This Article is submitted by –
- Saksham Jain- GGSIPU; Amity Law School, Delhi; BA-LLB(h); 4th year
- Abhishek Taneja- GGSIPU; Amity Law School, Delhi; BA-LLB(h); 4th year
The Contract of guarantee is defined as a contract to perform the promise or discharge the liability of the third person if he makes any default. The person on whom guarantee is given is called “Principal Debtor”, the person to whom guarantee is given is called the “Creditor” and the person who promises to perform or discharge the liability of the third person is called the “Surety”[1].
The dynamics in the concept of Bank Guarantee changes as it has 3 parties to the contract making it a tripartite contract. The person who promises to perform or discharge the liability of the third person is called the “Guarantor” (Banker). The person on whom guarantee is given is called “Applicant” (Bank’s Client) and the person to whom guarantee is given is called the “Beneficiary” (Third Party). In Cases of Foreign Bank Guarantees like in international export situations, there may be a fourth party – a correspondent bank that operates in the country of domicile of the beneficiary.
A bank guarantee is an affirmation that a bank provides to a contract between two parties of the contract, a buyer and a seller, or in respect to the guarantee, an applicant and a beneficiary. The bank guarantee is a risk management tool for the beneficiary, as the bank takes upon the liability for completion of the contract should the buyer default on their debt or obligation. These Agreements are an important banking arrangement and play a vital role in promoting both international and domestic trade.
Illustration:
Mr. ‘X’ leases his studio apartment to Mr. ‘B’ for Rs. 100,000 per month. Mr. ‘X’ insists on a bank guarantee from Mr. ‘Y’s bankers, the Bank of India for Rs.250,00,000 to compensate him in case Mr. ‘Y’ refuses to hand over possession at the end of the lease period. Here, ‘Y’ is the principal debtor, The Bank of India is the surety and ‘X’ is the creditor. For any default of ‘Y’ Mr. ‘X’ can be indemnified directly by the bank of India.
It has numerous advantages connected thereto as this is an assurance to a beneficiary that the bank will uphold a contract if the applicant and counterparty to the contract are not able to do so. These guarantees ensure the purpose of facilitating business in situations that would otherwise be too risky for the beneficiary to engage.
The Fundamental contracts of a bank guarantee can be either financial (such as loan repayment), or performance-based (such as a service provided by one party to another).
Types of Bank Guarantees
A bank guarantee is for a specific amount and its maturity may depend upon either fulfilment of a specific condition (Conditional) or on demand (unconditional). A bank guarantee may be:
- A Financial bank guarantee, the bank will guarantee that the buyer will repay the debts owed to the seller. If the buyer fails to do so, the bank will assume the financial burden itself, for a small initial fee, which is charged from the buyer upon issuance of the guarantee.
- A performance-based guarantee, the beneficiary can seek reparations from the bank for non-performance of the obligation as laid out in the contract. In case the counterparty fails to deliver on the services as promised, the beneficiary will claim their resulting losses from non-performance to the guarantor – the bank.[2]
- A Conditional Bank Guarantee, whose maturity depends upon fulfilment of a specific condition and only in those conditions.
- An Unconditional Bank Guarantee, whose maturity may depend upon the demand of the party in whose favour that particular bank guarantee, is made, and it shall not be affected by any pending disputes; the bank shall honour the maturity of such.[3]
Invocation of Bank Guarantees
A bank is obliged to accept any legitimate claim within the validity period of the guarantee. If the invocation is in proper order, which means that under the fulfilment of a condition already specified or after completion of time of that guarantee, and there is no court prohibiting the payment, the bank is required to accept the claim payment to the beneficiary.
The opinions of the domestic courts are enunciated as follows:
In the case of United Commercial Bank v Bank of India[4], the apex court held that the courts shall not intervene with the Bank Guarantee procedures as more involvement may lead to delays and also affect the transaction process of the same, which would defeat the most important function of bank guarantee.
In Road Machines India (p) Ltd v. Projects & Equipment Corporation India[5], it was held that the invocation of a bank guarantee does not necessarily have to be initiated by setting out the entire case in the form of a plaint with a specific cause of action, and that it was a commercial document and not a statutory notice or a pleading. It was also stated that if the bank concerned understood that the beneficiary in terms of the guarantee was invoking the guarantee, the bank guarantee may be invoked.
In UP State Sugar Corporation v. Sumac International Ltd[6]It was held that when an unconditional bank guarantee is given or accepted, the beneficiary is entitled to realize such bank guarantee irrespective of pending disputes and that a bank guarantee constituted a bargain between the two parties, by which the banker creditor was unconditionally required to pay the amount in question. However, the court also stated that injunction restraining the invocation may be granted in the case of fraud of an egregious nature or an irretrievable injury. This opinion of the court has been considered to be a general rule and the same has been accepted in many judgments like those of U.P. Co-op. Federation Ltd. v. Singh Consultants and Engineers (P) Ltd[7], U.P. State Sugar Corporation v. Sumac International Ltd.[8]Hindustan Steelworks Construction Ltd. v. Tarapore & Co.[9], Centax (India) Ltd. v. Vinmar Impex Inc[10].
In Himadri Chemicals Industries Ltd. vs. Coal Tar Refining Company[11], while agreeing to the above stated principle, the court laid down certain guidelines in respect to invocation and injunction of bank guarantees, which has been enunciated below:
(i) While dealing with an application for injunction in the duration of commercial dealings, and when an unconditional bank guarantee or letter of credit is given or accepted, the beneficiary is entitled to realise such a bank guarantee or a letter of credit in terms thereof irrespective of any pending disputes in respect to the terms of the contract.
(ii) The bank giving such guarantee is bound to accept it as per its terms irrespective of any dispute raised by its customer.
(iii) The courts should be slow in granting an order of injunction to restrain the realisation of a bank guarantee or a letter of credit.
(iv)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.
(v)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, and if this is the case, the injunction can be granted by the court.
(vi)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, and if this is the case, the injunction can be granted by the court.
In the case of Hindustan Construction Co. Ltd. v. State of Bihar and Ors.[12], the bank guarantee in question was considered to be a conditional bank guarantee, by the apex court judging on the terms of the bank guarantee in question itself and an injunction was granted on the same, because the condition was not fulfilled by the party.
The court in the recent case of Halliburton Offshore Services Limited vs. Vedanta Limited and Another[13], granted interim injunction against invocation and encashment of eight bank guarantees as the non-performance of the contract by the petitioner was on account of the lock down caused by the pandemic, which was prima facie in the nature of a force majeure event.
Limitation period for filing of any disputes related to invocation or injunction on Bank Guarantees
The limitation period for bringing any dispute or claim by the beneficiary in case of guarantee contracts is generally 3 years from the breach of contract.
Section 28 of the Act prohibits the parties to an agreement to substitute their own periods of limitation in place of the periods laid in the act. However, till the time the account is alive i.e. it is not settled nor there is any disagreements by the guarantors to carry out the obligations of the contract, the limitation period do not begin. This, however, mentions two exceptions to the same, where the parties might refer to arbitration for solving of their disputes or referring to questions already arisen may be referred to arbitration by the parties in writing will also be considered legal.[14]
However, the third exception is brought about by the Banking Laws (Amendment) Act 2012, which is enunciated below:
“This section shall not render illegal if a contract in writing by which any bank or financial institutions stipulate a term in a guarantee or any agreement making a provision for guarantee for extinguishment of the rights or discharge of any party thereto from any liability under or in respect of such guarantee or agreement on the expiry of a specified period which is not less than one year from the date of occurring or non-occurring of a specified event for extinguishment or discharge of such party from the said liability”.
The above-mentioned exception to the banking law provisions enables banks and financial institutions to limit the validity period of the guarantee. The beneficiary of the guarantee shall invoke the guarantee as per clause of the bank guarantee in order to honour his/her claim.
Conclusion
Therefore, it can be concluded that the bank guarantees are the lifeline of present day commercial transactions. These provide confidence in transactions even with new business houses and reduces the financial risk involved in the commercial dealings. It also acts like a shield against any probable loss a party can suffer from a third party. In these times of uncertainty, bank guarantees can provide more confidence and secure ways of dealings in commerce. Thus, imparting the necessary oxygen supply to the money supply for further economic growth. The parties to the Bank Guarantee are the one that control the functioning of that bank guarantee and the [15] courts tend not to interfere with them unless there is a Fraud of an egregious nature or irretrievable harm or injustice to one of the parties concerned, and only in these case shall the court grant injunction to the encashment or invocation of the Bank Guarantee.
“The views of the authors are personal“
Reference
[1] Indian Contract Act, 1872, Section 126
[2]Shivani Kumbhojkar, “ Bank Guarantees And Injunction On Their Invocation”, see at- https://www.mondaq.com/india/financial-services/958018/bank-guarantees-and-injunction-on-their-invocation
[3] Ravi Singhania, “VALIDITY OF INVOCATION OF BANK GUARANTEE TO BE JUDGED ON FACTS OF EACH CASE: SUPREME COURT” see at- https://singhania.in/validity-of-invocation-of-bank-guarantee-to-be-judged-on-facts-of-each-case-supreme-court/
[4] AIR 1981 SC 1426
[5] AIR 1983 Cal 91
[6] 1997 1 SCC 568
[7] (1988) 1 SCC 174
[8] 1997 1 SCC 568
[9] 1996, 5 SCC 34
[10] (1986) 4 SCC 136
[11] (2007) 8 SCC 110
[12] 1999, 8 SCC 436
[13] 2020 SCC OnLine Del 542
[14] Dr. R.K. Bangia, “INDIAN CONTRACT ACT”(Allahabad Law Agency, 15th edition) pg209