The restraining of the invocation of a bank guarantee has traditionally been one of the less ventured into areas of law. In India as well as in common law, Courts have laid down strict standards and thresholds for judicial intervention, and only in the rarest cases would Courts allow an injunction against invocation of a bank guarantee. This trend, however, is changing and evolving constantly.
A bank guarantee is a written tripartite contract given by a bank (say, A), on behalf of its customer (say, B) in relation to a particular commercial contract with a third-party (say, C). By issuing this guarantee, Bank A takes responsibility of paying a fixed sum of money in case of non-performance of contractual obligations by B towards C.
Fundamentally, there are two types of bank guarantees:
Generally, courts in India have taken the view that invocation of a conditional bank guarantee may be restrained in the event of a pending dispute between the contractual parties (B and C).
However, the view as regards unconditional bank guarantees has been that the same should not be interfered with when challenged. The principle behind the same is that 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.
The age-old and settled exceptions to the above principle is the presence of (a) egregious fraud at the time of execution of the contract, or (b) where special equities exist such that the encashment of the bank guarantee would cause irretrievable injury.[1]
This article seeks to discuss the updates in the understanding of the above two exceptions to the rule that the invocation of unconditional bank guarantees should not be interfered with.
The proof in relation to a fraud, in the context of restraining invocation of bank guarantees, is that the same has to be egregious in nature, such that it would vitiate the very foundation of such a bank guarantee. Further, the Bank has to have notice of such fraud, and both such facts have to be established by way of prima facie averments and proof.[2]
Vague and indefinite allegations made do not satisfy the requirement in law, constituting any fraud, much less a fraud of an egregious nature as to vitiate the entire transaction.[3]
The understanding of fraud was traditionally interpreted through the lens of Section 17 of the Indian Contract Act, 1872, which required there to have been a fraud at the time of entering into a contract, and that such fraud induced the other party to enter into the contract. However, Courts are now of the view that a demand by the beneficiary under the bank guarantee may become fraudulent not because of any fraud committed by the beneficiary while executing the underlying contract, but it may become so because of subsequent events or circumstances, and that even in such cases, courts should not refrain from restraining a person making such a fraudulent demand by enforcing a bank guarantee[4].
The concept of “special equities” is extremely wide and slightly vague and depends on the facts present before a Court and the inclination of the judge hearing the matter. The term “special equities” was first coined by the Calcutta High Court in Texmaco Ltd. v. State Bank of India[5], without going into the same is great detail.
In Vinitec Electronics Pvt. Limited v. HCL Infosystems Limited [6], it was further made clear that irretrievable injury and injustice was connected to special equities. It was apparent that the judgment does not intend to say that special equities and irretrievable injury are synonymous, but in fact it appears to be that irretrievable injury was held to be a part of special equities, thereby giving it a more wider meaning.
A particular form of “special equities” was identified in Svenska Handelsbanken v. M/s. Indian Charge Chrome[7], where the Court observed that there should be a prima facie case of fraud and of special equities in the form of irretrievable injustice and injury between the parties. It was further held that the nature of irretrievable injustice and injury was recognised and was laid down to be as the one held by the United States District Court, Massachusetts in Itek Corporation v. The First National Bank of Boston[8].
Itek (supra) dealt with a situation where a corporation in the United States of America had entered into a contract with a company in the Republic of Iran and a bank guarantee had been given on behalf of the American corporation. Thereafter, hostilities broke out between USA and Iran, with advisories against US citizens traveling to Iran. The Court in Itek stated that a peculiar situation was created where if the bank guarantee was allowed to be invoked, and thereafter the American corporation was successful in obtaining a decree against the Iranian entity, such a decree could not have been enforced in Iran due to the conflict. The Court identified that such a situation of impossibility of enforcing a decree would amount to special equities existing in favour of the American corporation, and thereby restrained any invocation of the bank guarantee.
The Supreme Court in Dwarikesh Sugar Industries Ltd v Prem Heavy Engineering Works (P) Ltd & Anr.[9] has stated that “[…] 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”
In fact, the position in Itek (supra) and Dwarikesh (supra) has recently been re-emphasised by the Bombay High Court in Transrail Lighting Limited v. Public Electricity Corporation Republic of Yemen[10], where a plaintiff was unable to perform a contract due to civil unrest in Yemen and travel advisories issued by the Government of India against travelling to Yemen.
Therefore, while it may be stated that bank guarantees are the lifeline of commerce and commercial transactions, there exist extreme conditions and peculiar facts and circumstances where the exception of irretrievable injury, coupled with the egregious nature of a fraud can be grounds for restraining and invocation of unconditional bank guarantees.
In any event, irretrievable injury and harm along with special equities are an evolving concept and Courts are slowly becoming more liberal towards the same, depending on the facts and circumstances of each case, keeping in mind that bank guarantees are also independent contracts and only in a situation where no other adequate remedy is available, relief is granted, allowing the aggrieved to be remedied.
[1] Himadri Chemicals Industries Limited V. Coal Tar Refining Co., AIR 2007 SC 2798
[2] U.P. State Sugar Corporation v. Sumac International Ltd., (1997) 1 SCC 568
[3] Vinitec Electronics Private Ltd. v. HCL Infosystems Ltd., (2008) 1 SCC 544
[4] Mercator Oil & Gas Limited v Oil & Natural Gas Corporation Limited, 2019 SCC OnLine Bom 1378
[5] AIR1979Cal44
[6] (2008)1SCC544
[7] (1994) 1 SCC 502
[8] 566 F Supp. 1210
[9] (1997) 6 SCC 450
[10] Bombay High Court, Commercial Suit (L) No. 185 of 2020, order dated March 11, 2020.
