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Performance Bank Guarantees: The Linchpin Of Commercial Transactions [Part III]

Ragini Agarwal
27 Sep 2020 6:13 AM GMT
Performance Bank Guarantees: The Linchpin Of Commercial Transactions [Part III]
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This series of blog posts shall recount the law on evolution of performance bank guarantee in India. It shall cover the meaning of bank guarantee as distinguished from indemnity and letter of credit, and the legal framework governing performance bank guarantees in India in Part 1; the types of bank guarantees and character of such guarantees in Part 2; and finally, the exceptions and rules concerning invocation of bank guarantees in Part 3.

Invocations and Encashment

"[C]ommitments of banks must be honoured free from interference by the courts."

  • Justice Oza, U.P Coop. Federation Ltd. v. Singh Consultants & Engineers (P) Ltd. (1988)

Since the character of performance bank guarantees is independent of the underlying contract (see Part 2/3), at the time the invocation of bank guarantees is sought to be injuncted, courts cannot go into the question of whether there was breach of contract etc. If the invocation of guarantee is in the manner specified in the contract, banks are obligated to honour the guarantee, even if the amount is disputed. The beneficiary's decision on the quantum suffices. In case of unconditional bank guarantees, the ordinary principles of grant of injunction with the three pronged test, viz., prima facie case in favour, balance of convenience and irretrievable injury, as specified in Order XXXIX Rules 1 and 2 of the Code of Civil Procedure, 1908, are not looked at.

Bank guarantees stand on a different footing and the ordinary rule is that trading operations should not be jettisoned, and the faith of the people in the efficacy of the banking transactions should not be eroded or brought to disbelief [Ansal Engineering v. Tehri Hydro Development Corporation (1996)]. Courts have evolved two narrow grounds which, if proven to exist in the facts and circumstances of the case, would entitle the applicant for an injunction.

A. Exceptions to Invocation of Performance Bank Guarantee

The application of exceptions originated from the law on letter of credit which was applied to performance bank guarantees as well [See, UCO Bank vs. Bank of India, (1981) and Centax (India) Ltd. v. Vinmar Impex Inc. (1986) applied in U.P Coop. Federation Ltd. v. Singh Consultants & Engineers (P) Ltd. ("Singh Consultants case") (1988)]. The above Singh Consultants case was one of the first cases to lay down the two exceptions of:

  1. Egregious fraud; and
  2. Irretrievable injury and injustice

to determine whether grant of injunction against performance bank guarantee was justified. This was reiterated in the later 2019 Supreme Court case of Standard Chartered v. Heavy Engineering Corporation Ltd & Ors. (2019).
[1] It may be noted that the act of a beneficiary in not invoking guarantee does not act as a bar in later invoking the guarantee. Let us understand the two grounds as specified for invoking guarantees.

1. Egregious Fraud:

Fraud as an exception to invoking guarantee is based on the maxim exturpi causa non oritur actio i.e. a party cannot be allowed to take advantage of his own wrongful act. Here, the fraud must be on the part of the beneficiary. Fraud has been defined under §17, Indian Contract Act, 1872 as any act committed by a party, or with his connivance, or by his agent, to deceive the other party or his agent or to induce him to enter into a contract.

When it comes to bank guarantees, the fraud must be egregious, i.e. go to the root of the matter to vitiate the contract of guarantee. Mere existence of dispute between parties cannot amount to fraud and become a ground for restraining enforcement of guarantee. It has been argued that fraud vitiating the bank guarantee is required to have a nexus with the acts of the parties prior to entering in the contract, however, in Hindustan Steel Works Construction Ltd. v. Tarapore & Co. (1996) it was clarified that the subsequent conduct of the beneficiary as well, could lead to a conclusion of fraud. To justify injunction, the fraud must be an established fraud and not mere speculation. This was held by Sir John Donaldson, M.R. in Bolivinter Oil SA v. Chase Manhattan Bank NA as quoted with approval in the Singh Consultants case.
[2]

To be successfully argued, such a fraud must of a nature in relation to the bank guarantees or have a bearing on the invocation of the bank guarantees, and must also be a fraud to the knowledge of the bank (¶53). In the case of Mercator Oil & Gas Limited v. Oil & Natural Gas Corporation Limited (2019), Bombay High Court refused to entertain the argument that there was fraud committed when the respondent had merely taken a decision in the best commercial interests of the project. Vague allegations of fraud would not amount to fraud of egregious nature, vitiating the entire transaction [Vinitec Electronics Private Ltd. v. HCL Infosystems Ltd. (2008), ¶25]

2. Special Equities:

Special equity is a broad term and denotes existence of special circumstances that justify the injunction against performance bank guarantees. It was coined in the Indian context in the Calcutta High Court judgment of Texmaco Ltd. v. State Bank of India (1979). However, mere existence of special equities does not suffice to justify an injunction, it must be accompanied by irretrievable injustice and harm, as was held in Svenska Handelsbanken v. Indian Charge Chrome (1994). Here, the American case of Itek Corporation v. The First National Bank of Boston
[3] was quoted wherein the realization of bank guarantees when Iran was undergoing turmoil was not permitted as it would cause irreparable harm to the plaintiff. In Dwarikesh Sugar Industries Ltd v Prem Heavy Engineering Works (P) Ltd & Anr., (1997), this standard was clarified and it was stated that it must be decisively established that there is no possibility of recovery based on principles of restitution, if the guarantee is allowed to be invoked.

In cases where contract is not completed owing to war like situations in foreign nations, injunction against invocation is granted based on the ground of special equities. In BHEL v. Egyptian Electricity Transmission Co. (2020), where majority of the supply under the contract had been done and only a miniscule remained which could not be completed due to war-like situation in Egypt, the Delhi High Court concluded that this amounted to force majeure. Special equities were said to exist since the plaintiff would not be able to recover the amounts under guarantee, if encashed, on account of the disturbance in Egypt, and hence the balance of convenience also lay in its favour. This inability to recover money in case of wrong invocation also played a role in grant of injunction in BHEL v. Ethiopian Electric Power Corporation (2018).

It is seen from the above that special equities are said to exist not merely on the happening of a force majeure event, but if the event is also qualified by an additional causal link of irretrievable injustice being caused to the party on account of the situation of special equity.

Note: The question of whether the "irretrievable injury or irretrievable injustice" exception is used interchangeably with "special equities" is academically unclear, although in practice interchangeable usage does seem to be the case. In General Electric Technical Services Comp. Inc. vs Punj Sons (P) Ltd. (1988), for example, the grounds for exception were noted to be "fraud and special equities in the form of preventing irretrievable injustice between the parties" (emphasis supplied). In Indu Projects Ltd. v. UOI (2013), the Delhi High Court held that the expression irretrievable injury or irretrievable injustice have been used interchangeably with expression special equities. However, the Apex Court in the judgment of Standard Chartered Bank v. Heavy Engineering Corporation (2019) stated the grounds to be "fraud, irretrievable injustice and special equities" (¶26) thereby denoting the grounds of "irretrievable injustice" and "special equities" to be distinct from each other.

The treatment of injunction in COVID-19 situation is analysed in Section C of this article.

B. Other exceptions

"Unjust enrichment" was argued as a ground for grant of injunction in Klen & Marshall Manufacturers v. Reserve Bank of India (1999) before the Delhi High Court. The plaintiff argued that the invocation of bank guarantee by the defendant was with the intent of unjustly enriching himself at the expense of the plaintiff. The Court dismissed the petition since the law on contractual obligations under bank guarantee was well settled and relying upon Dwarikesh Sugar Industries Ltd v. Prem Heavy Engineering Works (P) Ltd. (1997) stated that ground of unjust enrichment would not be a valid one, to injunct the performance of the guarantee.

In BSES Ltd. v. Fenner India Ltd. (2006), it was argued before the Supreme Court that an injunction must be granted against invocation on grounds of "lack of good faith" or "enforcing with an oblique purpose". The basis for this ground was found in the U.K. case of TTI Team Telecom Ltd. v. Hutchison 3G UK Ltd. (2003) where it was said:

"The basis for a contention of a breach of faith must be established by clear evidence even for the purposes of interim relief. A breach of faith can arise in such situations as: a failure by the beneficiary to provide an essential element of the underlying contract on which the bond depends; a misuse by the beneficiary of the guarantee by failing to act in accordance with the purpose for which it was given; a total failure of consideration in the underlying contract; a threatened call by the beneficiary for an unconscionable ulterior motive; or a lack of an honest or bona fide belief by the beneficiary that the circumstances, such as poor performance, against which a performance bond had been provided, actually exist."

While it was clarified that disputes with respect to breach of contract, a determination of a contract for cause, a repudiation of a contract or the incurring of loss have occurred, where these are events covered by the performance guarantee would not be allowed to be brought under the grounds of breach of faith, this ground of "breach of faith" was wider than the ambit of fraud. Further, the Appellant also placed reliance upon a Singapore case of Samwoh Asphalt Premix Pte. Ltd. v. Sum Cheong Piling Pte. Ltd. (2002) where it was held that invoking a performance guarantee for an oblique purpose was not permissible. Using it as a "bargaining chip" or a "deterrent" or in an "abusive manner" so that it would be an unconscionable invocation, would not be permissible.

The Supreme Court, while appreciating the tenor of the arguments held that the arguments were unsustainable in light of the long line of judgments which had clearly held that there were only the two grounds for stopping the encashment of guarantees. Creating a third ground would not be permissible.

The judgment established that unless the challenge to invocation could be pigeon-holed into one of the two exceptions to invocations, the unconditional bank guarantee would be allowed to be performed.

Notably, while invocation under "breach of faith" was specifically dismissed in BSES v. Fenner case, special equities were held to exist by the Delhi High Court when the invocation is done in a distrustful manner. For instance, in Leighton India Contractors v. DLF Ltd. before the Delhi High Court on May 13, 2020, the respondent had already received the amount after invocation of performance bank guarantees. Going into the question of injunction at that juncture was fruitless, however, the Court took into account the clauses of the contract and the bank guarantee, noted the fact that the invocation was done in a distrustful manner, and held that a case of special equities existed. The facts of the case showed that the parties had been working with each other in a collaborative manner and that the communication by the respondent did not show an intention to invoke the guarantee or to terminate the contract. To protect the interests of the petitioner, the Court ordered that the amount of performance bank guarantees be placed in an interest bearing fixed deposit on auto renewal mode.

In another case before the Delhi High Court, Tecnimont Private Limited v. ONGC Petro Additions Ltd. on 20 June, 2020 (Del HC), the invocation of guarantee with the intention to subvert an arbitral award was held to be invalid.

C. Analysis of COVID-19 as a situation of Special Equity to injunct invocation

The pandemic that has affected contractual obligations and economy world over has been argued by parties to be a force majeure event which justifies the injunction of bank guarantees as a condition of special equities exists. Courts have been slow to prima facie grant injunction only in light of the pandemic. Force majeure has been narrowly interpreted in light of the dicta of the Supreme Court in Energy Watchdog (2017) wherein the Court declared that it was not the domain of the Courts to absolve the parties from performing their part in the contract.

In Haliburton Offshore Services v. Vedanta Ltd (2020), the Delhi High Court further clarified that mere existence of COVID-19 would not justify every breach or non-performance of the parties.

"The Court would have to assess the conduct of the parties prior to the outbreak, the deadlines that were imposed in the contract, the steps that were to be taken, the various compliances that were required to be made and only then assess as to whether, genuinely, a party was prevented or is able to justify its non- performance due to the epidemic/pandemic." (¶62)

In Indrajit Power Private Limited v. UOI (2020) as well, the Delhi High Court interpreted adopted a strict approach to force majeure and noting that the party had failed to fulfil its obligations even before the pandemic, refused to grant an injunction.

It may be noted that in case of a dispute between the parties with respect to whether a force majeure clause was properly invoked or not, the arbitral tribunal has the final jurisdiction to determine such a question [Global Steel Philippines v. State Trading Corporation of India Ltd. (2009)]. Courts refuse to intervene in contractual obligations of the parties even for interim relief under the broad ambit of §9 of the Arbitration and Conciliation Act, 1996 [Rashmi Cement Ltd. v. World Metals & Alloys (Fzc) (2020)].

The Bombay High Court, in Standard Retail Pvt. Ltd. v. M/s. G. S. Global Corp & Ors. (2020), outright refused to allow the limited period of lockdown to allow the petitioner to resile from its contractual obligations. However, where the party is unable to perform the contract on account of force majeure conditions, courts have allowed grant of injunction against invocation of bank guarantee. For instance, in Transrail Lighting Limited v. Public Electricity Corporation Republic of Yemen (2020), the plaintiff was unable to perform the contract on account of civil unrest in Yemen and the project had not been completed because the situation of civil unrest situation in Yemen had remained unchanged for five years. Here, injunction was granted.

The position that seems to emerge from the above holdings of various courts is that while the existence of the pandemic may create an unviable situation for performance of contracts, the obligation of honouring the unconditional bank guarantee will not be discharged unless special equities are shown to exist within the facts and circumstances of the case. The pandemic by itself will not lead to a free getaway for parties from honouring contractual obligations. There must be an accompanying fact of irretrievable injustice or injury to the applicant in case of invocation of guarantee. This is a sound principle.

D. Potential Cases of Departure from Established Principles

The 2016 Supreme Court case of Gangotri Enterprises Limited v. Union of India & Ors. is particularly controversial. In this case, the appellant contended that the performance bank guarantee was not liable to be invoked since the works had been completed to the satisfaction of the respondent evident by the issue of the completion certificate. Among other grounds pleaded to stop the encashment of guarantee, one was that arbitration proceedings were pending to decide the amount payable for damages. The Supreme Court relied upon Union of India v. Raman Iron Factory (1974) to hold that one party could not be the sole judge to quantify the amount payable and that the phrase "sum due" denoted a sum for which there is an existing obligation to pay in praesenti. It may be pertinent to point out that encashment of bank guarantees was not an issue in Raman Iron Factory case.

The Supreme Court in Gangotri Enterprises found that the amount being claimed did not relate to the amount for which guarantee was given. The amount being claimed under the guarantee was in the nature of damages which was still pending adjudication in the arbitration proceedings. Since the sum was neither due in praesenti, nor payable, but was disputed, there existed no right to encash the guarantee (42). Hence, the Supreme Court went on to hold that whether or not injunction can be granted must be decided taking into account facts involved in each case and that the lower courts had erred in dismissing plea to grant an injunction.

This decision is controversial since it seems to militate against established principles on character and invocation of bank guarantee, namely that the beneficiary shall be sole determinant of the sum payable, and that the bank cannot demand proof of liability if the invocation is done as per the terms of guarantee contract (See Part 2). In support of the decision, at the same time, it may be argued that the turning point of this case was the fact that the contract on which the bank guarantee had been based was already completed.

In 2017, the Andhra Pradesh High Court in NCC Limited v. Sembcorp Gayatri Power Limited and Ors. stated that the Gangotri Enterprises case seemed to be bad in law and ran contrary to the three judge bench decision in Ansal Engineering v. Tehri Hydro Development Corporation (1996). It also noted that reliance upon Raman Iron Factory case by the Supreme Court was misplaced. Previously, when in the case of Tarapore & Co. (1996), the High Court had relied upon the Raman Iron Factory case to hold that one party could not be the sole judge of the quantification of sum payable in the context of bank guarantee, the Supreme Court had allowed the appeal against the High Court decision. It had stated:

"The High Court also committed a grave error in restraining the appellant from invoking bank guarantees on the ground that on India only reasonable amount ca be awarded by way of damages even when the parties to the contract have provided for liquidated damages and that a term in a bank guarantees making the beneficiary the sole judge on the question of breach of contract and the extent of loss or damages would be invalid and that no amount can be said to be due till and adjudication in that behalf is made either by a court on an arbitrator, as the case may be. In taking that view the High Court has overlooked the correct position that a bank guarantees is a independent and distinct contract between the bank and the beneficiary and is not qualified by the underlying transaction and the primary contract between the person at whose instance the bank guarantee is given and the beneficiary."

Thus, reliance upon Raman Iron Factory case by the Supreme Court in Gangotri Enterprises being based upon a false premise, the Andhra Pradesh High Court refused to grant injunction against invocation of bank guarantee. In Larsen and Toubro v. Experion Developers Pvt. Ltd. (2019) as well, the Delhi High Court dismissed reliance on Gangotri Enterprises case and following the established law on bank guarantees did not grant an injunction on the same.

It may be noted that the practice of not following the established law on guarantees has been deprecated by the Supreme Court on a previous occasion.

E. Release from Performance Bank Guarantee

Once the opposite side is fully satisfied regarding the performance of the contract and its execution, the release from guarantee is granted.
[4] Where a bank guarantee stands discharged on account of its own contractual terms, it cannot be invoked.

This summarises the evolution of law on performance guarantees.

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