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Banking Coronavirus

COVID Pandemic, Bank Guarantees, and Special Equity: Desperate Measures For Troubled Times

By Shivanakar Sukul and Mudit Burad 

The recent Covid-19 pandemic has tremendously altered the dynamics in which commercial contracts operate. In such desperate times when the business machinery of the nation has been brought to a grinding halt, several parties are not able to honour their end of the contract. Consequently, the creditors or the beneficiaries seek to enforce bank guarantees or letters of credit anticipating non-performance of the contract.

In this background, it becomes pertinent for us to analyse the law relating to bank guarantees and the circumstances under which it can be invoked, or an injunction can be granted against its invocation.

What is a bank guarantee?

A bank guarantee is a tripartite agreement usually between buyer, seller, and a bank. In this system, the bank where the buyer has an account, guarantees payment on behalf of the buyer, in case the buyer fails to pay on the due date. The bank then reimburses itself from the account of the buyer.

Bank guarantee can be conditional as well as unconditional. Usually, unconditional bank guarantees are preferred by the parties as a risk-mitigating instrument over conditional bank guarantees because of their absolute nature. Courts usually place unconditional bank guarantees on a sacrosanct position, hence, whenever the bank guarantee is presented for encashment they are mandated to promptly honour it irrespective of the disputes which may arise in the underlying contract.[1] Courts have time again reasoned that bank guarantees are to be considered as a “separate contract” and hence the beneficiary is merely required to conform to the stipulations such as producing the mentioned documents inter alia for claiming encashment.[2] The reason behind  such a nature is for  the maintenance of the credibility of  bank guarantees as instruments.

What are the grounds on which the injunction against encashment of bank guarantees can be given?

The judiciary in several instances  has taken the stance that bank guarantees are critical for reposing trust in international trade; thus they must be honoured without court interference.[3] Hence, the courts are usually cautious in granting an injunction against the encashment of bank guarantees.[4] Bank guarantee is payable on demand except in two cases.

First, where there is a prima facie case of fraud by the beneficiary.[5] The nature of fraud which can form the basis of granting an injunction against the encashment must be of “egregious nature” so as to vitiate the entire underlying contract and the bank must have  knowledge of the same[6] Moreover the onus for substantiating the allegation of fraud must rest on the applicant praying for grant of an injunction.[7]

The second exception is created when invoking the bank guarantee would lead to irreparable and immediate harm or injustice to any of the parties.[8] One of the few exceptional instances when this plea was accepted by the US Court of Appeals was in the matters of Itek Corporation v. First National Bank of Boston [9].

In this case, an exporter in the USA entered into an agreement with the Imperial Government of Iran for the export of certain goods. The contract was rendered impossible on account of the situation created after the Iranian revolution when the American Government cancelled the export licenses in relation to Iran. Fearing the cancellation of the contract, the Iran govt. applied for encashment of the bank guarantees which was opposed by the exporter on the ground that it would cause “irreparable” harm to it. The court observed that the exporter can claim “irreparable harm” and warrant an injunction only if it has no adequate remedy at law to reclaim the money. The court reasoned that since the contract stipulated that the disputes between the parties shall be adjudicated by the courts in Iran and in the background of the relations between US and Iran, any suit for reclaiming the guaranteed money in the courts of Iran would be futile. Hence it came to the conclusion that injunction should be granted on the ground that no adequate remedy lied for the exporter to get back his amounts in case the encashment were to be allowed.  

While these exceptions were created, the Supreme Court in Gangotri Enterprises v. Union of India opined that an injunction can be granted against the encashment of bank guarantee when demand is not done as per the conditions or the terms contained in the bank guarantee document. [10]

The Recent COVID Pandemic and Special Equity

The recent pandemic has brought the issue of invocation of Bank Guarantee yet again in the centre of storm with the moot question being whether the recently imposed lockdown be considered to be a ground for granting an injunction against encashment of bank guarantees. The issue has been complicated by the divergent decisions of Delhi HC and Bombay HC in this context. In the matters of Halliburton Services v. Vedanta Ltd, the Delhi HC granted an ad-interim injunction to the petitioner ruling that the lockdown imposed by the government constitutes special equity calling for an injunction on the invocation of bank guarantee. Whereas Bombay HC in the matters of Standard Retail Pvt. Ltd. v. G.S Global Corps gave a conflicting opinion holding that the current circumstances do not require granting of injunction on the ground of special equity. While Bombay HC dealt with an agreement relating to an essential commodity that could have been performed even during the lockdown, hence its decision was in line with the established principles. Hence, we will analyse the Delhi HC decision in the light of the settled law.

Halliburton Services v. Vedanta Ltd.: Delhi HC’s Take on “irreparable damage” and “special equities”

The  Petitioner entered into a contract for the development of three petroleum fields under which several bank guarantees were furnished from the petitioner for the performance of the contract which formed the subject matter of the issue . Due to the recently imposed lockdown, all the industrial and commercial activities were brought to a grinding halt and rendered the petitioner incapable of performing the contract. The respondent communicated to the petitioner that he reserved the right to terminate the contract and take alternate recourse available in the contract. Hence the petitioner approached the court for an injunction on the encashment of bank guarantee.

The court while granting the same reiterated that “special equities” can be a ground for granting an injunction against the invocation of bank guarantee relying on Standard Chartered Bank Ltd. v. Heavy Engineering Corporation Ltd [11]  and the  Itek Corporation case where the US Appellate Court provided that an injunction can be granted only when encashment of the guarantee would cause irreparable harm to the petitioner. The court was of the opinion that the recent COVID pandemic necessitates judicial intervention as it created circumstances of special equity.

 While doing so the court glossed over the interpretation of the “irreparable damage” given by the US Courts and Indian courts alike in a catena of decisions such as the Itek Corporation case [12], Svenska Handelsbanken v Indian Charge Chrome [13]and Dwarikesh Sugar Industries Ltd. v. Prem Heavy Engineering Works Ltd. [14] where the court held that the exception of “special equity” must be applied only when there is no adequate remedy available to the petitioner.  However, in the given facts and circumstances the petitioner had the option of claiming the amount of bank guarantee as arbitration proceedings were already underway.

Hence, the Delhi HC clearly bypassed the established principles when it observed that this pandemic situation would still cause “irretrievable damage” to the petitioner even if the petitioner would be able to recover the money back after succeeding in the arbitration. Hence the judgement of Delhi HC is contrary to the settled law on this point.

Conclusion

As the lockdown is in place right now, the production of goods and services is on halt. Therefore, it is almost impossible for most of the businesses to honour their part of the contract due to no fault of their own. As explained above though, the settled principles of law and precedents do not come to our rescue but there’s no denying that in such desperate times encashment would be counterproductive for both the banking sector and businesses. In such times when the economy is in desperate need of liquidity and RBI is trying to boost liquidity in order to incentivize lending in the post-COVID economy, the encashment of bank guarantees is counterproductive due to their effect of reducing the credit capacities of banking institutions.[15]

Such a moratorium will also reduce the risk to MSMEs which are struggling to complete contractual obligations due to the lockdown and non-availability of labour. Similar measures have already been announced by the UAE when it declared to exempt startups from paying performance guarantees for projects up to 500,000 AED’s and refunding the bank guarantees which were taken for custom clearance.

Hence, rather than courts giving ambiguous interpretations to the settled law, RBI should step up and announce a moratorium on encashment of bank guarantee in order to pump liquidity in the banking sector and safeguard the interests of MSME Sector.

The authors are second year students, pursuing their law degree from the National Law University, Jodhpur.


[1] Prashant Saran, Master Circular on Guarantees and Co-acceptances, (18th May, 2020, 3:14 AM) https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=1786&Mode=0.

[2] RD Harbottle and Standard Chartered Bank v. Heavy Engineering Corporation (2019) SCC Online 1638.

[3] Svenska Handelsbanken v. M/s. Indian Charge Chrome. (1994) 2 SCC 155; Standard Chartered Bank Limited v. Heavy Engineering Corporation Limited (2019) SCC Online 1638.

[4] Mahatma Gandhi Sahakra Sakkare v. National Heavy Engineering Coop. (2007) 6 SCC 470.

[5] U.P. Co-Op. Federation Ltd. v. Singh Consultants & Ers. Pvt. Ltd, (1998) 1 SCC 174.

[6] U.P. Co-Op. Federation Ltd. v. Singh Consultants & Ers. Pvt. Ltd, (1998) 1 SCC 174.

[7] Svenska Handelsbanken v. M/s. Indian Charge Chrome. (1994) 2 SCC 155.

[8] Itek Corpn. v. First National Bank of Boston, 566 FED Supp. 1210, at 1217 quoted in Svenska Handelsbanken v. M/s. Indian Charge Chrome. (1994) 2 SCC 155, at 507; Himadri Chemicals Industries Ltd. also in Standard Chartered Bank Limited v. Heavy Engineering Corporation Limited (2019) SCC Online 1638 at 23.

[9] Itek Corporation v. First National Bank of Boston 566 FED Supp. 1210.

[10] Gangotri Enterprises v. Union of India. (1994) 6 SCC 77.

[11] Standard Chartered Bank Limited vs. Heavy Engineering Corporation Limited (2019) SCC Online 1638.

[12] Itek Corporation v. First National Bank of Boston 566 FED Supp. 1210.

[13] Svenska Handelsbanken v. M/s. Indian Charge Chrome. (1994) 2 SCC 155.

[14] Dwarikesh Sugar Industries Ltd. v. Prem Heavy Engineering Works Ltd (1997) 6 SCC 450.

[15] Swati Bhat, RBI surprises with reverse repo rate cut in bid to spur bank lending (20th May, 2020, 3:14 AM), https://in.reuters.com/article/health-coronavirus-india-rbi/rbi-surprises-with-reverse-repo-rate-cut-in-bid-to-spur-bank-lending-idINKBN21Z0JQ; Abdulwahid Alulama, Sami E. Al-Louzi, Marcus Booth and Ali Shaikley,COVID-19: UAE’s Government Financial Assistance Measures (20th May, 2020, 3:14 AM), https://www.lexology.com/library/detail.aspx?g=3a84f530-4873-40f0-b7de-c2f71d424b4e

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