Can you read Recitals in a Bank Guarantee as a condition to decide the stay/ invocation of Bank Guarantee?

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SHUBHAM BUDHIRAJA[1]

 

Company-A invited tenders for the construction of Hospitals at various locations in India. Company-B was accepted as the successful bidder and the Contract was executed between them pursuant to letter of award. Company B instructed the Bank to issue 3 unconditional Bank guarantees in favor of Company A ‘for the purpose of main contract between A & B’. Company A issued the demand letter to the Bank seeking credit of Bank guarantee amount in its favor. Company B filed section 9 petition seeking stay of the Bank guarantee, inter-alia, on the ground that the Company-A does not need those funds/ there is dispute on performance as per Contact between Company-A and Company-B. The Hon’ble High Court dismissed the stay application stating that Bank guarantee is an independent contract between its beneficiary Company-A and the Bank to which Company B is a complete stranger. The conditions of contract between Company-A & Company B cannot be read in Contract of Bank Guarantee merely because recital of Bank Guarantee refers the purpose of Bank Guarantee is ‘performance of main contract’.[2]

 

(i)                  Commercial contracts often contain clauses requiring the contractor to furnish bank guarantees. These bank guarantees are, principally, either bank guarantees provided towards security, for having been awarded the contract, or performance bank guarantees, to guarantee performance of the contract, though, on occasion, other bank guarantees such as bank guarantees towards mobilization advance etc. may also be required to be provided.  The contract, in such cases, also provides for the circumstances in which the bank guarantees could be invoked, as well as the purpose for requiring the bank guarantees to be provided in the first place.

 

(ii)                No bank guarantees payment to anyone gratis. Every bank guarantee is of necessity issued by a bank on instructions. In case of a commercial contract, such as the contract in the present petition, the instruction to the bank, to provide a bank guarantee, is given by the person to whom the contract is awarded; in the present case, the petitioner. The party to whom the contract is awarded, in other words, instructs the bank, in lieu of having been awarded the contract, to issue a bank guarantee in favour of the person awarding the contract.

 

(iii)               These bank guarantees are, however, bilateral contracts between the bank and the beneficiary, even if they were issued at the instance of the petitioner. The petitioner is not a party to the bank guarantees. It is, therefore, legally a stranger to the contract, insofar as the bank guarantees are concerned.

 

(iv)              Like all independent commercial contracts, every bank guarantee has to abide strictly by its terms. Honour and compliance of a bank guarantee, as per its terms, is, therefore, mandatory. In the case of bank guarantees, especially, the Supreme Court has stressed this aspect, as there is an overwhelming element of public interest involved in requiring banks to honor their commitments towards customers and clients. If a bank is to be interdicted, at the instance of a third party, who is a stranger to the bank guarantee between the bank and the beneficiary, from honouring the bank guarantee, the Supreme Court has held in United Commercial Bank v. Bank of India (1981) 2 SCC 766 and Hindustan Steelworks Construction Ltd. v. Tarapore & Co (1996) 5 SCC 34 , that it would erode the public faith in the banking institution of the country.

 

(v)                Equally, it is not permissible, either, for the Court to interdict the invocation of a bank guarantee on the ground that the stage for such invocation, as per the contract, has not been reached, or that the exigency in which the bank guarantee could be invoked as per the contract, does not exist, unless that stage, or that the exigency, is incorporated as a condition for invocation in the bank guarantee itself.

 

(vi)              Interdiction of invocation of unconditional bank guarantees would be justified, where the invocation is otherwise in terms of the covenants in the bank guarantees, only where there is found to exist egregious fraud, or special equities, or where irretrievable injustice would ensue were invocation not to be injuncted.

 

(vii)             It is necessary to distinguish between recitals in a bank guarantee which set out the purpose for issuing the bank guarantee and recitals which set out the conditions for invoking the bank guarantee. These are aspects which are often confused with each other. Bank guarantees issued in compliance with the requirements in commercial contracts often set out, in their preambular or opening recitals, the fact that they are being furnished to ensure performance of the contract by the contractor/contract awardee. That recital, by itself, does not make performance of the contract by the contract awardee, a condition for invocation of the bank guarantee. A bank guarantee has, therefore, to be carefully read in order to understand the exact governing condition in which the bank guarantee would become invocable, and in which the bank would be obligated to honor the bank guarantee.

 

(viii)           A plea for stay of invocation of a bank guarantee would be predicated either on the premise that the invocation was contrary to the terms of the agreement between the parties or contrary to the terms of the bank guarantee itself. Once, however, the beneficiary of the bank guarantee proceeds towards invocation of the bank guarantee by writing to the bank, the first argument, of the invocation being contrary to the terms of the parent contract between the parties, ceases to be available to the contractor.

 


[1] LLB, ACS, BCOM(H), Advocate, Delhi High Court, shubhambudhiraja02@gmail.com , 9654055315

[2] O.M.P.(I) (COMM.) 200/2021, M/S GARG BUILDERS v. HINDUSTAN PREFAB LTD, 02.05.2022, Delhi High Court

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