INVOCATION OF BANK GUARANTEE IN TIMES OF COVID-19

Preface:

The questions of law which this article attempts to answer are the following:

(1)  Whether “Covid-19 Lockdown” is a force majeure event?

(2)   Can “Covid-19 Lockdown” be perceived as a circumstance granting “special equities” to a party furnishing bank guarantee, enabling it to seek injunction to restrain the beneficiary of the bank guarantee from invoking it?

(3)  Is the ground of “special equities” a sub-set of the ground “irretrievable harm or injustice” available for seeking restrain on invocation of bank guarantee?

“Irretrievable injustice”, when can be said to have occasioned?

In the matter of: U.P. Cooperative Federation Ltd. V/s Singh Consultants & Engineers (P) Ltd, (1988) 1 SCC 174, it was observed that: 

“… in order to restrain the operation either of irrevocable letter of credit or confirmed letter of credit or bank guarantee, there should be serious dispute and there should be good prima facie case of fraud and special equities in the form of preventing irretrievable injustice between the parties.”

The Hon’ble Supreme Court of India, in the matter of: Svenska Handelsbanken V/s Indian Charge Chrome, (1994) 1 SCC 502, reiterated the dictum in the matter of U.P. Cooperative Federation Ltd. (Supra) and further, went on to clarify that the “irretrievable injustice” or “irretrievable injury” which would result, if injunction were not granted, was required to be of the nature as noticed in the case of: Itek Corporation V/s First National Bank of Boston, 566 Fed Supp 1210.

Notably, in the matter of Itek Corporation (Supra) it was observed that:

“… Because I find that Itek has demonstrated that it has no adequate remedy at law, and because I find that the allegations of irreparable harm are not speculative, but genuine and immediate. I am satisfied that Itek will suffer irreparable harm if the requested relief is not granted.”

Lastly, in the matter of: U.P. State Sugar Corporation V/s Sumac International Ltd., (1997) 1 SCC 568, it was observed that:

i.               When in the course of commercial dealings an unconditional bank guarantee is given or accepted, the beneficiary is entitled to realize such a bank guarantee in terms thereof irrespective of any pending disputes.

ii.             The bank giving guarantee is bound to honour it as per the terms contained in the bank guarantee irrespective of any dispute raised by its customer. The very purpose of giving such a bank guarantee would otherwise be defeated. The courts should be slow in granting an injunction to restrain the realization of an unconditional bank guarantee.

iii.            There are two situations, having regard which, the court would be inclined to grant relief of injunction, restraining the beneficiary from invoking the unconditional bank guarantee, and these are:

(a)   A fraud in connection with a bank guarantee, vitiates the very foundation of a bank guarantee. If there is such a fraud of which the beneficiary seeks to take advantage then he can be restrained from doing so. That the fraud in connection with the bank guarantee must be of an egregious nature, that is, one which has the potentiality of vitiating the entire underlying transaction. 

(b)  The second exception relates to cases where allowing the encashment of an unconditional bank guarantee would result in irretrievable harm or injustice to one of the parties concerned. The irretrievable harm or injustice must be of such an exceptional nature as would override the terms of the guarantee and adverse effect of such injunction on commercial dealings in the country.

That the two situations, namely, fraud and irretrievable harm, both can co-exist in some cases.

iv.            In the matter of: Bolivinter Oil SA V/s Chase Manhattan Bank, (1984) 1 All ER 351, it was observed that:

“… It is wholly exceptional case where an injunction may be granted is where it is proved that the bank knows that any demand for payment already made or which may thereafter be made will clearly be fraudulent. But the evidence must be clear both as to the fact of fraud and as to the bank’s knowledge. It would certainly not normally be sufficient that this rests on the uncorroborated statement of the customer, for irreparable damage can be done to a bank’s credit in the relatively brief time which must elapse between the granting of such an injunction and an application by the bank to have it charged.” (emphasis supplied)  

Thus, the underlying principle is that:

(1)  In order to seek restrain on invocation of irrevocable bank guarantee, the aggrieved party has to plead and show to the Hon’ble Court that the “irreparable harm” that shall occasion to it if bank guarantee is invoked is genuine and immediate, and not merely speculative.

(2)  While egregious fraud is one of the two grounds on which invocation of an unconditional bank guarantee may be injuncted, the contours of the second ground, of irretrievable/ irreparable injury, are somewhat elastic. 

(3)  Every case has to be decided with reference to the facts of the case involved therein. (Gangotri Enterprises Ltd. V/s Union of India, (2016) 11 SCC 720)

Six principles governing injuncting of invocation of unconditional bank guarantee:

In the matter of: Himadri Chemicals Industries Ltd. V/s Coal Tar Refining Co., (2007) 8 SCC 110, it was observed that:

i.               While dealing with an application for injunction in the course of commercial dealings, and when an unconditional bank guarantee or letter of credit is given or accepted, the beneficiary is entitled to realize such a bank guarantee or a letter of credit in terms thereof irrespective of any pending disputes relating to the terms of the contract.

ii.             The bank giving unconditional guarantee is bound to honour 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 realization of a bank guarantee or a letter of credit.

iv.            Since a bank guarantee or a letter of credit is an independent and 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.

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.

Restrain on invocation of bank guarantee: Additional ground of “Special Equities”

“Irretrievable injustice” and “special equities” are distinct circumstances which enable exercise of restrain on invocation of bank guarantee. In the matter of: Standard Chartered Bank Ltd. V/s Heavy Engineering Corporation Ltd, 2019 SCC Online SC 1638, it was held that:

“… The 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 honour 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.” (emphasis supplied)

In the matter of: Halliburton Offshore Services Inc V/s Vedanta Limited & Anr, OMP (I) (COMM) & I.A. 3697/ 2020, High Court of Delhi (Date of Decision: 20.04.2020), it was observed that:

“… It is significant, however, that, where the earlier understanding of the expression “special equities”, as a circumstance in which invocation of bank guarantees could be inducted, was that such equities were limited to cases where irretrievable injustice resulted, the recent decision in Standard Chartered Bank Ltd, 2019 SCC Online SC 1638, seems to visualize irretrievable injustice, and special equities, as distinct circumstances, the existence of either of which would justify an order of injunction. Viewed any which way, there appears to be no gainsaying the proposition that, where “special equities” exist, the court is empowered, in a given set of facts and circumstances, to injunct invocation, or encashment, of a bank guarantee.” (emphasis added)

“Covid-19 Lockdown” is a force majeure event:

Prior to the decision in the matter of: Taylor V/s Caldwell, (1863) 3 B&S 826: 122 ER 309, the law in England was extremely rigid. A contract had to be performed, notwithstanding the fact that it had become impossible of performance, owing to some unforeseen event, after it was made, which was not the fault of either of the parties to the contract. This rigidity of the Common Law in which the absolute sanctity of contract was upheld was loosened somewhat by the decision in Taylor (Supra), in which it was held that if some unforeseen event occurs during the performance of a contract which makes it impossible of performance, in the sense that the fundamental basis of the contract goes, it need not be further performed, as insisting upon such performance would be unjust.

Section 56 of the Indian Contract Act, 1872 (hereinafter referred to as the ICA) states that:

i.               The first paragraph of Section 56 of the ICA provides that an agreement to do an act impossible in itself is void.

ii.             The second paragraph of Section 56 of the ICA provides that a contract to do an act becomes unenforceable if the performance of the act becomes impossible or unlawful. 

iii.            The third paragraph of Section 56 of the ICA places a liability upon a promisor to compensate the promisee for non-performance of the promise, where the promisor knew, or with reasonable diligence might have known, and the promisee did not know, that the act promised by the promisor was impossible or unlawful. 

That holding “Covid-19 Lockdown” as a force majeure event, in the matter of Halliburton Offshore Services Inc (Supra), it was observed that:

“… The countrywide lockdown, which came into place on 24th March, 2020 was, in my opinion, prima facie in the nature of force majeure. Such a lockdown is unprecedented, and was incapable of having been predicted either by the respondent or by the petitioner.”

However, it is important to take note of the following five point observation made by the Hon’ble Supreme Court of India in the matter of: Energy Watchdog V/s CERC & Ors, (2017) 14 SCC 80, observing that a “force majeure” clause in a contract prevails upon the statutory scheme contained in Section 56 of the ICA. It was held that:

i.               If a contract has an express or implied “force majeure” clause, then it will prevail upon the statutory mandate contained in Section 56 of the ICA.

ii.             Application of the doctrine of frustration of contract must always be within narrow limits.

iii.            A rise in cost, price or expense will not as a rule of thumb, frustrate a contract.

iv.            Doctrine of frustration of contract will not come into operation until the fundamental basis of the contract remain the same or unchanged.

v.              A “force majeure” clause in a contract will not apply if alternate modes of performance are available.

Endnote:

The answers to the questions of law formulated above are as follows:

(1)   “Covid-19 Lockdown” is a force majeure event, provided the force majeure clause in the contract stipulates it to be so. Principles contained in Section 56 of the ICA can be applied even in absence of a force majeure clause in a contract.

(2)   “Covid-19 Lockdown” can be perceived as a circumstance granting “special equities” to a party furnishing bank guarantee, enabling it to seek injunction to restrain the beneficiary of the bank guarantee from invoking it.

(3)  The ground of “special equities” is not a sub-set of the ground “irretrievable harm or injustice” available for seeking restrain on invocation of bank guarantee.

Excursus:

In the matter of: Standard Retail (P) Ltd. V/s M/s. G.S. Global Corporation, Commercial Arbitration Petition (L) No. 404/ 2020 (Date of Decision: 08.04.2020), the High Court of Bombay refused to grant injunction albeit the invocation of bank guarantee stating that “Covid-19 Lockdown” did not amount to force majeure, as distribution of steel is an essential service under Section 2 (1) (a) (xii) of the Essential Services Maintenance Act, 1981, and therefore, there were no restrictions on its movement.

After the judgment in the matter of Halliburton Offshore Services Inc (Supra), the Hon’ble High Court of Delhi in the matter of: Indirajth Power Private Limited V/s Union of India & Ors, W.P. (C) No. 2957/ 2020 (C.M. No. 10268-70/ 2020), Date of Decision: 28.04.2020, refrained from injuncting the invocation of the bank guarantee by the Union Government, with regard to a mining project in Maharashtra. In this case the Petitioner was in non-compliance of the project milestones since April/June, 2018, and despite an extension of 12 months that was granted in its favour, the Petitioner remained non-compliant. As a result, the lockdown was merely an excuse for the Petitioner to seek restraining of the invocation of the bank guarantees and the exception of “special equities” was not extended to it.

*An Imprint of Lex Unified (Shivam Goel, Co-Founder)