What Are The Basic Principles Relating To Bank Guarantees, Their Invocation & Interdiction? Delhi High Court Answers

The Delhi High Court has settled down the basic principles relating to bank guarantees, their invocation and the interdiction of such invocation.

While observing that commercial contracts often contain clauses requiring the contractor to furnish bank guarantees, Justice C Hari Shankar said that such bank guarantees are either bank guarantees provided towards security for having been awarded the contract, or performance bank guarantees to guarantee performance of the contract, though, on occasion, other bank guarantees such as bank guarantees towards mobilization advance etc. may also be required to be provided.

The Court added that the contract, in such cases, also provides for the circumstances in which the bank guarantees could be invoked, as well as the purpose for requiring the bank guarantees to be provided in the first place.

The Court also set laid down the following principles:

- No bank guarantees payment to anyone gratis. Every bank guarantee is of necessity issued by a bank on instructions. In case of a commercial contract, the instruction to the bank, to provide a bank guarantee, is given by the person to whom the contract is awarded.

- The party to whom the contract is awarded, in other words, instructs the bank, in lieu of having been awarded the contract, to issue a bank guarantee in favour of the person awarding the contract.

- Like all independent commercial contracts, every bank guarantee has to abide strictly by its terms. Honour and compliance of a bank guarantee, as per its terms, is, therefore, mandatory. In the case of bank guarantees, especially, the Supreme Court has stressed this aspect, as there is an overwhelming element of public interest involved in requiring banks to honor their commitments towards customers and clients. If a bank is to be interdicted, at the instance of a third party, who is a stranger to the bank guarantee between the bank and the beneficiary, from honouring the bank guarantee, the Supreme Court has held in United Commercial Bank v. Bank of India and Hindustan Steelworks Construction Ltd. v. Tarapore & Co, that it would erode the public faith in the banking institution of the country.

- The bank is, therefore, concerned only with the terms of the bank guarantee. The elements of any dispute between the contractor and the beneficiary of the bank guarantee, or the conditions existing in the contract between the contract awardee and the beneficiary of the bank guarantee.

- In order for the aspect of performance, or failure of performance, of the parent contract, by either party, to become relevant as a consideration for invocation of the bank guarantee, they have necessarily to be incorporated by express reference in the bank guarantee itself. In other words, if the bank guarantee were to stipulate that the bank would be required to make payment to the beneficiary only in the event of failure, on the part of the contract awardee, to abide by its obligations under the Contract, then the aspect of performance of the contract by the contract awardee would become a relevant consideration, while assessing the obligation of the bank to make payment to the beneficiary.

- Similarly, oftentimes, a contract may stipulate the particular stage at which, or exigency in which, the bank guarantee could be invoked by the beneficiary. Such a stipulation in the contract would, however, become relevant for the bank, when called upon by the beneficiary to honour the bank guarantee, only if that stipulation figures expressly in the body of the bank guarantee itself.

- Else, the bank is not expected, much less required, to advert to the covenants of the original contract between the contract awardee and the beneficiary, to which the bank is a stranger – just as the contract awardee is a stranger to the bank guarantee. Nor is it required to enter into the disputes between the contract awardee and the beneficiary of the bank guarantee, or into the aspect of performance, or non-performance, of the contract. Nor, for that matter, is the bank entitled to examine whether the stage at which the contract between the parties envisages invocation, or enforcement, of the bank guarantee, has, or has not, been reached. The bank, being a stranger to the contract between the contract awardee and the beneficiary of the bank guarantee, has no authority to probe into the said contract, unless the terms of the bank guarantee expressly require it to do so. The bank has necessarily to be concerned only with the terms of the bank guarantee, to which alone it is a party.

- If the invocation of the bank guarantee by the beneficiary thereof is, therefore, in terms of the bank guarantee, the Court cannot interdict the bank from honouring the bank guarantee, by referring to the covenants in the contract between the contract awardee and the beneficiary of the bank guarantee. Any such attempt by the Court would amount to directing the bank to violate the contract, with the beneficiary of the bank guarantee, to which it is a party and, therefore, to direct the bank to commit an illegality. This, quite obviously, is completely impermissible.

- Equally, it is not permissible, either, for the Court to interdict the invocation of a bank guarantee on the ground that the stage for such invocation, as per the contract, has not been reached, or that the exigency in which the bank guarantee could be invoked as per the contract, does not exist, unless that stage, or that the exigency, is incorporated as a condition for invocation in the bank guarantee itself.

- Interdiction of invocation of unconditional bank guarantees would be justified, where the invocation is otherwise in terms of the covenants in the bank guarantees, only where there is found to exist egregious fraud, or special equities, or where irretrievable injustice would ensue were invocation not to be injuncted.

At the outset, the Court was of the view that it is necessary to distinguish between recitals in a bank guarantee which set out the purpose for issuing the bank guarantee and recitals which set out the conditions for invoking the bank guarantee.

"Bank guarantees issued in compliance with the requirements in commercial contracts often set out, in their preambular or opening recitals, the fact that they are being furnished to ensure performance of the contract by the contractor/contract awardee. That recital, by itself, does not make performance of the contract by the contract awardee, a condition for invocation of the bank guarantee. A bank guarantee has, therefore, to be carefully read in order to understand the exact governing condition in which the bank guarantee would become invocable, and in which the bank would be obligated to honor the bank guarantee," the Court observed.

The facts of the matter was that Hindustan Prefab Limited (HPL) had invited tenders from interested bidders for construction activities to be carried out at various locations in the country. With respect to three of the tenders thus floated, petitioner Garg Builders was the successful bidder.

Tenders were awarded to the petitioner, by HPL, for carrying out of construction activities at Ghaziabad, Uttar Pradesh, Raipur, Chhattisgarh and Asansol, West Bengal vide Letters of Award dated 3rd March, 2016, 9th January, 2017 and 4th August, 2018, followed by agreements dated 21st March, 2016, 25th January, 2017 and 25th September, 2018 respectively.

Each of these Agreements required the petitioner to provide Bank Guarantees towards security deposit as well as Performance Bank Guarantee (PBGs). Bank Guarantees, as so required, were undisputedly furnished by the petitioner to HPL. All the Bank Guarantees were issued by HDFC Bank Ltd.

Therefore, three pleas were filed in the matter with similar relief. In each of the cases, the petitioner had averred that HPL had written to the Bank on 1st July, 2021, invoking the Bank Guarantees furnished by the petitioner, and calling upon the Bank to credit the amount secured by the Bank Guarantees into HPL's account. The petitioner had sought a restraint against such invocation, pending resolution of the disputes between the petitioner and HPL by arbitration.

The Court noted that it was yet another case in which valuable judicial time was expended in dealing with a prayer for a restraint against invocation of "unconditional" and irrevocable bank guarantees.

The Court noted that the bank guarantee dated 17th December, 2016, merely required HPL to demand, of the bank, the amount governed by the bank guarantee and the bank would become immediately liable to transmit the amount to HPL.

"The remaining three bank guarantees are a trifle more specific, in requiring the demand from HPL to state that the amount claimed was required to meet the recoveries due or likely to be due from the petitioner. Once such a demand, with such a statement, is made by HPL, the demand is conclusive regarding the amount covered thereby and operates proprio vigore, rendering the bank liable to honour the bank guarantee and to pay, to HPL, the amount covered by the bank guarantee, as demanded by it. All the four bank guarantees are equally categorical in stipulating that the demand by HPL would be conclusive regarding the liability of the bank, notwithstanding any dispute raised by the contractor, i.e. the petitioner," the Court observed.

Applying the principles to the facts of the case, the Court said that no case existed for interdicting invocation of the subject bank guarantees, consequent on the letter of invocation dated 1st July, 2021, issued by HPL to the bank. The Court observed that once HPL made the requisite statement in terms of the concerned clauses in the bank guarantees, the matter had to address there.

"Subsequently, if it was found that the statement was incorrect-as the petitioner would seek to contend-the remedy with the petitioner would be to seek restitution in the substantive arbitral proceedings. There are several ways in which this can be done, and it is not for this Court to offer any suggestion in that regard. Suffice it to state that no case for restraining invocation of the bank guarantees, as having been invoked contrary to the terms of the bank guarantees, can be said to exist," it added.

"Egregious fraud, in any case, as already noted, would have had to vitiate the bank guarantees themselves, in order for it to be pleaded as a ground to restrain invocation. The bank guarantees having been issued by the bank at the instance of the petitioner and as required by the covenants of the agreement, it cannot be said that the bank guarantees were fundamentally vitiated on the ground of egregious fraud."

Accordingly, the Court dismissed all the three pleas, clarifying that the decision was limited to the aspect of the prayer for stay of invocation of the Bank Guarantees.

"It shall not operate as a restraint on the petitioner seeking any other remedy under Section 9 of the 1996 Act before the learned Arbitral Tribunal. Any such application if made shall be considered by the learned Arbitral Tribunal on its own merits," the Court added.

Case Title: M/S GARG BUILDERS THROUGH SHRI MOHINDER PAL GARG v. HINDUSTAN PREFAB LTD. AND ANR

Citation: 2022 LiveLaw (Del) 406

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