A bank guarantee is a guarantee that is given by an entity or institution who is lending money or a lending institution to a person. This guarantee means that if the debtor fails to settle a debt or defaults on a loan, the lending institution or entity will cover it, or in other words they will pay the debt off. A bank guarantee enables the customer, or debtor, to acquire goods, buy equipment or draw down a loan. This is done according to the provisions of the Indian Contract Act, 1872. This kind of guarantee lets a customer buy what they otherwise could not invest in; this not only helps in encouraging startups and entrepreneurs but also makes businesses grow. Additionally there are many types of bank guarantees, namely direct and indirect, conditional and unconditional, financial, performance and deferred payment guarantees.
Coming to what is invocation of a bank guarantee. Invocation of bank guarantee means the process of calling upon a bank or lending institution to honor its commitment or obligation. In other words, when a beneficiary of a bank guarantee fails to fulfill the legal obligations of the contract for which they got the bank guarantee, that beneficiary can call upon the bank to fulfill their commitment and pay off the debt. This process is called invocation of a bank guarantee.
Now there are two main types of bank guarantees which we are concerned with, they are as follows:
- Unconditional Guarantee – In this type of the guarantee, the bank or lending authority or guarantee has to pay the guarantee amount to the beneficiary when the guarantee is invoked, which is when the beneficiary fails to perform some contractual obligation or defaults on a debt.
- Conditional Guarantee – In this type of guarantee, the bank or lending authority puts forth some conditions or obligations of the contract that a beneficiary has to fulfill in order to be able to invoke the guarantee.
In the case of an unconditional guarantee the court doesn’t interfere and thus cannot put a stay or injunction on the invocation of the guarantee, however, the court can interfere in the case of a conditional guarantee. There can be three grounds for such an injunction or stay order, they are as follows:
Fraud: If there is a case of fraud, then the lending authority or bank cannot be compelled to fulfill their end of the obligation under bank guarantee. It is important to understand that the theft should be from the Recipient and not from any other unknown individual / entity. If the bank suspects that any dishonest activity has been done on behalf of the Recipient then the payment can be refused lawfully. However, mere allegation of fraud is not sufficient; there must be evidence of fraud that should be adequately substantive, both as to the fact of the fraud and as to the knowledge that the bank has of the same.
Irretrievable injustice or injury: In a case of injustice or injury that has the possibility of occurring, then the Courts can and will put a stay on the invocation. This is done because if the guarantee is allowed invocation then the payment of the guarantee will adversely affect the bank and its beneficiary at whose instance the guarantee was given.
Special Equities: In case of special equities, the court grants relief on account of injuries caused due to exceptional circumstances. However the concept of “special equities” is very wide and substantially vague, hence this allows a discretionary power to the court to decide if the guarantee can be invoked or not depending on the facts of the case.
What happened in the case Indrajit Power Private Limited v Union of India & Ors. ?
Facts: In this case the petitioner, Indrajit Power Pvt Ltd, had sought extension of the deadline to complete the pending work that they had taken up with regards to a coal mine which is located in Maharashtra. For this purpose they had also taken a bank guarantee with the Respondent on April 13, 2015 for an amount of over Rs 30 crores.
The petitioner had moved the High court seeking to quash an email dated April 4, which informed them about the Central Government’s decision to appropriate the Bank Guarantee in its favour. The guarantee was being invoked by the Respondent because the Petitioner had failed to comply with the parameters laid down in the Coal Mine Development and Production Agreement, before the mining operation began.
Court proceedings: The petitioners were seeking for an extension of time given to complete the work and a renewal of the bank guarantee which would expire on April 12, 2020. They had submitted in court that they ran a captive power plant for a company, which has been closed because of lockdown imposed due to COVID-19. Thus if the bank guarantee was invoked by the central government in this situation, then they would no immediate source of revenue. This would result in non-payment of salaries of the employees and they will be pushed into default and towards being declared as NPA.
They argued that the invocation of the bank guarantee was unfair and inequitable because the respondent did not acknowledge the submissions made by them in reply to show cause notice. They also argued that in a situation of a pandemic of COVID-19, economic instability is on the rise because of everything being closed down, thus appropriating a bank guarantee which would further risk bankruptcy and unemployment should be barred because it is irretrievable injustice and injury.
Observations of the court: The court took notice of the fact that since April-June 2018 Indrajit has been in non-compliance with benchmarks and performance requirements and was given a 12-month extension well before the COVID-19 crisis. It was also reiterated that it is not a ground of stay merely because invocation will cause financial distress unless the exception of irrevocable injury is proven. On the basis of this, the court dismissed the petition.
“A pandemic, of the nature which affects the world today, has not visited us during the lifetime of any of us and, hopefully, would not visit us hereinafter either. The devastation, human, economic, social and political, that has resulted as a consequence thereof, is unprecedented. The measures, to which the executive administration has had to resort, to somehow contain the fury of the pandemic, are equally unprecedented. The situation of nationwide lockdown, in which we find ourselves today, has never, earlier, been imposed on the country. The imposition of the lockdown was by way of a sudden and emergent measure, of which no advance knowledge could be credited to the petitioner – or, indeed, to anyone else.” – C. Hari Shankar, J., April 20, 2020.
What is the conclusion we reach by analyzing the case with regards to stay on invocation of bank guarantee?
Though it may be claimed that bank guarantees are the foundation of commerce and financial transactions, there are exceptional situations and unusual facts and circumstances under which the case of irretrievable harm, combined with the heinous existence of a scam, can be grounds for limiting and invoking unconditional bank guarantees. In any event, irretrievable injuries and damage along with different equities are an emerging term and the courts are gradually getting more tolerant about it, relying on the facts and circumstances of each case, keeping in mind that bank guarantees are also individual contracts and only in a situation where there is no other reasonable solution practicable, compensation is given for the grieved to be remedied.
In India, a restrictive order to prevent an issuing bank from paying the amount under a demand guarantee is difficult to obtain, unless the party seeking an injunction can bring its case within the exceptional grounds listed above. The legislation in this area is well settled and has been reiterated in multiple court decisions. As mentioned above, the orders issued by the Hon’ble Delhi High Court reflect the path being taken by the judiciary because of COVID-19. The courts are aware of these unprecedented circumstances and walk a more cautious path and avoid any devastating and shocking consequence.
However, it is important to remember that in situations where parties have attempted to take COVID-19’s argument for mitigating their inability to meet commitments, the courts have not resorted to issuing injunctions, because they were granted sufficient time before the crisis reached the world. In fact, the courts are mindful of the danger presented by COVID-19 to the nation as a whole, and it is imperative for the courts to ensure that they seek to minimize any irreparable harm or damage done to the parties through their attempts to uphold contractual obligations. It should also be remembered that such orders issued by the courts are of an ad hoc type, in cases where time is of value and are subject to further proceedings by the courts in the related matters. Thus, the quote which is aforementioned gives us an apt idea of what are the economic consequences of the COVID-19 pandemic.
This article is authored by Sonali.