Can you restrain the bank to encash the LC in case of breach of contract?

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Shubham Budhiraja (ACS, LLB, BCOM(H))

Shubhambudhiraja02@gmail.com , 9654055315


Injunction Application filed by A against Bank & B for seeking restraint against B and Bank to en-cash the letter of credit (LC) for reason that B has supplied the defective products in shipment. Therefore the Bank should not allow LC in favor of B. The HC in its original jurisdiction under commercial court held that the LC cannot be restrained. The defective supply of goods by B is by most stretch is a case of breach of contract and not a case of fraud. Therefore, unless there is a case of ‘egregious fraud and irretrievable injustice’, the LC cannot be restrained[1]. 

 

(i)                  It is a settled position of law that contracts in respect of Bank Guarantees and LCs are independent of the main contract between the parties. Therefore, even if there is a breach of the main contract between the parties, that cannot be a ground for injuncting payments under the Bank Guarantees/LCs. Letter of Credit is an irrevocable obligation undertaken by the issuing bank, to honour the same if the documents in terms of the said LC are submitted by the beneficiary.

 

(ii)                It is normal practice in international trade that LCs are issued by the buyers through their banks in favour of the seller through the seller’s banks, more particularly when buyer and seller are located in different jurisdictions/countries. LCs are the bedrock on which international trade and commerce is based. The goods are supplied by the seller to the buyer on the strength of the LCs provided by the buyer in favour of the seller, which functions as an assurance that once the goods are shipped and the documents in respect thereof are presented by the seller, the payment would be assured. The courts should be loathe to interfere with the mechanism of LCs as it would have an impact on the efficacy and functioning of international trade.

 

(iii)               Merely because there is a dispute between the buyer and the seller with regard to the contract of supply of goods, that cannot be ground for interfering with the LC. Therefore, the courts have recognized only two exceptions to the aforesaid principle where courts would pass an injunction in respect of payments under an LC, in cases of ‘egregious fraud and irretrievable injustice’. It has repeatedly been held by the courts that ‘egregious fraud’ has to be a fraud of the kind which goes to the very root of the matter. 


[1] CS (COMM) 29/2022, DELHI HIGH COURT

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