Critical Analysis of Bank Guarantee with Respect to Hindustan Steel Works Corp Vs Tarapore & Co. (1996)
ABSTRACT
A reliable source is required to safeguard and lower the risks in business transactions as globalisation draws near and we see increase in both domestic and international trade. In order to accomplish the original goal of a guarantee, which was to provide security for payments or for our claims, a new type of distinctive institution must be created in the contemporary economic climate, where parties conduct business on a global scale and independently of one another. This directly inspired the concept of a bank guarantee. Bank guarantees are seen as the “life-blood” of both domestic and international trade. When a bank provides a conditional guarantee, the beneficiary is prohibited from using the guarantee on their own initiative. Depending on the particulars of the case, the court can order an injunction that prevents the assurance from being enforced. A conditional bank guarantee must be utilised exactly as specified under the terms under which it was made available. In the course of its examination, the article defines bank guarantees in accordance with the Indian Contract Act of 1872[1], including a few examples to aid comprehension. In addition to this, I will investigate the significance of bank guarantees and the impact that Covid-19 will have on them. The potential of an injunction being granted against the provision of bank guarantees will also be addressed in this research paper. In addition to that, this essay will shed light on a number of rules and laws that pertain to bank guarantees.
INTRODUCTION
According to Section 126 of the Indian Contract Act, 1872[2], a contract to execute the promise or release the responsibility of a third party in the event of that person’s violation or failure is referred to as a guarantee. Bank guarantees play an incredibly essential role in the expansion of businesses and the creation of new businesses.
In case customer fails to live up to his obligations, the bank will either pay the beneficiary the agreed-upon sum of money or make the necessary arrangements for the customer to be able to meet his obligations. This kind of agreement involves three parties. In essence, it serves as a guarantee from the bank for the uninterrupted flow of commercial activity and allows the creditor the ability to collect debt in the event of failure without having to go through a drawn-out judicial process. There is a wide variety of structures that can be utilised for direct or indirect bank guarantees. People typically use direct guarantees for international and worldwide transactions because they are less formal and, as a result, are simpler to adapt to the legal systems and norms of other countries.
This is especially true of cross-border and global transactions. Bank guarantees have been a crucial component for affluent businessmen and businesses to secure their large investments and commercial activities throughout the past many decades. Yet, it has on occasion been the subject of legal challenges over the grounds for the injunction and the nature of the order.
MEANING, NATURE AND IMPORTANCE OF A GUARANTEE AND BANK GUARANTEE
The employment of devices that safeguard payments is often required in the current business environment, which is characterized by physical distance and the incapacity of the parties to a financial contract to conduct an accurate assessment of the trustworthiness of a business partner. This is due to the parties’ incapacity to undertake a reliable evaluation of a business partner’s dependability. The payment of cash in a business transaction is currently insured by a legal instrument called a “bank guarantee.” The approach was developed in recent times. A “contract of guarantee” is defined by the Indian Contract Act (ICA), 1872[3] as a contract to carry out a third party’s promise or release them from their obligation in the event of their default. Similarly, a bank guarantee is a unilateral legal agreement in which the bank promises to guarantee payment of the guarantee’s beneficiary in the event that the original contract’s debtor breaches any of its obligations. The majority of the time, banks are contacted since they are the only organizations with the resources required to fulfil such obligations. It protects the creditor from harm and grants the creditor the right to debt recovery in the event of default without requiring the creditor to go through a drawn-out legal procedure. This is referred to as a bank guarantee for free commerce.
NEED OF BANK GUARANTEE
A bank guarantee is frequently offered as a method for mitigating the risks associated with a transaction. Bank guarantees enabled the launch of a large number of successful new businesses; but, businesses can also be started with very little initial capital investment. People who want to start enterprises but don’t have a lot of money to invest are given a huge advantage by the fact that they can now get the money they need on credit with the help of a bank that acts as a surety for the loan. This presents a significant opportunity for more people. It is also possible for the creditor to make loans in the name of the bank without taking any risks, as the bank will compensate the creditor for any losses incurred in the event that the debtor is unable to pay. The bank guarantee is one of the reliable sources in the commercial world that helps to reduce the risk involved in dealing with other businesses. In addition to the protection afforded to the vendor, the bank guarantee will also cover any payments or advances made by the purchaser.
TYPES OF BANK GUARANTEE
On the basis of issuance:
1. Direct Bank Guarantee
A Direct Bank Guarantee is one in which the account holder requests a guarantee from the bank on behalf of the beneficiary. Direct Bank Guarantee doesn’t really rely on the main obligation’s existence, legality, or enforceability.
2. Indirect Bank Guarantee
An Indirect Bank Guarantee is one that is issued in exchange for a Direct Bank Guarantee by another bank. In such circumstances, the issuing bank will ensure that it covers all losses if the second bank incurs them as a result of a claim made against a guarantee.
On the basis of the type of performance by the bank as per the guarantee:
1. Financial Bank Guarantee
A Financial Bank Guarantee ensures repayment of funds in the event that the party does not carry out a specific project or operation entirely. The bank will pay when a project isn’t finished on time in accordance with the financial guarantee agreement
2. Advance Payment Bank Guarantee
If the party (debtor) does not fulfil its contractual obligations after getting an advance, the bank is obligated under this guarantee to repay the advance.
3. Deferred Payment Bank Guarantee
Deferred Payment Bank Guarantee is made available to the beneficiary for a predetermined or deferred period of time. In the event that the debtor is unable to fulfil their contractual commitments, the bank will often pay the amount in instalments under the terms of this guarantee.
4. Performance Bank Guarantee
This guarantee ensures that services will be provided as agreed upon and that items will be delivered on time. In the event of any delay in the provision of services or the fulfilment of the contract, the bank shall provide financial compensation.
INVOCATION OF BANK GUARANTEES
The beneficiary shall use the Bank Guarantee in accordance with the provisions of the Contract and on or before the expiration date of the Bank Guarantee. Because the issuing bank is required to uphold and implement the guarantee’s terms, a recipient cannot be barred from relying on the guarantee. This makes it impossible for the beneficiary to be prevented from relying on the guarantee. The bank will be relieved of its obligation under the guarantee if no claims are made before or during the validity period specified in the guarantee’s conditions. The conclusion of the validity period will mark the beginning of this release.
Since unconditional bank guarantees are “irrevocable,” they cannot be the subject of injunctions. The bank guarantees are distinct from one another and stand alone. They are unrelated to the primary problem, and as a result, it is impossible to terminate the unconditional bank guarantees while the primary dispute is still being worked out.
SITUATIONS IN WHICH A RESTRAINING ORDER CAN BE ISSUEDTO AVOID THE BANK GUARANTEES BEING WITHDRAWN
In the case of Reliance Salt Ltd. v. Cosmos Enterprises[4], the supreme court cited Section 17 of the Indian Contract Act, 1872[5], and stated that any action made by one party to trick another into entering into the contract against their will constitutes fraud. The supreme court ruled in Up State Sugar Corp. v. Sumac International Ltd[6]. that fraud should ‘vitiate the fundamental foundation of bank guarantees’ when it comes to unconditional bank guarantees. In the decision of General Electric Technical Services Co. Ltd. vs. Punj Sons Ltd.,[7]The SupremeCourt further determined that fraud could only be committed by the recipient and had to be “egregious in nature.”In Hindustan Steelworks Construction Ltd. vs. Tarapore & Co.,[8] the court also rejected the notion that the deceit had to be flagrant and compromise the integrity of the entire underlying transaction. The utilization of the bank guarantees may result in irreparable loss or unfair gain to one of the contracting parties. In the case of Klenn & Marshall Manufacturers v. Reserve Bank of India[9],regarding bank guarantees, the highest court considered the ideas of unjust enrichment and irreparable harm to a party. In the case of Himadri Chemicals v. Coal Tar Refining Co[10], the exception of irreversible loss or unfairness if such encashments of bank guarantees are authorized was created by the court, which contributed to the restoration of the concept.
To support a court order requiring the issuance of bank guarantees, special equities must also be connected to irreparable injury or injustice. Svenska Handelbaken v. Indian Charge Chrome[11] was the case in which this was decided. Itek Corp. v. First National Bank of Boston[12] is an American case that the court relied in this instance. Whereas the warlike circumstances in Iran permitted the ban on issuing bank guarantees. In the case of Dwarikesh Sugar Industries Ltd. vs. Prem Heavy Engineering Works Ltd. &Others[13], this premise was made clear.The court ruled that an injunction should only be issued where there is no hope of recovery and it will be difficult or impossible to fulfil the terms of the contract.
CRITICAL ANALYSIS OF A LANDMARK JUDGEMENT OF BANK GUARANTEE
Hindustan Steel Works Construction Limited and Tarapore and Co. & Another
FACTS OF THE CASE
Tarapore & Co. was hired by Hindustan Steel Construction Ltd. (HSCL) to perform civil work in their steel facility in Visakhapatnam. On April 25, 1984, a contract for a one-time payment of Rs. 19,21,36,804 was signed. When the work wasn’t finished by the deadline, the contractor requested additional time to finish it. However, even after getting more time, he still wasn’t able to fulfil the deadline. A disagreement developed between the sides, and after they mutually agreed to engage an arbitrator to resolve it, the parties agreed on a reduced scope of work and a fee of Rs. 4.5 crore. HSCL terminated the contract when the contractor once more failed to finish the work within the additional time allotted. During this time, HSCL received a total of 14 guarantees from Bank of India in support of HSCL for operating capital related to the Contract. These bank guarantees were provided to protect HSCL from any losses or damages the contractor might incur as a result of contract violations. When the bank provided the guarantees, it was indicated that HSCL would be the only judge to determine whether there had been a contract breach.
ISSUE RAISED
Was it appropriate for the High Court to stop the Appellant from implementing the Bank Guarantees?
RULE
The courts should only act in cases of extreme fraud or irreparable injustice, and that fulfilling Bank pledges without any intervention from the judiciary is the proper position under the law.
ARGUMENTS FROM THE PETITIONER
- Since the guarantee is enforceable and HSCL is designated as the exclusive arbitrator for determining whether a breach of contract has occurred, they may do so. However, the top court denied it, citing the UOI v. Raman Iron Factory[14]
- Shankar argued that the court did not apply the laws properly and that issue of payment should not be interfered with by the court unless there is a case of fraud or it may lead to irreparable injustice with the support of case scenarios likeand U.P. Cooperative federation Ltd. v. Singh Consultants and Engineers Ltd[15].
- The learned attorney contends that the law has been established in the case of General Electric Technical Services Inc. v. U.P. Cooperative Federation Ltd[16], which was heard by a three-judge bench, and that the courts may intervene in exceptional circumstances, such as when fraud or irreparable injustice will be committed.
ARGUMENTS FROM THE RESPONDENT
- The bank guarantees, which were stipulated for proper performance, shall become enforceable after the arbitrator has found that there has been a contract breach and the loss or damage caused by HSCL has been proven.
- While acknowledging that fraud constitutes an exception to the rule regarding judicial intervention, the learned counsel claims that the court should step in when extraordinary circumstances or particular equities are apparent.
JUDGEMENT
The earlier judgement and order were overturned by the decision made in this case. The remaining of these appeals did not receive a stay. According to the ruling, the court can only get involved in a dispute by cashing in a bank guarantee in cases of fraud and irreparable wrongdoing. The High Court erred in interfering and issuing an injunction against appellant since the case of fraud wasn’t really proved and did not warrant the court’s intervention. However, the respondent attempted to argue that the person who broke the contract was responsible due to unusual circumstances or specific equities. The courts should only get involved if there has been fraud or irreparable injustice committed by cashing in the bank guarantee, which is against the law. Until then, banks should be free from interbank involvement. Therefore, the court dismissed it by declaring that the bank guarantee cannot be cashed until the matter has been resolved through arbitration first.
LEGISLATIVE FRAMEWORK WITH RESPECT TO BANK GUARANTEE
According to Section 126 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.[17]
Section 127 discusses the consideration in a guarantee contract. According to this section “Anything done, or any promise made, for the benefit of the principal debtor, may be a sufficient consideration to the surety for giving the guarantee”.[18] In Section 128 of The Indian Contract Act, 1872’s The liability of the surety is co- extensive with that of the principal debtor, unless it is otherwise provided by the contract.[19]
Continuing guarantee is defined under Section 129 of the ICA[20]. An ongoing guarantee covers numerous transactions. It encompasses more than just one transaction. The surety under this assurance is responsible for paying the creditor for every transaction. The revocation by notice is described in Section 130 of the ICA[21]. A continuous guarantee may be revoked at any moment by the surety with the creditor being notified for future transactions.
RBI GUIDELINES FOR ENFORCING BANK GUARANTEES
Bank Guarantee Scheme of Government of India
The Bank Guarantee Scheme, developed by the Government of India, has undergone a number of modifications over the years. It allows contractors to provide bank guarantees in place of security deposits, etc., in favour of Central Government Departments. Government Departments are permitted to take guarantees and other documents from any scheduled commercial banks under the terms of the plan.Banks should utilise the Model Form of Bank Guarantee Bond. The Indian government has urged all PSUs to include bank guarantees in the Model Bond and ensure that any modifications or additions are not unilateral and done with the guaranteeing bank’s permission.[22]
As shown in the following, the banks should adhere to certain general principles with regard to their guarantee business:
1. Banks should refrain from placing an excessive emphasis on certain customer and trade groupings when making unsecured guarantee agreements.
2. The entire amount of outstanding guarantee obligations at any given moment cannot exceed 10% of the bank’s total owned resourcesw. The percentage of unsecured guarantees that may be outstanding at any given moment under the overall ceiling may not exceed 25% of the bank’s owned funds or 25% of the entire number of promises, whichever is smaller.
Banks should, as a general rule, limit their guarantee-related activities to providing money guarantees and exercise due prudence while engaging in performance guarantee operations. Providing financial guarantees is the only type of guarantee that should be provided.
In general, no bank guarantee should be issued with a tenure of more than ten years. However, if banks extend long-term loans for periods more than 10 years for specific projects, they may also provide guarantees for durations longer than 10 years. Before making such assurances, banks are recommended to think about how they will impact their asset liability management.
JUDICIAL PRECEDENTS
1. In the case of Maharashtra SEB vs Official Liquidator[23], A bank agreed to act as a guarantee on behalf of a supplier and reimburse the SEB Rs. 50,000 within 48 hours of request. The board mandated the payment. A company that filed for bankruptcy was the supplier. The bank was prevented from paying the bank and the board from realising the guarantee by the liquidator. The board, however, is permitted to demand the payments because they are delivered “On Demand” under a promise, according to the top court.
2. In UP Coop Federation Ltd. vs Singh Consultants and Engineers Ltd[24]The Supreme Court ruled that regardless of the conflict between the parties,with no objections or disputes, the bank must pay when the demand is made. The court also emphasised the need to limit unconditional bank guarantees solely in instances of fraud, irreparable injury, and particular equities.
3. In Capacite Infra Projects Ltd vs Siddha Sheka Developers[25], It was decided that the bank guarantee letter does not include the sums owed by the appellant to the respondent. The aforementioned invocation letter makes no mention of the sums. As a result, it is inappropriate to use the full Bank Guarantee for such a little sum payable and should be prohibited.
4. Due to conditions that resemble war, a restriction on the issuance of bank guarantees has been issued in other countries. In Bhel vs Egyptian Electricity Transmission Company[26], Due to the military situation in Egypt, several goods could not be produced. The Delhi High Court ruled that because the plaintiff is unable to retrieve the cash under guarantee, there would be unique equities and force majeure. If the money is cashed, the defendant will unfairly get richer.
CRITICAL ANALYSIS
The necessity for bank guarantees is mostly brought on by uncertainty and a lack of faith in the major debtor’s capacity to fulfil the obligation. In order to protect the major debtor’s creditors from fraud and to reassure the beneficiaries that the contractual obligations he is accepting will be met, bank guarantees are the surety bank’s supplemental obligations. It makes sure that the payments or execution of the contract are not in danger. In times of financial ambiguity, bank guarantees take on even greater importance as tools for business.
The prior judgement and order in Hindustan Steel Works Corp v. Tarapore & Co[27]were reversed by the decision. No stay was granted throughout the ongoing appeals. The decision states that the court cannot become involved in the dispute; instead, it can get involved by implementing the Bank Guarantee in cases of fraud and irreparable misconduct. Since there was no evidence of fraud, the High Court erred byintervening and issuing a restraining order against the appellant. This prevented the court from taking any action. On the other hand, the responder tried to make it seem as though the breach of the contract was due to exceptional circumstances or unique equities. According to the proper law, banks shouldn’t interact with other banks; the judiciary should only become involved in cases of fraud or irreparable injustice, which may be performed by cashing in a bank guarantee. The panel dismissed it as a result, finding that the bank guarantee could not be redeemed unless the dispute was settled through arbitration first.
There is no question as to the proper legal position in the case of U.P. Co-operative Federation Limited v. Singh Consultants and Engineers Ltd.[28] regarding the execution of the Bank Guarantee provided by the Bank. It is well recognized that this rule governs many commercial transactions, and breaking it would stop the flow of commerce. In certain situations, the court would have to intervene in fraud cases that might negatively impact the Bank Guarantee transaction itself and inform the financial institution of such fraudulent acts. The Beneficiaries must have carried out such fraud in these transactions, but there was none. The right to cash the entire amount or a portion of it is also granted to the Beneficiaries by a bank guarantee, regardless of whether there is a dispute over the person to whom the guarantee was made.
SUGGESTIONS
One of the less explored areas of law has historically been the restricting of the invocation of a bank guarantee. Courts in India and the common law have established stringent criteria and limits for judicial action, and they would very sometimes grant an injunction against the use of a bank guarantee. The use of a conditioned bank guarantee may generally be prohibited, according to the Indian courts, if there is a lingering dispute between the contract’s parties. On the other hand, it is generally accepted that unconditional bank guarantees should remain unchanged in the event of a challenge. Due to the fact that special equities and cases of damage or injury are both notions that are constantly evolving, the courts need to be more lenient in the situations where they arise. Not just in cases involving fraud but also in any other circumstance in which there are insufficient other remedies available, injunctions ought to be granted.
CONCLUSION
Bank Guarantees have shown to be a significant benefit in the present corporate environment. Big businessmen and businesses rely on bank guarantees to safeguard their substantial investments and transactions. The contractual duty that exists between the bank and the creditor is not affected in any way by the bank’s provision of bank guarantees, which are separate contracts between the bank and the creditor. However, it has been the focus of legal arguments over both its character and the prohibition against delivering them. The analysis in the paper demonstrates their important contribution to the free flow of both domestic and international trade. Bank guarantees are required since numerous industries from various nations enter into high-stakes commercial contracts, reducing the risks associated with their investments. The reasons for the exemption remain obscure since there are fewer courts and they do not all consistently base their rulings on the same criteria. Special equities provide relief for parties that, through no fault of their own, are unable to carry out their obligations as a result of uncontrollable circumstances, such as war, political unrest, etc. However, given the COVID-19 pandemic’s numerous concerns raised by the courts, its status is still uncertain. Bank guarantees are recognized as a reliable source of money collection by the business sector.
[1] Indian Contract Act,1872
[2]Section 126 of the Indian Contract Act,1872
[3]Indian Contract Act,1872
[4]Reliance Salt Ltd. v. Cosmos Enterprises (2006) 13 SCC 599
[5]Section 17 of the Indian Contract Act,1872
[6]Up State Sugar Corp. v. Sumac International Ltd (1997) 1 SCC 568
[7]General Electric Technical Services Co. Ltd. v. Punj Sons Ltd. (1991) 4 SCC 230
[8]Hindustan Steelworks Construction Ltd. v. Tarapore & Co. (1999) 8 SCC 436
[9]Klenn & Marshall Manufacturers v. Reserve Bank of India 1999 (50) DRJ 163
[10]Himadri Chemicals Industries Limited v. Coal Tar Refining Co., (2007) 8 SCC 110
[11]Svenska Handelsbanken v. Indian Charge Chrome, (1994) 1 SCC 502
[12]Itek Corp. v. First National Bank of Boston (1997) 1 SCC 568
[13]Dwarikesh Sugar Industries Ltd. v. Prem Heavy Engineering Works (P) Ltd. (1997) 6 SCC 450
[14]UOI v. Raman Iron Factory,1974 AIR 1265
[15]U. P. Cooperative Federation Ltd v. Singh Consultants and Engineers (P) Ltd. [(1988) 1 SCC 174]
[16]General Electric Technical Services Inc. v. U.P. Cooperative Federation Ltd 1988 AIR 2239
[17]Section 126 of The Indian Contract Act,1872
[18]Section 127 of The Indian Contract Act,1872
[19]Section 128 of The Indian Contract Act,1872
[20]Section 129 of The Indian Contract Act,1872
[21]Section 130 of The Indian Contract Act,1872
[22]RBI – Master Circular – Guarantees and Co-acceptances https://taxguru.in/rbi/rbi-master-circular-guarantees-coacceptances.html. (last visited April. 7, 2023)
[23]Maharashtra SEB vs Official Liquidator 1982 AIR 1947
[24]UP Coop Federation Ltd. vs Singh Consultants and Engineers Ltd 1988 AIR 2239
[25]Capacite Infra Projects Ltd vs Siddha Sheka Developers COMAP. No.53 OF 2021
[26]Bhel vs Egyptian Electricity Transmission Company 270 (2020) DLT 201
[27]Hindustan Steelworks Construction Ltd. vs. Tarapore & Co. (1999) 8 SCC 436
[28]UP Coop Federation Ltd. vs Singh Consultants and Engineers Ltd 1988 AIR 2239
Author Bio
Article is nicely presented. Some points are missing.
1. About counter guarantee, no points were given in the article. Counter guarantee will be obtained by banks or financial institutions in order to put the contract in writing.
2. About the cases in bank guarantees, each case is unique and the underlying issues are critical fo solving the issues. for example: a High Net worth customer was given a performance guarantee. The beneficiary company demanded payment from Bank saying the performance of the contractor is not as per provisions of the contact. On the other hand Customer to whom guaranatee was given pleads with bank they have performed as per provisions of the contract and differs with the views of beneficiary. He also puts pressure on Bank not to pay the amount to beneficiary. If the bank pays, customer will be aggrieved and there is a chance of break of relationship which results in unhappy situations like closing of deposits etc. If not paid beneficiary issues legal notice. Even if beneficiary was paid by bank, customer will not keep up his promise as per counter guarantee given by him to bank which results in NPA.
3. The case mentioned is a practical one and good to understand for beginners.
4. The Banking Law, Theory and Practice are three edges of the sword hanging above the Manger’s head.
Lot to be discussed. but not possible in this forum. I am a retired Manager and Auditor conducting audits
5. Last but not the least Bank’s show lethargy in filling Counter Guarantee and obtaining discharge on Deposit offered for margin or non extension of Collateral securities offered for a loan or cash credit account.
My observation as an auditor is bank staff are not following guideline’s by their Head Office and RBI in letter and spirit. A Casual approach was observed during audits.
NISHTALA AGNIHOTHRA SARMA
Retired Manager and Concurrent Auditor
[email protected]