BANK GUARANTEES: RECENT DEVELOPMENT & JUDICIAL INTERPRETATION (By : Rahul Jain)
BANK
GUARANTEES: RECENT DEVELOPMENT & JUDICIAL INTERPRETATION
Author By : Rahul Jain
Affiliation: Student, Symbiosis Law School, Noida
Introduction
Guarantee,
as the very name suggests, is the assurance given by one person for another.
With the advent of time, the needs and aspirations of business have shown an increasing
trend and so have the risks associated alongside. Be it a harsh reality, but
today, money decides the extent of growth of an individual or a business.
Resources however are limited at the same time. The question lies as to whether
the meagre means of the people of India should act as a hurdle in its prospect
of development and expansion.
Owing
to the same deficiency, in the olden days, India experienced a comparatively
slow rate of growth. As regards innovation and determination, we have stood supreme
but the economic power to set those thoughts in the right direction is where
we’ve lacked. As the need to expand grew, so came a way out of this defect.
There was a constant wave of uncertainties pertaining to whether the sum
expected to be received in future was secure or not. However, with the concept
of Bank Guarantees coming into the picture, this faded away.
A
Contract of Guarantee in general shifts the liability to the guarantor in case,
the person for whom the guarantee is being taken, fails to do what he was
required to or simply, acts in default. This assists both the person whose
guarantee is being taken and the person in receipt of such a guarantee. The
former’s ability to “buy now, pay later” is similarly put to use while
the latter finds a sense of security of not having to suffer any loss/damage in
future. When the Bank acts as a guarantor to aid its customers in availing
credit elsewhere, the same is referred to as Bank Guarantee. The Judiciary has
over time, given it a distinct interpretation. We will be dealing with the
concept of Bank Guarantees in detail, laying weight on its judicial
interpretation and the recent developments that have taken place in this
regard.
Research Questions/Research
Objectives
1. To understand the concept of Bank
Guarantees and analyze related provisions of the Indian Contract Act, 1872
2. To know about the recent developments
that have taken place in this regard
3. To bring about the judicial
interpretation with respect to Bank Guarantees
Meaning And Definition
According
to Section 126 of the Indian Contract Act, 1872 – ‘A "contract of guarantee" is 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". A guarantee may be either oral or written.’[1]
Hence, Bank Guarantees are dealt with in Section
126 of the Indian Contract Act, 1872. Put simply, it may be defined as an
arrangement/contract whereby the bank promises to fulfil the contractual
obligations of some third party in case of his/her default. It is a three-party
agreement between the promisor/principal debtor, promisee/creditor/beneficiary
and the bank/surety. All three contracts are independent of each other.
When the promisor fails to perform his/her
promise or the debtor fails to pay back the loan as required, the Bank does the
same on his behalf.
Illustration: Mr. ‘A’ of India wishes to procure
expensive machinery worth INR 12,00,000 from Mr. ‘B’ of Russia. Mr ‘B’ insists
that a bank guarantee be given in respect of the same. XYZ Pvt. Ltd., the
bankers of Mr. ‘A’ provide a guarantee in writing to indemnify Mr. B in case of
his default to do so.
Here, Mr. ‘A’ is the principal debtor, Mr. ‘B’
the creditor and XYZ Pvt. Ltd., the surety.
If default occurs on part of Mr. ‘A’, Mr. ‘B’ can
directly ask XYZ Pvt. Ltd. to indemnify the same.
Need For Bank Guarantees
With the modernization and up-gradation of India,
ideals of globalization and innovation came up, which furthered the need for
finance. Now is the era of startups and entrepreneurship wherein mass
investment is required. However, the immediate capacity to pay is what hinders
the growth of the business industry. In the majority of these cases, it is
expected that the amount falling short of, shall be earned/procured in the near
future. Bank Guarantees, by minimizing transaction risks, removes these
hindrances.
New firms/businessmen have insufficient means to
further their prospects. Also, raising loans becomes difficult consequently.
Such persons can avail of credit facilities by using Bank Guarantees as a tool
of security. Creditors, on receipt of such guarantee, advance the money as they
find Bank Guarantees as a reliable source of securing their transaction. From
the point of view of creditors, they have a sense of security that in case the
promisor fails to perform his/her contractual obligations, they will be
reimbursed for the same.
Henceforth, Bank Guarantees not only ease things for
the principal debtor but also provide security to the Creditors.
Recent Developments
The
outbreak of COVID-19 was an unforeseen and exceptional challenge, one which
India had not witnessed. In a setting of uncertainties and chaos, the business
world was adversely affected. Further, the Judiciary was not taking its usual
course of action. Bank Guarantees was another aspect that went through
disorderly interpretation when a whole lot of contracts came to a standstill,
with their future ambiguous. However, the Government of India vide order dated
13th May 2020,
declared
the ongoing pandemic as force majeure. Doing so raised the question as to
whether Covid-19 be used as a pretext to bank guarantees.
The
Delhi High Court and the Bombay High Court had differing opinions on this
subject matter. In Haliburton Offshore Services Inc. vs Vedanta Ltd.
&Anr.[2],
the Delhi High Court observed that the defendant was wanting the invocation of
Bank Guarantees despite the outbreak of Covid-19 which had prevented the
plaintiff from discharging his contractual obligations. It provided relief to
the plaintiff and held that the lockdown having affected the plaintiff’s
ability to discharge obligations, was a state of distinct circumstances, and
hence, granted an injunction restraining the invocation of bank guarantees.
In
contrast to this, the Bombay High Court, in Standard Retail Pvt. Ltd. vs M/s
G.S. Global Corp. &Ors.[3],
wherein as against the demand for bank guarantees by a South Korean company,
that had exported steel to an Indian party, the Indian party sought an
injunction to restrain encashment of bank guarantee by reason of lockdown
restrictions, held that the defence of force majeure cannot be applied in the
given situation and allowed the invocation of bank guarantees.
Thus,
we saw a disagreeing take on the matter by two different Courts. The decision
of the Supreme Court is still awaited, which will show us a way out without any
shadow of reasonable doubt. The Insolvency and Bankruptcy Code, 2016 was well
touched upon consequently. As a matter of fact, Non-performance guarantees
cannot be revoked during the moratorium period, as has been upheld in GAIL
(India) Ltd. vs Rajeev Manaadiar[4].
However, ambiguity arose when an inconsistent judgement was given in ICICI
Bank Ltd. vs Vista Steel Pvt. Ltd.[5],
whereby bank guarantees were stayed on the ground of the moratorium period
being in operation.
We
can find, through recent developments that the law pertaining to Bank
Guarantees is still to undergo many changes.
Judicial Interpretation
The
Judiciary has over time, held the opinion that its intervention in the
execution of Bank Guarantees would be unfair to the very resolution of the law.
These guarantees can be invoked as and when the Principal Debtor defaults on
his/her promise without the Court, having to enforce the same. This saves both
money and time that goes into litigation. Further, it has been found that the
contract between the Bank and the Creditor is one independent of the original
contract. Hence, in case the party for whom a guarantee has been taken fails to
discharge his/her obligations, the Bank’s liability arises. This liability is
unqualified and absolute. Hence, regardless of any enduring dispute between the
Principal Debtor and the Creditor, the Bank cannot escape its legal
responsibility.
In
Tarapore and Co. vs M/s V/O Tractors Export[6],
the Court held that Bank Guarantees are independent of the original contract.
Hence, they are absolute in nature. It reinstated the purpose of this tool as
being to avoid legal proceedings. Overall, the invocation of Bank Guarantees
has been unconditional. However, as an ever-growing judicial system, the Court
has laid down certain exceptions, when such guarantees can be revoked.
In
view of the same, we find that the Courts in India have treated Bank Guarantees
as a contract distinct from the original one, and established that the same can
be invoked on the fulfilment of required conditions (Conditional) or on-demand
(Unconditional), as the case may be, without
regard
to the contract between the Principal Debtor and the Creditor. The Banks, if
not protected by the special exceptions, are bound to be liable undeniably.
Analysis And Conclusion
Bank
Guarantees, a means of ensuring security in business transactions, serve
various purposes for us. Be it the real-estate industry, or the setting up of
tech giants, little would have been possible but for the aid of such
guarantees. Foreign Bank Guarantees, Deferred Bank Guarantees, EMDs, Advance
Payment Guarantees and Performance Bank Guarantees – these guarantees exist as
a whole sphere. An added advantage to
this arrangement is the absence of the need for the Judiciary to undertake
enforcement since it is an independent contract between the Bank and the
Beneficiary. No matter what the state of affairs persists between the original
parties to contract, it has no bearing on this relationship.
However,
the Judiciary realizes that this should not be taken as an opportunity and in
lieu of the same, has considered exceptions for granting injunctions
restraining Bank Guarantees. As held by the Supreme Court in U.P. State Sugar Corporation v. Sumac
International Ltd.[7], when there exists fraud on part of the
beneficiary of such a nature as to “vitiate the entire underlying transaction”,
an injunction can be granted in order to restrain such guarantee of the Bank.
In furtherance of the view as per Section 17 of the Indian Contract Act, 1872,
fraud should be seen not only as one being committed while entering into the
contract but thereafter as well. Moreover, where the Court believes that
enforcement of the Bank Guarantee would cause irreparable injustice to either
of the parties, causing severe consequences for the nation as a whole.
Henceforth, I believe that Bank Guarantees are
the fillers to the voids surfacing in the trade and commerce of India. The only
thing to be given due regard is the misuse of the elimination of the judicial
mechanism in general. In consideration of the same, have the exceptions been
listed out, as and when the need arose. However, I believe that there should be
a regulatory mechanism, thus removing the ‘absolute’ nature of such
guarantees. A Quasi-judicial body in respect of the same is what can be worked
upon. The law pertaining to Bank Guarantees is still in the process of
evolution and defining some vibrant scope for the same should be thought upon
by competent persons.
References
1. LEGAL SERVICE INDIA, https://www.legalserviceindia.com/legal/article-5590-bank-guarantees-judicial-interpretation-and-recent-developments.html#:~:text=Bank%20Guarantees%3A%20Judicial%20Interpretation
%20and%20Recent%20Developments,By%20Anushka%20Singhal&text=Bank%20guarantees%20fall%20under%20section,the%20promisor%EF%BF%BDs%20default
(last visited March 23, 2022).
2. MONDAQ, https://www.mondaq.com/india/financial-services/958018/bank-guarantees-and-injunction-on-their-invocation#:~:text=In%20light%20of%20such%20stringent,the%20bank%20has%20notice%2C%20and
(last visited March 21, 2022).
3. LAWFOYER, https://lawfoyer.in/bank-guarantees-judicial-interpretation-and-recent-developments/
(last visited March 21, 2022).
4. CYRIL AMARCHAND MANGALDAS, https://corporate.cyrilamarchandblogs.com/2020/05/injunction-against-encashment-invocation-of-bank-guarantees-evolution-of-fraud-and-special-equities/
(last visited March 23, 2022).
5. AVTAR SINGH, TEXTBOOK ON LAW OF
CONTRACT AND SPECIFIC RELIEF 389 (EBC 2019).