Updated: Dec 27, 2021
In this era of globalisation and digitization, when demand for exported goods is increasing and domestic as well as international trade is flourishing and growing at a faster rate than ever before, it is crucial to have a dependable source that prevents fraud, mitigates risk, and ensures a secure business transaction. In today's commercial world, where hundreds of thousands of business transactions occur every minute internationally and parties live thousands of miles apart, an innovative institution is needed to fulfil the basic objective of a guarantee, i.e., to give security for our claims or payments. Because of this very reason, the concept of Bank Guarantee was created, which is regarded as the “life-blood” of trade, whether worldwide or domestic.
The Indian Contract Act, 1872 defines a guarantee as a contract to perform a promise or discharge a third party's duty if they default. A guarantee contract protects the lender's money by making a third party accountable if the borrower defaults. The “Surety” offers to discharge the third party's liability. The principal debtor is the individual for whom the guarantee is given, and the creditor is the person to whom the guarantee is given or who lends the money.
In other words, Bank Guarantee is a three-party arrangement between the banker, the customer or creditor, and the beneficiary. It is a contract where the consumer pledges to pay the debtor in event of default. When it comes to Bank Guarantee, the bank is the guarantee who pledges to cover or repeat the Debtor's loan. These guarantees are separate contracts that are not concerned with the basic debtor and creditor's relationship. To maintain free flow of trade, the bank guarantees the creditor that he will not suffer any losses, and also allows the creditor to recover the debt in case of failure, without having to go through the lengthy legal process.
To better understand the parties involved and their roles, let us take an example. Vishal leases his flat to Vibhuti for Rs. 50,000 per month and he insists on a bank guarantee from Vibhuti’s bank i.e., United Bank of India for Rs. 15,00,000 to compensate him if in case Vibhuti refuses to empty the flat and give back its possession when the lease period ends. Here, Principal Debtor is Vibhuti, Vishal is the Creditor and United Bank of India is the Surety or the Guarantor. If Vibhuti defaults then Vishal can directly be indemnified by the United Bank of India.
In the case of Maharashtra SEB v Official Liquidator, a bank becomes a surety and undertakes to pay Rs 50,000 to the SEB within 48 hours of demand. The supplier's company went bankrupt and the BOD sought payment. But the liquidator stopped the Board from collecting the guarantee and bank from paying it. However, the SC held that the Board can collect the guarantee and get the money on demand, not on breach. Defined as ‘On demand Guarantee' or ‘Unconditional performance,' a Bank Guarantee is basically a liability to pay without any proof of breach or damage by the creditor. In the event of the debtor defaulting, the creditor may request the performance of the bank or the guarantor, and the bank is obligated to indemnify the creditor without the requirement for proof of default. Hence, Bank Guarantee is “Absolute” and “Unconditional”.
To further elaborate, an absolute guarantee is a contract wherein the guarantor or the surety promises that if the principal obligation is not performed by the debtor, the guarantor will perform an act such as pay the amount due, for creditor’s benefit, with the only condition being the principal’s default. Upon the maturing of the principal debt, the obligation that is absolute or unconditional becomes fixed and the guarantor or the surety is not entitled to require that the creditor first exhausts all remedies. Injunctions can also not be granted against Unconditional guarantees as they are ‘irrevocable in nature’.
In other cases, the bank only pays the sum when specific conditions are met, such as third-party consent or a proof of default. When a conditional bank guarantee is enforced, a court can issue an injunction, and the receiver is not permitted to exercise the guarantee on their own initiative. In the case of Hindustan Construction Co. Ltd. vs State of Bihar and Ors., it was laid down that when a Conditional Guarantee is issued, the beneficiary does not have an unlimited right to activate the guarantee and seek payment from the financial institution. It was also determined that in order to exercise the bank guarantee, the requirements specified in the contract of bank guarantee must be met. Same thing was also held in Mahalingam Shelly Co. v NPC Corporation.
Covid-19 has shaken the planet and its economies to its very foundations. Large multinational corporations, other businesses and industries, have been impacted and forced to close their doors due to the pandemic's highest-ever losses. This pandemic has impacted contractual duties as well, and the Covid-19 epidemic has been deemed a “force majeure” occurrence in many circumstances, exception being that of special equities. Although many courts have agreed to use Covid-19 as the only basis for issuing injunctions, there are still several that have not. To elucidate, in the instance of Halliburton Offshore Services Inc v Vedanta Ltd & Anr., a state-wide lockdown was imposed because of the Covid-19 pandemic and therefore all industrial activity ceased. As a result of this, the petitioner failed to perform contractual obligations, causing the defendant to cancel the contract and collect eight bank guarantees from the petitioner. Finally, the High Court of Delhi decided in the petitioner's favour and issued an interim restraining order against the encashment of the assurances provided by the government. Additionally, the court concluded that the petitioner's failure to meet its obligations was exclusively attributable to the closure, which was prima facie evidence of a case of force majeure for the petitioner. The Court cited another comparable case, Standard Chartered Bank Heavy Limited v Heavy Engineering Corporation Ltd., and reaffirmed the premise of the 'Special Equities' exemption being separate from irreversible injury, and also the fact that 'special equities' can be utilized to obtain injunctions. However, there have been cases where the court has decided otherwise. In Standard Retail Pvt. Ltd. v M/S G.S. Global Corp. & Others, the Bombay HC decided that Covid-19, and thus the shutdown in this case, would not be considered force majeure in this instance.
Bank Guarantees have long been an important aspect of the trading process, as they assist large corporations and industries in protecting their most recent investments and transactions. We can readily see, however, that despite the fact that the process has been mostly devoid of judicial interference, it's not been totally devoid of it. Unless there is fraud and irreparable damage, the courts should refrain from interfering with the invocation of a bank guarantee, unless it is essential to act to protect the parties' interests in question. The whole basis of the bank guarantee system would crumble if bank guarantees could not be redeemed by the parties voluntarily, and people's belief in it would diminish over time as the outcome of their loss of trust in bank guarantee.
~Authored by Vidhika Panjwani