
United Commercial Bank v. Bank of India, [1981]3 SCR 300
14
Kerr. J. in R.D. Horbottle (Mercantile) Ltd. v. National Westminster Bank Ltd (1977) 3 W.L.R. 752
15
Union of India v. Raman Iron Factory [1974] 3 SCR 556
the appellant from enforcing the bank guarantees”. The High Court was therefore not right in
restraining the appellant from enforcing the bank guarantees.

Judgment:

These appeals are, therefore, allowed. The judgment and order passed by the High Court are
set aside. The respondent No. 1 shall pay the cost of these appeals to the appellant.

6. Hindustan Steel Works Construction Ltd. Vs. Tarapore and Co. and another
(AIR 1996 SC 2268)

a) Facts

The Hindustan Steel Works Construction Ltd. (HSCL) awarded a contract to the respondent
contractor (Tarapore and co.) for construction of civil works in its Visakhapatnam Steel Plant
and the formal contract was signed on 25.10.1984. It was a lumpsum contract for which a
deadline was set but the contractor could not finish work on time and extended the deadline.
On 28.8.1986 some disputes arose and the contractor initiated to solve it through arbitration
and now the dispute was pending before the arbitrators appointed.

In August, 1988 by mutual agreement the contract work was reduced and the contract price
was fixed at Rs. 4.5 crores. Again, the deadline was extended due to unfinished work.
Finally, when for the 2nd time the reduced work could not be completed on the set date,
HSCL cancelled the contract on 17.10.1988.

In between 30.1.84 and 8.12.87, fourteen guarantees had been given by Bank of India in
favor of HSCL at the instance of the Contractor for various objects. The bank guarantee held
that:

• HSCL would be indemnified against any loss or damage caused to or suffered by it

by reason of any breach by the contractor of any term and condition of the contract.
• HSCL shall be the sole Judge on the question as to whether the contractor has
committed any breach of the contract and what is the extent of loss or damage.
• The decision of HSCL in this behalf shall be treated as final and binding on the bank.
• The bank has undertaken to pay HSCL on demand any amount payable by the
contractor without any demur and protest, without any reference to the contractor and
such demand by HSCL has to be regarded as conclusive and binding on the bank
notwithstanding any difference between the HSCL and the contractor.

On the day of cancellation of contract HSCL demanded its damages to be paid by the bank.

b) Issues

The petitioner had filed a Special Leave Petition against the Andhra Pradesh high court’s
order of injunction where the issue to be decided was:

• Whether High Court was right in restraining the appellant from enforcing the bank
guarantees?
 c) Laws Involved

• Arbitration and Conciliation Act 1996

• Code of Civil Procedure, 1908
• Indian Contract Act, 1872

d) Arguments

The counsel for the appellant submitted that in the matter of encashment of a bank guarantee
the Court should not as a rule interfere unless it is a clear case of fraud and is likely to result
in irretrievable injustice.

The Counsel for the respondents, on the other hand, contended that though fraud is an
established exception to the general rule regarding interference with the autonomy of
irrevocable letter of credit or a bank guarantee that is not the only exception and the Court
can and should interfere where special circumstances or special equities exist and they are
likely to result in irretrievable injustice.

e) Court’s Decision

The court held bank guarantees were irrevocable obligations assumed by banks and should be
treated as confirmed letter of credits. The correct position of law is that commitment of banks
must be honored free from interference by the courts and it is only in exceptional cases, that
is to say, in case of fraud or in a case where irretrievable injustice would be done if bank
guarantee is allowed to be encashed, the court should interfere. That a dispute was pending
before the arbitrators to find out the defaulter and fix the award was not sufficient to be a
special circumstance or equity in the case.
It was thus held that the HC of Andhra Pradesh was not right in restraining HSCL from
enforcing the bank guarantees till the arbitration as it failed to observe the real object nature
of bank guarantees and overlooked its position as an independent and distinct contact.

7. Hindustan Copper Ltd., vs. Rana Builders Ltd. (AIR 1999 Calcutta 230)

a) Facts

The appellant issued a Letter of Intent (LoI) for carrying out the works mentioned therein by
the respondents. In terms thereof, the respondent furnished a bank guarantee for Rs. 1.38
crores in lieu of security deposit. On 14th January, 1995, contract in writing was entered into
between the appellant and the respondent. By the said contract, the respondent agreed to carry
out excavation and removal of 4 (four) Million cubic meters rock works at the appellant's
Malanjkhand Copper Project at Balaghat in M.P. It contained an Arbitration clause for
referring the dispute to the Chairman-cum-Managing Director of appellant or his nominee.

According to the appellant since the inception, the respondent failed to duly, properly or in
terms of the said contract execute and perform the works and discharge its obligation
thereunder and that since February, 1997 virtually stopped the work at the said project and
abandoned the same. The appellant thereupon by its letter dated 9th August, 1997 called upon
the respondent to show cause as to why the contract should not be terminated by reason of its
failure and neglect to execute the works and perform the obligation thereunder.

On 16th August, 1997, the respondent instituted a suit being Regular Suit No. 1417 of 1997
in the court of Civil Judge, Vadodara for an injunction restraining the Bank of Baroda from
making any payment of the amounts of the said bank guarantees and an ex-parte interim
order was issued by the said court directing status quo in respect of the said bank guarantees.
On 1st October, 1997, the appellant terminated the contract. By a letter dated 6th October,
1997, the appellant invoked bank guarantee for Rs. 1.38 crores and by another letter of same
date that is 6th October, 1997, the appellant invoked the second bank guarantee for Rs. 1.93
crores. A reminder letter was issued by the appellant on 20th October, 1997 to the bank
calling upon it to pay the amounts of the said two bank guarantees. In reply to the said letter,
the bank by its letter dated 24th October, 1997 enclosed a copy of a letter dated 21st October,
1997 of the respondent by which it was intimated to the bank that the respondent had
obtained the stay order from the court directing the appellant to maintain status quo in respect
of the said two bank guarantees.

b) Issues before the court

The questions to be decided were:

• Whether interim relief against enforcement of bank guarantee could be granted

• Whether during pendency of arbitration proceedings relating to the disputed matter,

the order of injunction granted by the lower court could be interfered with.

c) Laws Involved

• Arbitration and Conciliation Act 1996

• Code of Civil Procedure, 1908
• Indian Contract Act, 1872

d) Arguments

The Bank of Baroda had furnished a bank guarantee undertaking to pay a specified amount to
the
appellant at the request of M/s. Rana Builders, contractor against any loss or damage caused
to
or suffered by appellant by reason of any breach by the said contractor of any of the terms
and conditions of the agreement. The High Court of Calcutta observed that the learned single
judge was in error in assuming that this matter was not to be decided strictly on principles of
injunction in relation to bank guarantee but general principles of injunction on lenders would
be applicable and, on that basis, had proceeded to decide the matter. The contention of the
respondent that the entire dispute was pending before arbitration and until the same was
adjudicated upon, the injunction order under appeal which had provided adequate safeguard
to both the parties could not be set aside, had to be rejected. The Court relied upon the
judgement of the Supreme Court of India in Hindustan Steel Works Construction Ltd. vs.
GS Atwal and Company (AIR 1966 SC 131) in which the Supreme Court did not accept the
reasoning of the High Court that before invoking the performance guarantee the appellant
should assess the quantum of loss and damages and mention the ascertained figure. The Court
further observed that the letter of invocation in respect of the bank guarantee cannot be
equated with documents that are required to be tendered under letters of credit. The bank
guarantee can be invoked in a commercial manner and it is sufficient if the bank is satisfied
that the guarantee is being invoked in accordance with its terms.

e) Court’s Decision

The Court held that the respondent had failed to show prima facie case of fraud or
irretrievable
injury and the order of the learned single judge restraining the enforcement of bank guarantee
was set aside. The appeal was allowed.

Cases referred to:

• Edward Owen v. Barclays Bank International (1978) 1 A.E.R. 976
• Union of India v. Raman Iron Factory MANU/SC/0005/1974 : [1974]3SCR556
• United Commercial Bank v. Bank of India MANU/SC/0003/1981 : [1981]3SCR300
• Centax (India) Ltd. v. Vinmar Impex Inc. MANU/SC/0003/1986 : AIR1986SC1924
• U.P. Cooperative federation Ltd. v. Singh Consultants and Engineers (P) Ltd. [1988] SCC
174.
• Tarapore & Co. v. Tractors Export, Moscow MANU/SC/0215/1968 : [1969]2SCR920
• Jenkins L.J. in Hamzeh Malas and Sons v. British Imex Industries Ltd. [1958] 2 Q.B. 127
• Kerr. J. in R.D. Horbottle (Mercantile) Ltd. v. National Westminster Bank Ltd (1977) 3
W.L.R. 752
• Electric Technical Services Co. Inc. v. Punj Sons (P) Ltd. MANU/SC/0442/1991 :
[1991]3SCR412
• Larsen and Toubro Limited v. Maharashtra State Electricity Board MANU/SC/0086/1996 :
AIR1996SC334
• Hindustan Steel Workers Construction Ltd. v. G.S. Atwal & Co. (Engineers) Pvt. Ltd.
MANU/SC/0030/1996 : AIR1996SC131
• R.D. Harbottle (Mercantile) Ltd. v. National Westminster Bank Ltd. [1977] 2 All ER 862
• Elian and Rabbath v. Matsas and Matsas [1966] 2 LR 495
• Svenska Handelsbanken v. Indian Charge Chrome MANU/SC/0138/1994 : AIR1994SC626
• Handerson v. Candian Imperial Bank of Commercie and Peat Marwick Ltd., 40 BCLR 318
• Itek Corporation. v. The First National Bank of Boston, 566 Fed Supp 1210
 8. Lloyds Steel Industries Ltd. vs Indian Oil Corporation Ltd. & Anr. on 26
February, 1999 (AIR 1999 Delhi 248)

Facts:

1. The plaintiff is a public limited company incorporated under the Indian Companies
Act, 1956. Defendant No.1 are a government company within the meaning of Section
617 of the Indian Companies Act, 1956. Defendant No.2 are a banking company
formed and constituted under the Banking Companies (Acquisition and Transfer of
Undertaking) Act, 1970. The first defendant have set up a refinery at Mathura in the
State of Uttar Pradesh.
2. They thus wanted to install horton spheres at the above said refinery and with the said
and in view floated a tender inviting offers on turnkey basis from prospective
contractors. On July 7, 1994, the plaintiff along with many other contractors
responded to the same. The quotation of M/s. G.R. Engineering was the lowest at Rs.
10,34,42,400/- while that of the plaintiff was the second lowest at Rs.
10,75,39,109.40. The plaintiff were persuaded to agree to the execution of the
contract at a lower value and below that of lowest on the assurance that such an
acceptance would be compensated by awarding works on other projects of defendant
No.1.
3. The plaintiff thus agreed to work at a bare minimum profit margin with a view to
establishing long term relationship with the first defendant. A formal acceptance of
the plaintiff's offer was conveyed by the first defendant

Issue:

1. The question to be decided was whether an order restraining the first defendant from
encasing the bank guarantee can be passed in favor of the plaintiff.

Law:

1. Section 126, Indian Contract Act, 1872.

Observations of the court:

1. The High Court of Delhi observed referring to the relevant provisions of the bank
guarantee that even assuming there had been a variation in the contract between the
plaintiff and first defendant, the impugned bank guarantee given at the instance of the
 plaintiff by second defendant permitted such type of variation with out affecting the
liability of second defendant in any manner. Thus any change, modification or
novation of the contract was taken care of by the bank guarantee in question and it
would remain unaffected despite the change or modification.
2. The contract of guarantee by a bank in favor of the beneficiary is an independent
contract between the bank and the said beneficiary and the said contract can always be
enforced by the beneficiary by invoking the said bank guarantee at any time, during
the subsistence of the contract of guarantee, whenever the beneficiary thinks it fit to
do so. The Court referred to and relied upon the decision in Hindustan Steel Works
Construction Ltd. vs. Tarapur & Company (AIR 1996 SC 2268).
3. The Court further observed that the plaintiff had nowhere pleaded the particulars of
any fraud nor had he shown prima facie case of any irretrievable injury. The variation
was within the general condition of the contract. Since the contract of guarantee is
regarded as an independent contract the variation would have absolutely no effect on
the liability of the banker to make payment to the beneficiary in accordance with the
bank guarantee.

Decision

1. The Court held that there is no force in the application for injunction to restrain the
encashment of bank guarantee. The petition was dismissed and the encashment of
bank guarantee was allowed
9. Standard Chartered Bank v. Heavy Engineering Corporation

Facts:

1. The dispute primarily arose with regard to two bank guarantees amounting to Rs.
71,35,100/ and Rs. 20,32,500/ in terms of the letters of intent, HECCS150281 dated
19th May, 1981 and HECCS150281 dated 19th May, 1981 furnished on behalf of the 2nd
defendant by the appellant Bank (1st defendant) in favor of the 1st respondent plaintiff
“as advance against supply of plant and equipment” by the 1st respondent plaintiff to
the 2nd respondent (defendant no. 2). The two bank guarantees are on identical terms
and the only difference is the date and the amount which are reproduced as under:

2. The said two bank guarantees were furnished for and on behalf of 2nd respondent
towards the sum insured “against any loss or damage caused to or suffered by the
 Corporation by reason or any breach or failure by the said supplier, in due performance
of the aforesaid contract.”

3. By a letter of intent dated 19th May, 1981, 1st respondent placed an order on 2nd
respondent (Simon Carves India Ltd. ‘SCIL’) for the complete design, supply of both
indigenous and imported equipment’s, erection and commissioning of requisite civil
and construction works of the Dankuni Coal Complex at a total price of Rs. 21.10
crores. The letter of intent dated 19th May, 1981 after describing 4 sections of the LTC
plant at Dankuni stated as under: “The above price covers the complete design, supply
of both indigenous and imported equipment, erection and commissioning with requisite
civil and structural works complete in all respects except land filling up to 4.00 M level,
railways siding, roads & outside drawing and peripheral lighting which will only be
outside your scope or work.

4. Pursuant to the letter of intent, a formal Memorandum of Agreement dated 8th August,
1985 was executed by and between SCIL. Thereafter, the 1st respondent (plaintiff) from
time to time advanced for the said work against several bank guarantees furnished by
SCIL. It may be noticed that the instant dispute pertains to two bank guarantees dated
16 th February, 1983 and 29th August, 1984, which were advanced to SCIL, the details
of which have been indicated above. The said guarantees furnished by the appellant
bank were extended from time to time and revalidated.

5. In due course of time, in breach of contract with the 1st respondent-plaintiff, SCIL failed
to duly complete the supply of equipment and the other conditions of the letter of intent
and further defective equipment’s. It is alleged that the work had to be abandoned due
to which 1st respondent suffered huge losses and damages. Ultimately, a sum of Rs.
139.90 lakhs, was deducted by the 1st respondent from final bill which pertained to the
apportioned work handed over to SCIL.

6. In view of the letter dated 6th November, 1998, 1st respondent plaintiff demanded
encashment of both the said guarantees which were refused by the bank to honor and
diverse correspondence was exchanged by and between the 1st respondent plaintiff and
the appellant defendant bank. 1st respondent in continuation made subsequent demands
for encashment of the guarantees by letter dated 19th December, 1998. This was
 followed by the letter dated 28th December, 1998. A further complaint was made by
way of a letter dated 22nd February, 1999 to the Banking Ombudsman, Calcutta.
Ultimately, 1st respondent-plaintiff was constrained to institute a suit before the High
Court of Calcutta for decree of Rs. 1,10,33,207.07/ along with interest being the
aggregate sum of both the said guarantees.

Issues:

1. Whether invocation of bank guarantee is subject to approval of the bank?

2. Whether a dispute between the beneficiary and the party at whose instance the bank has
given the guarantee invalidate the bank guarantees?

Law:

1. Section 126, Indian Contract Act, 1872.

Analysis:

It was contended by the bank that the bank guarantees are in reference to two category
of losses (i) non-supply/defective supply of plant & equipment (ii) “other contractual
deficiencies” and by the invocation vide letter dated 19th December, 1998 claims caused by
“non-supply/defective supply of plant & equipment and other contractual deficiencies” is
outside the purview of the bank guarantee. Further, assuming the correctness of the claim, the
1st respondent if suffered loss for both (i) non-supply/defective supply of plant and equipment
(ii) “other contractual deficiencies”, it is difficult to determine the apportionment between the
two categories, because the invocation does not state how they are apportioned. The invocation
is thus inchoate and incomplete and this according to the appellant does not constitute a valid
invocation at all and reliance was placed on the case of Hindustan Construction Co. Ltd. Vs.
State of Bihar & Others and Gangotri Enterprises Ltd. Vs. Union of India and Others.

It was submitted on behalf of the 1st respondent that the question of law is no more res
integra and is well settled that the bank guarantee is an independent contract between the bank
and the beneficiary and the bank is always obliged to honor its guarantee as long as it is an
unconditional and irrevocable one. At the same time, the dispute between the beneficiary and
the party at whose instance the bank has given the guarantee is immaterial and is of no
consequence and two exceptions to the rule have been carved out. The first is when there is a
fraud of which the Bank has notice and a fraud of the beneficiary from which it seeks to benefit.
The second exception to the general rule of nonintervention is such when there is a
‘irretrievable injury’ or ‘irretrievable injustice’ that would occur to the Bank. Reliance was
placed on (i) Ansal Engineering Projects Ltd. Vs. Tehri Hydro Development Corporation Ltd.,
(ii) State Bank of India and Another Vs. Mula Sahakari Sakhar Karkhana Ltd., (iii) Himadri
Chemicals Industries Limited Vs. Coal Tar Refining Co., (iv) Gujarat Maritime Board Vs.
Larsen & Toubro Infrastructure Development Projects Ltd. & Anr.

The Apex Court held that settled position in law that emerges from the precedents of
this Court is that the bank guarantee is an independent contract between bank and the
beneficiary and the bank is always obliged to honor its guarantee as long as it is an
unconditional and irrevocable one. The dispute between the beneficiary and the party at whose
instance the bank has given the guarantee is immaterial and is of no consequence. There are,
however, exceptions to this Rule when there is a clear case of fraud, irretrievable injustice or
special equities. The Court ordinarily should not interfere with the invocation or encashment
of the bank guarantee so long as the invocation is in terms of the bank guarantee. The
guarantees in the instant case were unconditional, specific in nature and limited in amount. The
terms of the guarantee categorically covered money which the 1st respondent had advanced
against supply of the plant and equipment by SCIL. The said guarantees covered any loss and
damage caused to or suffered by the 1st respondent-plaintiff in due performance of the contract
for supply of plant and equipment. The guarantee documents dated 16th February, 1983 and
29th August, 1984, as a whole and clause 2 of the guarantee document in particular cover the
advance which had been paid by the 1st respondent-plaintiff by reason of any breach or failure
by SCIL in due performance of the aforesaid contracts i.e. against the contract for supply of
plant and equipment.

Conclusion:

The Hon'ble Supreme Court extended the exceptions to three, where a court can injunct
invocation and encashment of bank guarantee and included ‘Social equities’ as one of the
grounds, as mentioned earlier. The concept of special equities has been traditionally linked to
irretrievable injustice. The criteria were said to be fulfilled where the court is satisfied that the
party seeking refuge under special equity is likely to suffer losses, which cannot be recovered
if the matter is finally adjudicated in favor of the said party seeking the interim injunctive relief.
The Supreme Court in the said Standard Chartered Bank Limited case, however, extended the
scope of avenues available to a petitioner by visualizing irretrievable injustice and special
equities as distinct circumstances.

10. M/s. Saw Pipes Ltd. vs. Gas Authority of India Ltd. & Another 16

Issues:

The question to be decided was whether the application of the petitioner under Section
9 of the Arbitration and Conciliation Act seeking to restrain the first respondent from
encashing the bank guarantee issued on behalf of the petitioner by ANZ Grindlays Bank
Ltd. in favour of first respondent could be allowed.

Observations of the court

The High Court of Delhi referred to a number of decisions of the Supreme Court of
India and summarised the principles to be borne in mind by the Court in the matter of
grant of injunction against enforcement of bank guarantee as under :- (i) "a bank
guarantee is an independent and distinct contract between the beneficiary and the bank
and the rights and obligations therein are to be determined on its own terms; (ii) a bank
guarantee which is payable on demand implies that the bank is liable to pay as when a
demand is made upon the bank by the beneficiary. The bank is not concerned with any
inter se disputes between the beneficiary and the person at whose instance the bank had
issued the bank guarantee. (iii) Commitments of the banks must be honoured free from
interference by the Courts. Otherwise trust in commerce, internal and international,
would be irreparably damaged; (iv) An irrevocable commitment either in the form of
confirmed bank guarantee or irrevocable letter of credit cannot be interfered with except
in case of established fraud of an egregious nature as to vitiate the entire underlying
contract; or in case of special equities in the form of preventing irretrievable injustice
between the parties as noticed in the case of Itek Corporation. v. The First National
Bank of Boston etc. (566 Fed Supp 1210). Allegations of irretrievable injustice must be
genuine and immediate as well as irreversible." The Court pointed out that the petition
contains no facts or particulars in support of allegation of fraud. The main contract
pursuant to which the bank guarantee was furnished was not sought to be avoided on
the ground of fraud nor was it at any point of time alleged that the bank guarantee was
issued because the first respondent was responsible for playing any fraud. On the facts

16
M/s. Saw Pipes Ltd. vs. Gas Authority of India Ltd. & Another AIR 1999 Delhi 308
no case of fraud has been made out. The question whether any amount was due to the
first respondent was to be adjudicated in arbitration proceedings. In this context, the
Court observed that the mere allegation that first respondent is attempting to encash the
bank guarantee for an amount which has already been recovered by it, will not suffice
to bring the case within the purview of the exception of irretrievable injustice. The
Court referred to the specific provisions of the bank guarantee while opining that the
guarantee was indisputably irrevocable and gave absolute discretion to the first
respondent for invoking the same.

Decision

The Court held that the bank cannot be restrained from honouring its commitment
under the bank guarantee. The petition was dismissed.

In the above cases, the Hon'ble High Courts have acknowledged and emphasised
the binding nature of the Bank's undertaking and obligation to make payment to
the beneficiary in accordance with the provisions of the document of bank
guarantee. The Courts have declined to interfere and refused to grant injunction
restraining the encashment of bank guarantee having found that no cogent ground
has been established. The above decisions support the view that the banks have a
duty to honour the bank guarantee when called upon to do so subject to certain
limited exceptions.