%
The appellant, a State Government enterprise, on or
about May 17, 1983, entered into a contract with the
respondent, a private limited company, for the supply and
installation of a vanaspati manufacturing plant at a place
in the district of Nainital. The contract bond contemplated
guaranteed performance of the work at various stages in
accordance with the time schedule prescribed and provided
for completion and commissioning of the plant after trial
run by May 15, 1984. According to the appellant, the time
was essentially and indisputably the essence of the
contract.
As per the terms and conditions of the contract bond,
according to the appellant, the respondent was to furnish a
performance bank guarantee for Rs.16.5 lakhs and yet another
bank guarantee for Rs.33 lakhs as security for the monies
advanced by the appellant to the respondent for undertaking
the work. Both these guarantees as also the contract bond
entitled the appellant to invoke them and call for their
realisation and encashment on the failure of the respondent
to perform the obligations for which the appellant was made
the sole judge.
It was alleged that the respondent defaulted at various
stages and finally failed to complete the work within the
stipulated time. The appellant invoked the two guarantees
one after the other, and thereafter proceeded to have the
plant completed, etc. According to the appellant, the plant
could actually be commissioned for commercial production in
July/August, 1985.
The respondent, on August 4, 1986, filed an application
under section 41 of the Arbitration Act, 1940 (The Act) in
the court of the Civil Judge, praying for an injunction
restraining the appellant from realis-
1125
ing and encashing the bank guarantees. The Civil Judge
dismissed the application. The respondent filed a revision
petition before the High Court, which allowed the same,
holding that the invocation of the performance guarantees
was illegal, and the contentions of the appellant that the
performance guarantees constituted independent and separate
contracts between the guarantor bank and the beneficiary and
created independent rights, liabilities and obligations
under the guarantee bonds themselves, as being "technical
pleas". The High Court, however, directed the respondent to
keep alive the bank guarantee during the pendency of the
arbitration proceedings. The appellant then moved this Court
for relief by special leave.
Allowing the appeal, The Court,
^
HELD: Per Sabyasachi Mukharji, J.
Under the terms agreed to between the parties, there is
no scope of injunction. The High Court proceeded on the
basis that this was not an injunction sought against the
bank but against the appellant. But the net effect of the
injunction is to restrain the bank from performing the bank
guarantee. That cannot be done. One cannot do indirectly
what one is not free to do directly. The respondent was not
to suffer any injustice which was irretrievable. The
respondent can sue the appellant for damages. There cannot
be any basis in the case for apprehension that irretrievable
damage would be caused, if any. His Lordship was of the
opinion that this was not a case in which injunction should
be granted. An irrevocable commitment either in the form of
confirmed bank guarantee or irrevocable letter of credit
cannot be interfered with except if a case of fraud or a
case of a question of apprehension of irretrievable
injustice has been made out. This is the well-settled
principle of the law in England. This is also the well-
settled principle of law in India. No fraud and no question
of irretrievable injustice was involved in the case. [1138C-
F]
In order to restrain the operation either of
irrevocable letter of credit or of confirmed letter of
credit or of bank guarantee, there should be a serious
dispute and a good prima facie case of fraud and special
equities in the form of preventing irretrievable injustice
between the parties; otherwise, the very purpose of bank
guarantees would be negatived and the fabric of trading
operation would be jeopardised. The commitments of the banks
must be honoured free from interference by the courts;
otherwise, trust in commerce internal and international
would be irreparably damaged. It is only in exceptional
cases, that is, in
1126
cases of fraud or in cases of irretrievable injustice that
the court should interfere. This is not a case where
irretrievable injustice would be done by enforcement of the
bank guarantee. This is also not a case where a strong prima
facie case of-fraud in entering into a transaction was made
out. The High Court should not have interfered with the bank
guarantee. The judgment and order of the High Court set
aside. The order of the Civil Judge restored.[1141A-B;
1142D-H]
Per K. Jagannatha Shetty, J. (concurring):
The crux of the matter relates to the obligation
assumed by the bank under a performance guarantee. [1143B]
Whether the obligation is similar to the one arising
under a letter of credit? Whether the Court could interfere
in regard to such obligation, and if so, under what
circumstances? These are the questions raised in the appeal.
[1143B-C]
The primary question for consideration is whether the
High Court was justified in restraining the appellant from
invoking the bank guarantees. The basic nature of the case
relates to the obligations assumed by the bank under the
guarantees given to the appellant. If under the law, the
bank cannot be prevented by the respondent from honouring
the credit guarantees, the appellant also cannot be
restrained from invoking the guarantees. What applies to the
bank must equally apply to the appellant. Therefore, the
frame of the suit by not impleading the bank cannot make any
difference in the position of law. Equally, it would be
futile to contend that the court was justified in granting
the injunction since it has found a prima facie case in
favour of the respondent. The question of examining the
prima facie case or balance of convenience does not arise if
the court cannot interfere with the unconditional commitment
made by the bank in the guarantees in question. [1144C-D;
1145A-B]
The modern documentary credit had its origin from
letters of credit. The letter of credit has developed over
hundreds of years of international trade. It was intended to
facilitate the transfer of goods between distant and
unfamiliar buyer and seller. It was found difficult for a
buyer to pay for goods prior to their delivery. The bank's
letter of credit came to bridge this gap. In such
transactions, the seller (beneficiary) receives payment from
the issuing bank when he presents a demand as per the terms
of the documents. The bank must pay if the documents are in
order and the terms of credit are satisfied. The bank,
1127
however, was not allowed to determine whether the seller had
actually shipped the goods or whether the goods conformed to
the requirements of the contract. Any dispute between the
seller and the buyer must be settled between themselves. The
Courts, however, in carving out an exception to this rule of
absolute independence, held that if there has been a "fraud
in the transaction", the bank could dishonour beneficiary's
demand for payment. The Courts have generally permitted
dishonour only on the fraud of the beneficiary, not the
fraud of somebody else. [1145C, E-H; 1146A]
In modern commercial transactions, various devices are
used to ensure performance by the contracting parties. The
traditional letter of credit has taken a new meaning. Stand-
by letters of credit are also used in business circles.
Performance bond and guarantee bond are also devices
increasingly adopted in transactions. The Courts have
treated ch documents as analogous to letter of credit. l
1148E]
Whether it is a traditional letter of credit or a new
device, like performance bond or performance guarantee, the
obligation of the bank appears to be the same. Since the
bank pledges its own credit, involving its reputation, it
has no defence except in the case of fraud. The nature of
the fraud that the courts talk about is the fraud of an
'egregious nature as to vitiate the entire underlying
transaction". It is the fraud of the beneficiary, not fraud
of somebody else. The bank cannot be compelled to honour the
credit in such cases. In such cases, it would be proper for
the bank to ask the buyer to approach the court for an
injunction. The court, however, should not lightly interfere
with the operation of irrevocable documentary credit. In
order to restrain the operation of irrevocable letter of
credit, performance bond or guarantee, there should be a
serious dispute to be tried and there should be a good prima
Facie act of fraud . [1149E-H; 1150A]
The sound banking system may, however, require more
caution in the issuance of irrevocable documentary credit.
It would be for the banks to safeguard themselves by other
means, and, generally, not for the courts to come to their
rescue with injunctions unless there is established fraud.
The appeal must be allowed, and the order of the civil
judge, restored. [1150D-E]
Hamzeh Melas & Sons v. British Imex Industries Ltd.,
[1958] 2 Q.B.D. 127; Elian and Rabbath (Trading as Elian &
Rabbath v. Mastas and Mastas & ors., [1966] 2 Lloyd's List
Law Reports 495; R.D. Harbottle (Mercantile) Ltd. and
Another v. Nahonal Westminster
1128
Bank Ltd. and Ors., [1977] 2 All England Law Reports 862;
Edward owen Engineering Ltd. v. Barclays Bank International
Ltd, [1978] 1 All England Law Reports 976; United City
Merchants (Investments) Ltd. & Ors. v. Royal Bank of Canada
, 1988( 1 )SCR1124, 1988( 1 )SCC 174, 1987( 2 )SCALE1149, 1987( 4 )JT 406
PETITIONER:
U.P. Co-OPERATIVE FEDERATION LTD.
Vs.
RESPONDENT:
SINGH CONSULTANTS & ENGINEERS (P) LTD.
DATE OF JUDGMENT19/11/1987
BENCH:
OZA, G.L. (J)
BENCH:
OZA, G.L. (J)
SHETTY, K.J. (J)
CITATION:
1988 AIR 2239 1988 SCR Supl. (2) 859
1988 SCC (4) 274 JT 1988 (3) 640
1988 SCALE (2)571
ACT:
Performance of contract-guaranteed performance in
accordance with time schedule prescribed-Failure to perform
obligation within time stipulated-Effect of-Bank guarantee
Right to invoke-To injunction against.
HEADNOTE:
%
The appellant, a State Government enterprise, on or
about May 17, 1983, entered into a contract with the
respondent, a private limited company, for the supply and
installation of a vanaspati manufacturing plant at a place
in the district of Nainital. The contract bond contemplated
guaranteed performance of the work at various stages in
accordance with the time schedule prescribed and provided
for completion and commissioning of the plant after trial
run by May 15, 1984. According to the appellant, the time
was essentially and indisputably the essence of the
contract.
As per the terms and conditions of the contract bond,
according to the appellant, the respondent was to furnish a
performance bank guarantee for Rs.16.5 lakhs and yet another
bank guarantee for Rs.33 lakhs as security for the monies
advanced by the appellant to the respondent for undertaking
the work. Both these guarantees as also the contract bond
entitled the appellant to invoke them and call for their
realisation and encashment on the failure of the respondent
to perform the obligations for which the appellant was made
the sole judge.
It was alleged that the respondent defaulted at various
stages and finally failed to complete the work within the
stipulated time. The appellant invoked the two guarantees
one after the other, and thereafter proceeded to have the
plant completed, etc. According to the appellant, the plant
could actually be commissioned for commercial production in
July/August, 1985.
The respondent, on August 4, 1986, filed an application
under section 41 of the Arbitration Act, 1940 (The Act) in
the court of the Civil Judge, praying for an injunction
restraining the appellant from realis-
1125
ing and encashing the bank guarantees. The Civil Judge
dismissed the application. The respondent filed a revision
petition before the High Court, which allowed the same,
holding that the invocation of the performance guarantees
was illegal, and the contentions of the appellant that the
performance guarantees constituted independent and separate
contracts between the guarantor bank and the beneficiary and
created independent rights, liabilities and obligations
under the guarantee bonds themselves, as being "technical
pleas". The High Court, however, directed the respondent to
keep alive the bank guarantee during the pendency of the
arbitration proceedings. The appellant then moved this Court
for relief by special leave.
Allowing the appeal, The Court,
^
HELD: Per Sabyasachi Mukharji, J.
Under the terms agreed to between the parties, there is
no scope of injunction. The High Court proceeded on the
basis that this was not an injunction sought against the
bank but against the appellant. But the net effect of the
injunction is to restrain the bank from performing the bank
guarantee. That cannot be done. One cannot do indirectly
what one is not free to do directly. The respondent was not
to suffer any injustice which was irretrievable. The
respondent can sue the appellant for damages. There cannot
be any basis in the case for apprehension that irretrievable
damage would be caused, if any. His Lordship was of the
opinion that this was not a case in which injunction should
be granted. An irrevocable commitment either in the form of
confirmed bank guarantee or irrevocable letter of credit
cannot be interfered with except if a case of fraud or a
case of a question of apprehension of irretrievable
injustice has been made out. This is the well-settled
principle of the law in England. This is also the well-
settled principle of law in India. No fraud and no question
of irretrievable injustice was involved in the case. [1138C-
F]
In order to restrain the operation either of
irrevocable letter of credit or of confirmed letter of
credit or of bank guarantee, there should be a serious
dispute and a good prima facie case of fraud and special
equities in the form of preventing irretrievable injustice
between the parties; otherwise, the very purpose of bank
guarantees would be negatived and the fabric of trading
operation would be jeopardised. The commitments of the banks
must be honoured free from interference by the courts;
otherwise, trust in commerce internal and international
would be irreparably damaged. It is only in exceptional
cases, that is, in
1126
cases of fraud or in cases of irretrievable injustice that
the court should interfere. This is not a case where
irretrievable injustice would be done by enforcement of the
bank guarantee. This is also not a case where a strong prima
facie case of-fraud in entering into a transaction was made
out. The High Court should not have interfered with the bank
guarantee. The judgment and order of the High Court set
aside. The order of the Civil Judge restored.[1141A-B;
1142D-H]
Per K. Jagannatha Shetty, J. (concurring):
The crux of the matter relates to the obligation
assumed by the bank under a performance guarantee. [1143B]
Whether the obligation is similar to the one arising
under a letter of credit? Whether the Court could interfere
in regard to such obligation, and if so, under what
circumstances? These are the questions raised in the appeal.
[1143B-C]
The primary question for consideration is whether the
High Court was justified in restraining the appellant from
invoking the bank guarantees. The basic nature of the case
relates to the obligations assumed by the bank under the
guarantees given to the appellant. If under the law, the
bank cannot be prevented by the respondent from honouring
the credit guarantees, the appellant also cannot be
restrained from invoking the guarantees. What applies to the
bank must equally apply to the appellant. Therefore, the
frame of the suit by not impleading the bank cannot make any
difference in the position of law. Equally, it would be
futile to contend that the court was justified in granting
the injunction since it has found a prima facie case in
favour of the respondent. The question of examining the
prima facie case or balance of convenience does not arise if
the court cannot interfere with the unconditional commitment
made by the bank in the guarantees in question. [1144C-D;
1145A-B]
The modern documentary credit had its origin from
letters of credit. The letter of credit has developed over
hundreds of years of international trade. It was intended to
facilitate the transfer of goods between distant and
unfamiliar buyer and seller. It was found difficult for a
buyer to pay for goods prior to their delivery. The bank's
letter of credit came to bridge this gap. In such
transactions, the seller (beneficiary) receives payment from
the issuing bank when he presents a demand as per the terms
of the documents. The bank must pay if the documents are in
order and the terms of credit are satisfied. The bank,
1127
however, was not allowed to determine whether the seller had
actually shipped the goods or whether the goods conformed to
the requirements of the contract. Any dispute between the
seller and the buyer must be settled between themselves. The
Courts, however, in carving out an exception to this rule of
absolute independence, held that if there has been a "fraud
in the transaction", the bank could dishonour beneficiary's
demand for payment. The Courts have generally permitted
dishonour only on the fraud of the beneficiary, not the
fraud of somebody else. [1145C, E-H; 1146A]
In modern commercial transactions, various devices are
used to ensure performance by the contracting parties. The
traditional letter of credit has taken a new meaning. Stand-
by letters of credit are also used in business circles.
Performance bond and guarantee bond are also devices
increasingly adopted in transactions. The Courts have
treated ch documents as analogous to letter of credit. l
1148E]
Whether it is a traditional letter of credit or a new
device, like performance bond or performance guarantee, the
obligation of the bank appears to be the same. Since the
bank pledges its own credit, involving its reputation, it
has no defence except in the case of fraud. The nature of
the fraud that the courts talk about is the fraud of an
'egregious nature as to vitiate the entire underlying
transaction". It is the fraud of the beneficiary, not fraud
of somebody else. The bank cannot be compelled to honour the
credit in such cases. In such cases, it would be proper for
the bank to ask the buyer to approach the court for an
injunction. The court, however, should not lightly interfere
with the operation of irrevocable documentary credit. In
order to restrain the operation of irrevocable letter of
credit, performance bond or guarantee, there should be a
serious dispute to be tried and there should be a good prima
Facie act of fraud . [1149E-H; 1150A]
The sound banking system may, however, require more
caution in the issuance of irrevocable documentary credit.
It would be for the banks to safeguard themselves by other
means, and, generally, not for the courts to come to their
rescue with injunctions unless there is established fraud.
The appeal must be allowed, and the order of the civil
judge, restored. [1150D-E]
Hamzeh Melas & Sons v. British Imex Industries Ltd.,
[1958] 2 Q.B.D. 127; Elian and Rabbath (Trading as Elian &
Rabbath v. Mastas and Mastas & ors., [1966] 2 Lloyd's List
Law Reports 495; R.D. Harbottle (Mercantile) Ltd. and
Another v. Nahonal Westminster
1128
Bank Ltd. and Ors., [1977] 2 All England Law Reports 862;
Edward owen Engineering Ltd. v. Barclays Bank International
Ltd, [1978] 1 All England Law Reports 976; United City
Merchants (Investments) Ltd. & Ors. v. Royal Bank of Canada
JUDGMENT:
v. State Bank of India & Ors. AIR 1979 Calcutta 44; State
Bank of India v; The Economic Trading Co. S.A.A. & ors., AIR
1975 Calcutta 145; B.S. Auila Company Pvt. Ltd. v. Kaluram
Mahadeo Prasad & Ors., AIR 1983 Calcutta 106; Union of India
& ors. v. Meena Steels Ltd. & Another, AIR 1985 Allahabad
282; Arul Murugan Traders v. Rashtriya Chemicals &
Fertilizers Ltd. Bombay and another, AIR 1986 Madras 161;
Tarapore & Co. Madras v. M/s. V/o Tractors Export, Moscow &
Anr., [1969] 2 SCR 920; United Commercial Bank v. Bank of
India & ors., [1981] 3 SCR 300; Centax (India) Ltd. v.
Vinmar Impex Inc. and others, [1986] 4 SCC 136; United
Commercial Bank v. Bank of India & Ors., [1981] 3 SCR 300
and Bolivinter oil SA v. Chase Mannettan Bank & Ors., [1984]
1 All E.R. 351 at 352, referred to.
&
CIVIL APPELLATE JURISDICTION: Civil Appeal No. 3054 of
1987.
From the Judgment and order dated 20.2. 1987 of the
Allahabad High Court in Civil Revision No. 157 of 1986.
A.B. Diwan, Sandeep Narain and Shri Narain for the
Appellant.
V.M. Tarkunde, Shakeel Ahmed Syed for the Respondent.
The following Judgments were delivered by
SABYASACHI MUKHARJI, J. Special Leave granted.
In the Special Leave Petition notice was issued on 13th
of July, 1987 and it was directed that the matter would be
disposed of at the notice stage. After hearing the rival
contentions, we grant leave to appeal and dispose of the
appeal by the order hereunder.
This is an appeal from the judgment and order of the
learned single judge of the Allahabad High Court Lucknow
Bench) in Revision Petition No. 157 of 1986. It appears that
the appellant, a State Government enterprise, on or about
17th of May, 1983 entered into a contract with the
respondent-a private limited company for the supply and
installation of a Vanaspati manufacturing plant at
Harducharu
1129
in the District of Nainital, in the State of Uttar Pradesh.
The contract bond contemplated, according to the appellant,
guaranteed performance of work at various stages in
accordance with the time schedule prescribed therein and
provided for completion and commissioning of the plant after
due trial run by the 15th May, 1984. The appellant contends
that time was essentially and indisputably the essence of
the contract.
The contention of the appellant was that as per the
terms and conditions of the contract bond, the respondent
was to furnish a performance bank guarantee for Rs 16.5
lakhs and yet another bank guarantee for Rs.33 lakhs as
security for the monies advanced by the appellant to the
respondent for undertaking the work. Both these two
guarantees as also the contract bond entitled the appellant
to invoke them and call for their realisation and encashment
on the respondent's failing to perform the obligations for
which the appellant was made the sole judge
The 15th of May, 1984 was the date fixed for completion
and commissioning of the plant after 15 days' trial run for
commercial production. It was alleged that between the 26th
of December, 1984 and 28th of January, 1985 the respondent
defaulted at various stages and finally failed to complete
the work within the stipulated time. The appellant invoked
the two guarantees one after the other. The appellant
thereafter on 15th March, 1985 proceeded to have the plant
completed and the plant was formally inaugurated. The
appellant contends that the plant could actually be
commissioned for commercial production in July/August, 1985.
The respondent on 4th of August, 1986 filed a petition under
section 41 of the Arbitration Act 1940 (hereinafter called
the Arbitration Act), in the Court of the Civil Judge,
Lucknow praying for an order restraining the appellant from
realising and encashing the bank guarantees. The learned
Civil Judge for the reasons indicated in his order dated
8.8.86 declined to issue any injunction and dismissed the
application
Being aggrieved by the aforesaid decision, the
respondent went up before the Allahabad High Court. The
learned Single Judge of the Allahabad High Court, by the
impugned judgment of 20th February, 1987, allowed the
revision petition and held that the invocation of the
performance guarantees were illegal and further held the
contentions of the appellant that the performance guarantees
constituted independent and separate contracts between the
guarantor bank and the beneficiary and created independent
rights, liabilities and obligations
1130
under the guarantee bonds themselves, as being "technical
pleas."
On 17th May, 1983, as mentioned hereinbefore, an
agreement had been executed between the appellant and the
respondent wherein it was decided as follows:
"WHEREAS THE PCF (the appellant herein) has
decided to set up a Vanaspati Plant of 62 5 M.T.
per day Vanaspati Capacity, comprising of 70 M.T.
per day hardening capacity based on 95% usage of
soyabean oil as raw oil 62.5 M.T. per day, post
refining capacity, 72 M.T. deodoursisation
capacity and 72 M.T filling and packing capacity,
complete with all necessary utilities such as
water and steam Distribution Equipments oil
Storage Section Electrification and Distribution
Equipments Automatic Weighing filling and
packing/sealing equipments and fire-fighting
equipments etc, at Halducharu, District Nainital
(UP) lying at Bareilly-Haldwani road about 3.5
Kms. from Lalkuan towards Haldwani." and the
agreement further stated:-
"AND WHEREAS the seller (the respondent herein)
has undertaken to provide technical know-how and
fabricate, design, engineer, manufacture, procure,
import, supply, erect, instal, give trial runs and
commission the Vanaspati Complex as referred to
above complete in all respects at Halducharu
District-Nainital (U.P.) as per specifications
contained at Annexures 'A' to 'Q' and signed by
both the parties in token of incorporation as an
integral part of this agreement with guaranteed
performance on the terms and conditions
hereinafter appearing and contained.
AND WHEREAS the contract price here-in-after
mentioned is based on the 'Seller's undertaking to
com mission and make ready for commercial
production the said Vanaspati Complex by May 15,
1984 and if the seller fails to do so the contract
price shall stand reduced to the extent as
hereinafter provided.
AND WHEREAS the contract price hereinafter
mentioned is also based on the guaranteed
performance of the said Vanaspati Complex as here-
in-after provided and it is a term of this
Agreement that if the said Vanaspati Complex fails
to give the guaranteed performance as hereinafter
1131
specified, the contract price shall stand reduced
to the extent hereinafter provided."
Clause 1.6 stipulated that the date of commissioning
and handing over shall be the date on which the PCF takes
over the complete Plant after successful commissioning and
fulfilling of guaranteed performance specified in the
agreement. This clause further stated:
"The seller shall be deemed to have completed the
erection and-commissioning after giving successful
trial runs for continuous period of 15 days with
all the Plants working simultaneously. However,
the seller should fulfil the Warrantees of
individual plants separately also as given in the
specifications. The complete
Warrantees/Performance guarantees shall be
demonstrated by the seller over a continuous
period of 15 days."
Thus the mutual obligations of the sellers as well as
purchasers were stated in the contract. It is not necessary
to set out in detail all the clauses, but clauses 5 2 and 5
3 are relevant and provide as follows:
"5.2 In case the seller fails to fulfil and his
obligations as referred to in this agreement the
PCF shall be at liberty to get the same completed
through and other agency or agencies without the
approval of the seller and all the additional
expenses so incurred by the P.C.F. shall be
recoverable from the seller.
5.3 The seller also agrees to exclude/include some
of the machines equipments components from the
plant as may be desired by the PCF during the
course of this agreement, and cost of such
machines equipments components on reasonable
actual basis shall deducted/added to from the
contract price and thus the reduced/increased
contract price shall be paid by the PCF However,
the PCF should intimate such exclusion/inclusion
within two months from the date of signing of the
agreement. The said price of Rs.1,65,00,000 (Rs.
One crores and sixty five lakhs only) shall be
paid by the PCF to the seller in the following
manners:-
on or about 25th of June, 1983 two bank guarantees were
executed by Bank of India, Ghaziabad and the bank guarantee
1132
numbered ]7/16 provided,inter alia, as follows:-
"NOW, THEREFORE, the Bank hereby guarantees to
make unconditional payment of Rs.16.5 lacs (Rupees
six teen lacs fifty thousand only) to the
Federation on demand at its office at Lucknow
without any further question or reference to the
seller on the seller's failure to fulfil the terms
of the sale on the following terms and conditions
(emphasis supplied)
A) The sole judge for deciding whether the seller
has failed to fulfil the terms of the sale, shall
be the PCF.
B) This guarantee shall be valid upto twelve
months from the date of issue. i.e upto 24.6.84.
C) Claims. if any must reach to be Bank in writing
on or before expiry date of this guarantee after
which the Bank will no longer be liable to make
payments to the pCF
D) Bank's liability under this guarantee deed is
limited to Rs.16.5 lacs (Rupees sixteen lacs fifty
thousand only).
E) This guarantee shall not be revoked by the Bank
in any case before the expiry of its date without
written permission of the Federation.
The Bank guarantee No. 17/ 15 of the said date further
went on to provide as follows:-
"AND WHEREAS to secure the said advance, the
seller requested the Bank to furnish a Bank
Guarantee of the said amount of Rs.33 lacs (Rupees
thirty three lacs) in favour of the PCF and the
Bank accepted the said request and agreed to issue
the required Bank guarantee in favour of the Feder
ation.
Now, therefore, in consideration of the
aforesaid advance of the said sum of Rs 33 lacs
(Rupees thirty three lacs only) to be paid by the
PCF to the seller as aforesaid the Bank hereby
agrees and guarantees to make unconditionally
immediate payment to the Federation at its office
1133
at Lucknow of the sum of Rs.33 lacks (Rupees
thirty three lacs only) or any part thereof, as
the case may be, due to the PCF from the seller at
any time on receipt of the notice of demand
without any question or reference to the PCF or to
the seller on the seller's failure to fulfil the
terms of the said advance on the following terms
and conditions:-
(Emphasis supplied)
1) The PCF shall be sole judge to decide whether
the seller has failed to fulfil any terms and
conditions of the said advance and on account of
the said failure what amount has become payable to
the PCF under this guarantee
2) This Guarantee shall be valid upto 15 5.84
(Fifteenth May 1984) after which period this
guarantee shall stand cancelled and revoked.
3) The claims of the PCF, if any, under this
guarantee, must reach the Bank on or before the
date of expiry of this guarantee and after the
date of expiry, no claim will be entertained by
the Bank.
4) The Bank shall not revoke this guarantee in any
case before its expiry date of 15.5 1984 except
with the writ- ten permission of the PCF."
I have set out in extenso the terms in order to
highlight the fact that under the terms agreed to between
the parties, there is no scope of injunction .
The trial Court in its judgment held that the Bank
should be kept to fulfil its obligations and commitments and
the Court should not come in the way But that principle was
distinguished by the High Court on the ground that the
respondent was seeking relief against the U.P. Cooperative
Federation Ltd. and the subject matter of the dispute itself
being as to whether the bank guarantee could be invoked and
encashed The High Court was of the view that even otherwise
it cannot be doubted that the appellant cannot be permitted
to take advantage of illegally invoking a bank guarantee on
a technical plea that the guarantee was independent of the
contract and involving only the bank and the opposite party
at pleasure. The High Court was of the view that prima facie
it appeared that the plant was handed over
1134
after a trial run and that the commercial production had
started and A this has not been assailed as a fact. The High
Court was of the view, that in these circumstances this
cannot be said that the invocation order was final and
irrevocable. The High Court was further of the view that
having taken over the possession of the plant it was
necessary to consider all the aspects and held that the bank
guarantees could not be invoked. The High Court was of the
view that it was not a question of restraining the
performance of any bank guarantee.
I am, however, unable to agree. The principles upon
which the bank guarantees could be invoked or restrained are
well-settled our attention was also drawn to several
decisions of the High Court as well as of this Court.
Reference had also been made to some of the English
decisions. So far as the position of English law is
concerned, the principles by now are well-settled. I will
refer to some of the decisions and explain the position.
The question arose before the Court of Appeal in
England in Hamzeh Melas & Sons v. British Imex Industries
Ltd., [1958] 2 Q.B .D. 127. There the plaintiffs, a
Jordanian firm, contracted to purchase from the defendants,
a British firm, a large quantity of reinforced steel rods,
to be delivered in two instalments Payment was to be
effected by the opening in favour of the defendants of two
confirmed letters of credit with the Midland Bank Ltd., in
London, one in respect of each instalment. The letters of
credit were duly opened and the first was realized by the
defendants on the delivery of the first instalment. The
plaintiffs complained that instalment was defective and
sought an injunction to bar the defendants from realizing
the second letter of credit. Justice Donovan refused the
application. The plaintiffs appealed to the Court of Appeal
in England. It was held that although the Court had wide
jurisdiction to grant injunction, this was not a case in
which, in the exercise of its discretion, it ought to do so.
The Court of Appeal emphasised that an elaborate commercial
system had been built up on the footing that a confirmed
letter of credit constituted a bargain between the banker
and the vendor of the goods, which imposed upon the banker
an absolute obligations to pay, irrespective of any dispute
there might be between the parties whether or not the goods
were up to contract. The principle was that commercial
trading must go on the solemn guarantee either by the letter
of credit or by bank guarantee or irrespective of any
dispute between contracting parties whether or not the goods
were upto contract. The banks cannot be absolved of their
responsibility to meet the obligations. Lord Jenkins L.J.
Observed that a vendor of goods selling against a con
1135
firmed letter of credit was selling under the assurance that
nothing would prevent it from receiving the price. That was
of no mean advantage when goods manufactured in one country
were sold in another. Though, in this case no international
trade was involved, bank guarantee was uninvocable and on
that assurance parties have bargained This principle
enunciated by Lord Justice Jenkins has been invokved by this
Court in some decisions in case of confirmed bank guarantee.
The Court of Appeal in England had occasion once again
to consider this question in Elian and Rabbath (Trading as
Elian & Rabbath). v. Matsas and Matsas & ors., [1966] 2
Lloyd's List Law Reports 495. In that case injunction was
granted to prevent irretrievable injustice. There the facts
were peculiar In that case the first defendants' Greek motor
vessel Flora M was chartered by Lebanese charterers for
carriage of plaintiffs' cargo (consigned to Hungary) from
Beirut to Rijeka. Discharge was delayed at Rijeka and
shipowners exercised lien on cargo in respect of demurrage
Third defendant bank put up guarantee in London in favour of
second defendants (first defendants' London agents) to
secure release of cargo. There was a claim by Yugoslavians
to distrain on goods, involving ship in further delay and
master of Flora M, on lifting original lien, immediately
exercised another lien in respect of extra delay (which was
raised when Hungarian buyers put up 2000) Two years later,
shipowners claimed arbitration with charterers to assess
demurrage for which first lien was exercised and claimed to
enforce guarantee. Plaintiff claimed declaration that
guarantee was not valid and injunction to restrain
shipowners or their agents from enforcing guarantee First
and second defendants appealed against granting of
injunction by Blain, J. It was held by the Court of Appeal
that it was a special case in which the Court should grant
an injunction to prevent what might be irretrievable
injustice. Lord Denning, M R., observed that although the
shippers were not parties to the bank guarantee,
nevertheless they had a most imporant interest in it. If the
Midland Bank Ltd., paid under this guarantee, they would
claim against the Lebanese bank, who in turn would claim
against the shippers. The shippers would certainly be
debited with the account. On being so debited, they would
have to sue the shipowners for breach of their promise
express or implied, to release the goods. Lord Denning, M R,
further posed the question were the shippers to be forced to
take that course? or can they short-circuit the dispute by
suing the shipowners at once for an injunction? He further
observed on page 497 of the Report that this was a special
case in which injunction should be granted. Lord Denning, M
R. went on to observe that
1136
there was a prima facie ground for saying that, on the telex
messages A which passed (and indeed, on the first three
lines of the guarantee) the shipowners promised that, if the
bank guarantee was given, they would release the goods. He
further observed that the only lien they had in mind at that
time was the lien for demurrage. But would anyone suppose
that the goods would be held for another lien? It can well
be argued that the guarantee was given on the understanding
that the lien was raised and no further lien imposed, and
that when the shipowners, in breach of that understanding
imposed a further lien, they were disabled from acting on
the guarantee But as mentioned here-in-before, this was a
very special case and I shall notice that Lord Denning, M R.
treated this as a very special case and in later decision he
expressed his views on this matter.
This question was again considered by the Queen s Bench
Division by Mr. Justice Kerr in R.D. Harbottle (Mercantile)
Ltd. and Another v. National Westminister Bank Ltd. and
others, [1977] 2 All England Law Reports 862. In this case
injunction was sought on a question in respect of a
performance bond. The learned Single Judge Kerr, J. gave the
following views:-
"i) only in exceptional cases would the courts
interfere with the machinery of irrevocable
obligations assumed by banks. In the case of a
confirmed performance guarantee, just as in the
case of a confirmed letter of credit, the bank was
only concerned to ensure that the terms of its
mandate and confirmation had been complied with
and was in no way concerned with any contractual
disputes which might have arisen between the
buyers and sellers. Accordingly, since demands for
payment had been made by the buyers under the
guarantees and the plaintiffs had not established
that the demands were fraudulent or other special
circumstances, there were no grounds for
continuing the injunctions.
"ii) It was right to discharge the injunctions
against the bank, the fact that the Egyptian
defendants had taken no part in the proceedings
could not be a good ground for maintaining those
injunctions. Further, equally strong
considerations applied in favour of the discharge
of the injunctions against the Egyptian
defendants, and their failure to participate in
the proceedings did not preclude the court from
discharging the injunctions against them."
1137
In my opinion the aforesaid represents the correct
state of the A law. The Court dealt with three different
types of cases which need not be dilated here
In Edward Owen Engineering Ltd. v. Barclays Bank
International Ltd., [1978] 1 All England Law Reports 1976.
English suppliers, entered into a contract with Libyan
buyers to supply goods to them in Libya The contract was
subject to a condition precedent that the plaintiffs would
arrange for a performance bond or guarantee to be given, for
ten per cent of the contract price, guaranteeing performance
of their obligations under the contract. Accordingly, the
plaintiffs instructed the defendants their bankers to give
on their behalf a performance guarantee for the sum of pound
50,203. Acting on those instructions the defendants
requested a bank in Libya to issue performance bond to the
buyers for that sum, and promised the Libyan bank that they
would pay the amount of the guarantee on first demand,
without any conditions or proof. The Libyan bank issued a
letter of guarantee for pound 50,203 to the buyers The
contract between the plaintiffs and the buyers provided for
payment of the price of the goods supplied by a confirmed
letter of credit. The letter of credit opened by the buyers
was not a confirmed letter of credit and did not therefore,
comply with the contract Because of that non-compliance the
plaintiffs repudiated the contract. Although it was the
buyers who appeared to be in default and not the plaintiffs,
the buyers nevertheless claimed on the guarantee given by
the Libyan bank who in turn claimed against the defendants
on the guarantee they had given The plaintiffs issued a writ
against the defendants claiming an injunction to restrain
them from paying any sum under the performance guarantee A
judge granted the plaintiffs an interim injunction in the
terms of the injunction claimed by the writ but subsequently
another judge discharged the injunction The plaintiffs
appealed to the Court of Appeal in England. It was held by a
Bench consisting of Lord Denning M. R., Browne and Geoffrey
Lane, LJ that a performance guarantee was similar to a
confirmed letter of credit. Where therefore, a bank had
given a performance guarantee it was required to honour the
guarantee according to its terms and was not concerned
whether either party to the contract which underlay the
guarantee was in default The only exception to that rule was
where fraud by one of the parties to the underlying contract
had been established and the bank had notice of the fraud.
Accordingly, as the defendants' guarantee provided for
payment on demand without proof or conditions, and was in
the nature of a promissory note payable on demand and the
plaintiffs had not established fraud on the part of the
buyers, the defendants were re-
1138
quired to honour their guarantee on the demand made by the
Libyan Bank. It followed that the judge had been right to
discharge the injunction and that the appeal would be
dismissed.
Lord Denning, M.R. held that Justice Kerr was right in
discharging the injunction and reiterated that the bank must
honour its commitment. The principle must be that upon that
basis trade and commerce are conducted. Lord Denning, M.R.,
indicated at page '984 that seeing that the bank must pay,
and will probably come down on the English suppliers on
their counter-guarantee, it followed that the only remedy of
the English suppliers was to sue the Libyan customers for
damages. The contract contained a clause giving exclusive
jurisdiction to the courts of Libya.
In the instant case, the learned Judge has proceeded on
the basis that this was not an injunction sought against the
bank but this was the injunction sought against the
appellant But the net effect of the injunction is to
restrain the bank from performing the bank guarantee That
cannot be done. One cannot do indirectly what one is not
free to do directly. But a maltreated man in such
circumstances is not remedyless The respondent was not to
suffer any injustice which was irretrievable. The respondent
can sue the appellant for damages. In this case there cannot
be any basis for apprehension that irretrievable damages
would be caused if any. I am of the opinion that this is not
a case in which injunction should be granted An irrevocable
commitment either in the form of confirmed bank guarantee or
irrevocable letter of credit cannot be interfered with
except in case of fraud or in case of question of
apprehension of irretrievable injustice has been made out.
This is the well-settled principle of the law in England.
This is also a well-settled principle of law in India, as I
shall presently notice from some of the decisions of the
High Court and decisions of this Court.
In the instant case there was no fraud involved and no
question of irretrievable in justice was involved.
Before, however, I deal with the decisions of India
reference may be made to a decision of the House of Lords in
United City Merchants (Investments) Ltd. and others v. Royal
Bank of Canada and others, [1982] 2 All England Law Reports
720 where it was reiterated that the whole commercial
purpose for which the system of confirmed irrevocable
documentary credits had been developed in international
trade was to give the seller of goods an assured right to be
paid before he
1139
parted with control of the goods without risk of the payment
being refused reduced or deferred because of a dispute with
the buyer. It followed that the contractual duty owed by an
issuing or confirming bank to the buyer to honour the credit
notified by him on presentation of apparently conforming
documents by the seller was matched by a corresponding
contractual liability on the part of the bank to the seller
to pay him the amount of the credit on presentation of the
documents The bank's duty to the seller was only vitiated if
there was fraud on the part of the seller, and the bank
remained under a duty to pay the amount of the credit to the
seller even if the documents presented, although conforming
on their face with the terms of the credit, nevertheless
contained a statement of material fact that was not
accurate. These principles must in my opinion apply in case
of bank guarantees in internal trade within a country.
I may notice that in India, the trend of law is on the
same line In the case of Texmaco Ltd. v. State Bank of India
and others, A.I.R. 1979 Calcutta 44, one of us (Sabyasachi
Mukharji) held that in the absence of special equities
arising from a particular situation which might entitle the
party on whose behalf guarantee is given to an injunction
restraining the bank in performance of bank guarantee and in
the absence of any clear fraud, the Bank must pay to the
party in whose favour guarantee is given on demand, if so
stipulated, and whether the terms are such have to be found
out from the performance guarantee as such. There the Court
held that where though the guarantee was given for the
performance by the party on whose behalf guarantee was
given, in an orderly manner its contractual obligation, the
obligation was undertaken by the bank to repay the amount on
"first demand" and 'without contestation, demur or protest
and without reference to such party and without questioning
the legal relationship subsisting between the party in whose
favour guarantee was given and the party on whose behalf
guarantee was given," and the guarantee also stipulated that
the bank should forthwith pay the amount due notwithstanding
any dispute between the parties," it must be deemed that the
moment a demand was made without protest and contestation,
the bank had obliged itself to pay irrespective of any
dispute as to whether there had been performance in an
orderly manner of the contractual obligation by the party.
Consequently, in such a case, the party on whose behalf
guarantee was given was not entitled to an injunction
restraining the bank in performance of its guarantee It
appears that special equities mentioned therein may be a
situation where the injunction was sought for to prevent
injustice which was irretrievable in the words of Lord
Justice Danckwerts in Elian and
1140
Rabbath (Trading as Elian & Rabbath) v. Matsas and Matsas &
Ors. (supra).
The same view was more or less expressed by the High
Court of Calcutta in its decision in the case of State Bank
of India v. The Economic Trading Co. S.A.A. and others,
A.I.R. 1975 Calcutta 145. See also a decision in the case of
B.S. Aujla Company Pvt. Ltd. v. Kaluram Mahadeo Prosad and
others, A. I . R . 1983 Calcutta 106. In the instant case I
have emphasised the terms of the Bank guarantee.
Our attention was drawn to Bench decision of the
Allahabad High Court in the case of Union of India and
others v. Meena Steels Ltd. and Another, AIR 1985 Allahabad
282. There a suit by a company was filed restraining
Railways to encash bank guarantee. In that suit application
was made for temporary injunction. The Court was of the view
that the matter would still be referred to arbitration and
in those circumstances if bank guarantees were permitted to
be encashed, if would be improper. I am however, unable to
sustain this view, in view of the well-settled principle on
which bank guarantees are operated.
Our attention was also drawn to the judgment of the
learned single Judge of the Madras High Court in Arul
Murugan Traders v. Rashtriya Chemicals and Fertilizers Ltd.
Bombay and another, A.I.R. 1986 Madras 161 where the learned
Single Judge expressed the opinion that there was no
absolute rule prohibiting grant of interim injunction
relating to Bank guarantees and in exceptional case courts
would interfere with the machinery of irrevocable
obligations assumed by banks, and that the plaintiff must
establish prima facie case, meaning thereby that there is a
bona fide contention between the parties or serious question
to be tried and further the balance of convenience was also
a relevant factor. If the element of fraud exists, then
courts step in to prevent one of the parties to the contract
from deriving unjust enrichment by invoking bank guarantee.
In that case the learned Single Judge came to the conclusion
that the suit involved serious questions to be tried and
particularly relating to the plea of fraud, which was a
significant factor to be taken into account and claim for
interdicting the enforcement of bank guarantee should have
been allowed.
I am however, of the opinion that these observations
must be strictly considered in the light of the principle
enunciated. It is not the decision that there should be a
prima facie case. In order to restrain
1141
the operation either of irrevocable letter of credit or of
confirmed letter of credit or of bank guarantee, there
should be serious dispute and there should be good prima
facie case of fraud and special equities in the form of
preventing irretrievable injustice between the parties.
Otherwise the very purpose of bank guarantees would be
negatived and the fabric of trading operation will get
jeopardised.
In Tarapore & Co. Madras v. M/s V/o Tractors Export,
Moscow and Anr. [1969] 2 S R 920 this Court observed that
irrevocable letter of credit had a definite implication. It
was independent of and unqualified by the contract of sale
or other underlying transactions. It was a machanism of
great importance in international trade and any interference
with that mechanism was bound to have serious repercussions
on the international trade of this country The Court
reiterated that the autonomy of an irrevocable letter of
credit was entitled to protection and except in very
exceptional circumstances courts should not interfere with
that autonomy
These observations a fortiori apply to a bank guarantee
because upon bank guarantee revolves many of the internal
trade and transactions in a country. In United Commercial
Bank v. Bank of India and others, [1981] 3 S C.R. 300, this
Court was dealing with injunction restraining the bank in
respect of letter of credit. This Court observed that the
High Court was wrong in granting the temporary injunction
restraining the appellant bank from recalling the amount
paid to the respondent bank. This Court reiterated that
Courts usually refrain from granting injunction to restrain
the performance of the contractual obligations arising out
of a letter of credit, or a bank guarantee between one bank
and another. If such temporary injunction were to be granted
in a transaction between a banker and a banker, restraining
a bank from recalling the amount due when payment was made
under reserve to another bank or in terms of the letter of
guarantee or credit executed by it the whole banking system
in the country would fail
The Court however, observed that the opening of a
confirmed letter of credit constituted a bargain between the
banker and the seller of the goods which imposed on the
banker an absolute obligation to pay. The banker was not
bound or entitled to honour the bills of exchange drawn by
the seller unless they and such accompanying documents as
might be required thereunder, were in exact compliance with
the terms of the credit.
This principle was again reiterated by this Court in
Centax
1142
(India) Ltd. v. Vinmar Impex Inc. and others, [1986] 4
S.C.C. 136 A where the appellant entered into a contract
with the respondent company of Singapore for supply of
certain goods to it. The Contract, inter alia stipulated
that the bills of lading should mention 'shipping mark
5202'. Pursuant to the contract, at the request of the
appellant the Allahabad Bank opened a letter of credit, it
favour of the respondent. The respondent thereupon
despatched the goods covered by the bills of lading
This Court was concerned with the bank guarantee and
referred to the previous decision of this Court in United
Commercial Bank v. Bank of India and others, (supra). This
Court found that this case was covered. The Court observed
that the Court should not, in transaction between a banker
and banker, grant an injunction at the instance of the
beneficiary of an irrevocable letter of credit, restraining
the issuing bank from recalling the amount paid under
reserve from the negotiating bank, acting on behalf of the
beneficiary against a document of guarantee, indemnity at
the instance of the beneficiary
On the basis of these principles I reiterate that
commitments of banks must be honoured free from interference
by the courts. Otherwise, trust in commerce internal and
international would be irreparably damaged. It is only in
exceptional cases that is to say in case of fraud or in case
of irretrievable injustice be done, the Court should
interfere.
Mr. Tarkunde submitted before us that in this case the
grievance of the appellant was that there was delay in
performance and defective machinery had been supplied. He
submitted that if at this stage appellant was allowed to
enforce the bank guarantee, damage would be done. He
submitted before us that appellant could not be permitted to
take advantage of illegality by invoking the bank guarantee.
But in my opinion these contentions cannot deter us in view
of the principle well-settled that there should not be
interference in trade. This is not a case where
irretrievable injustice would be done by enforcement of bank
guarantee. This is also not a case where a strong prima
facie case of fraud in entering into a transaction was made
out. If that is the position, then the High Court should not
have interfered with the bank guarantee.
In the aforesaid view of the matter, this appeal must
be allowed The Judgment and order or the Allahabad High
Court dated 20 2.87 must be set aside and the order of the
learned civil Judge Lucknow dated 8.8 86 restored.
1143
In the facts and circumstances of the case parties will
bear their own costs of this appeal.
JAGANNATHA SHETTY, J. l agree respectfully with the
judgment of my learned brother Sabyasachi Mukherji, J. I
wish, however, to draw attention to some of the aspects of
the matter to which I attach importance. The crux of the
matter relates to the obligation assumed by the bank under a
performance guarantee. Whether the obligation is similar to
the one arising under a letter of credit? Whether the Court
could interfere in regard to such obligation, and if so,
under what circumstances? These are the questions raised in
this appeal.
The facts which are relevant for my purpose are these:
On May 17, 1983, M/s. Singh Consultants & Engineers
(Pvt.) Ltd. ("SCE (P) Ltd.") entered into a contract
with U.P. Cooperative Federation Ltd. ("UPCOF Ltd.")
for constructing a Vanaspati manufacturing plant at
Haldpur, District Nainital, U.P. The contract required
that UPCOF Ltd. should be given two bank guarantees for
proper construction and successful commissioning of the
plant. In accordance with the terms of the contract,the
Bank of India gave two guarantees in favour of UPCOF
Ltd., one for Rs.16,50,000 and another for
Rs.33,00,000. These contain similar terms and
conditions. Thereunder, the bank has undertaken not to
revoke the guarantee in any event before the expiry of
the due date. The Bank has also undertaken to make
unconditional payments on demand. without reference to
SCE (P) Ltd. The guarantee also provides that the UPCOF
Ltd. was the sole judge for deciding whether SCE(P)
Ltd. has fulfilled the terms of the contract or not.
The guarantee was thus undisputedly irrevocable with
absolute discretion for UPCOF Ltd. to invoke the same.
The dispute arose between the parties as to the
erection and performance of the plant. The SCE(P) Ltd.
apprehending that the bank guarantees would be invoked by
the UPCOF Ltd, approached the Court of the Civil Judge,
Lucknow for a restraint order against the latter. The action
was brought under Sec. 41 of the Arbitration Act read with
order 39 r. 1 and 2 of the Code of Civil Procedure
contending inter-alia, that there was no default in the
construction or delivery of possession of the plant. But the
UPCOF Ltd. had a different version. It contended that the
construction was not within the time schedule and
performance of the plant was not up to the mark. It also
1144
contended that the Court should not grant injunction in the
matter.
The trial court refused to interdict UPCOF Ltd. the
SCE(P) Ltd. took up the matter in revision before Lucknow
Bench of the Allahabad High Court. The learned Judge before
whom the matter came up for disposal was of the view that
SCE(P) Ltd. has made out a prima facie case . It has prima
facie proved that the plant was delivered after a trial run
and commercial production had started. So stating, learned
Judge allowed the revision and granted the relief sought
for. The UPCOF Ltd. was restrained from invoking the bank
guarantees. The learned Judge, however, issued a direction
to SCE(P) Ltd. to keep alive the bank guarantees during the
pendency of the arbitration proceedings.
The UPCOF Ltd. by special leave has come up before this
Court challenging the validity of the order of the High
Court. The Primary question for consideration is whether the
High Court was justified in restraining the appellant from
invoking the Bank guarantees? The submission of Mr. A.B.
Diwan learned counsel for the appellant rested on the law
governing the irrevocable letter of credit where courts keep
themselves away from the liability assumed by the banks. In
support of the submission, the counsel strongly relied upon
the two decisions of this Court: (i) United Commercial Bank
v.. Bank of India & Ors., [1981] 3 SCR 300 and (ii) Centax
(India) Ltd. v. Vinmar Impex Inc. & Ors. [1986] 4 SCC 136.
Mr. V.M. Tarkunde, learned counsel for the respondent or the
other hand, urged that both the said decisions are not
relevant since the present case concerns with rights and
obligations of parties under a construction contract. The
rights under the contract in question are justiciable in the
Court of law. The performance guarantee given by the Bank
flows from the terms of the construction contract. But the
issues to be determined in the suit do not relate to the
obligations of the bank under the guarantees given and the
bank is also not a party to the suit. The counsel further
urged that the respondent has established a prima facie case
to justify the grant of injunction and this Court should not
interfere with the discretionary relief granted.
The argument for the respondent is attractive but it
seems to overlook the basic nature of the case. The basic
nature of the case relates to the obligations assumed by the
bank under the guarantees given to UPCOF Ltd. If under law,
the bank cannot be prevented by SCE(P) Ltd from honouring
the credit guarantees, the UPCOF Ltd. also cannot be
restrained from invoking the guarantees. What applies
1145
to the bank must equally apply to UPCOF Ltd. Therefore, the
frame of the suit by not impleading the bank cannot make any
difference in the position of law. Equally, it would he
futile to contend that the court was justified in granting
the injunction since it has found a prima facie case in
favour of the SCE(P) Ltd. The question of examining the
prima facie case or balance of convenience does not arise if
the court cannot interfere with the unconditional commitment
made by the bank in the guarantees in question.
The modern documentary credit had its origin from
letters of credit. We may, therefore, begin the discussion
with the traditional letter of credit. Paul R. Verkuil in an
article [Bank Solvency and Guaranty Letters of Credit,
Standford Law Review V. 25 (1972-73 at p. 719)] explains the
salient features of a letter of credit in these terms: C
"The letter of credit is a contract. The issuing
party-usually a bank-promises to pay the
'beneficiary'-traditionally a seller of goods-on
demand if the beneficiary presents whatever
documents may be required by the letter. They are
normally the only two parties involved in the
contract. The bank which issues a letter of credit
acts as a principal, not as agent for its
customer, and engages its own credit. The letter
of credit thus 'evidences-irrevocable obligation
to honour the draft presented by the beneficiary
upon compliance with the terms of the credit."
The letter of credit has been developed over hundreds
of years of international trade. It was most commonly used
in conjunction with the sale of goods between geographically
distant parties. It was intended to facilitate the transfer
of goods between distant and unfamiliar buyer and seller. It
was found difficult for the seller to rely upon the credit
of an unknown customer. It was also found difficult for a
buyer to pay for goods prior to their delivery. The bank's
letter of credit came into existence to bridge this gap. In
such transactions, the seller (beneficiary) receives payment
from issuing bank when he presents a demand as per terms of
the documents. The bank must pay if the documents are in
order and the terms of credit are satisfied. The bank,
however, was not allowed to determine whether the seller had
actually shipped the goods or whether the goods conformed to
the requirements of the contract. Any dispute between the
buyer and the seller must be settled between themselves. The
Courts, however, carved out an exception to this rule of
absolute independence. The Courts held that if there has
been "fraud in the transaction
1146
the bank could dishonour beneficiary's demand for payment.
The A Courts have generally permitted dishonour only on the
fraud of the beneficiary, not the fraud of somebody else.
It was perhaps for the first time the said exception of
fraud to the rule of absolute independence of the letter of
credit has been applied by Shientag, J. in the American case
of Sztejn v. J. Henry Schroder Banking Corporation, (31
N.Y.S. 2d 631). Mr. Sztejn wanted to buy some bristles from
India and so he entered into a deal with an Indian seller to
sell him a quantity. The issuing bank issued a letter of
credit to the Indian seller that provided that, upon receipt
of appropriate documents, the bank would pay for the
shipment. Somehow Mr. Sztejn discovered that the shipment
made was not crates of bristles, but crates of worthless
material and rubbish. He went to his bank which probably
informed him that the letter of credit was an independent
undertaking of the bank and it must pay.
Mr. Sztejn did not take that sitting down. He went to
court and he sought an injunction. Now in 1941 people just
did not get injunctions against payment under letters of
credit. The defendant bank, against its customer, filed the
equivalent of a motion to dismiss for failure to state a
claim. In that posture all the allegations of the complaint
were taken as true, and those allegations were gross fraud
that the holders in due course were involved. On those
facts, the court issued an injunction against payment.
The exception of fraud created in the above case has
been codified in sec. 5-114 of the Uniform Commercial Code.
It has been accepted by Courts in England. See: (i) Hamzeb
Milas and Sons v. British Lmex Industries Ltd. [1958] 2 QBD
127], (ii) R.D. Harbottle (Mercantile) Ltd. and another v.
National West-Minister Bank Ltd. [1977] 2 All E.R. 862;
(iii) Edward Owen Engineering Ltd. v. Barclays Bank
International Ltd., [1978] l All E.R. 976 and (iv) UCM
(Investment) v. Royal Bank of India, [1982] 2 All E.R. 720.
The last case is of the House of Lords where Lord Diplock in
his speech said (at p. 725):
"The whole commercial purpose for which the
system of confirmed irrevocable documentary
credits has been developed in international trade
is to give to the seller an assured right to be
paid before he parts with control of the goods and
that does not permit of the any dispute with the
buyer as to the performance of the contract of
sale being used as a ground for non-payment or
reduction or deferment of payment.
1147
"To this general statement of principle as to
the contractual obligations of the confirming bank
to the seller, there is one established exception:
that is, where the seller, for the purpose of
drawing on the credit, fradulently presents to the
confirming bank documents that contain, expressly
or by implication, material representations of
fact that to his knowledge are untrue. Although
there does not appear among the English
authorities any case in which this exception has
been applied, it is well established in the
American cases, of which the leading or 'landmark'
case is Sztejn v. Henry Schroder Banking Corp., [
1941] 3 1 NYS 2d 63 1. This judgment of the New
York Court of Appeals was referred to with
approval by the English Court of Appeal in Edward
Owen Engineering Ltd. v. Barclays Bank
International Ltd. [1978] 1 All E.R. 979 (1978)
QB 159 though this was actually a case about a
performance bond under which a bank assumes
obligation to a buyer analogous to those assumed
by a confirming bank to the seller under a
documentary credit. The exception for fraud on the
part of the beneficiary seeking to avail himself
of the credit is a clear application to the maxim
ex trupi cause non oritur actio or if plain
English is to be preferred, 'fraud unravels all',
the courts will not allow their process to be used
by a dishonest person to carry out a fraud."
This was also the view taken by this Court in United
Commercial Bank case [1981] 3 SCR 300. There A.P. Sen, J.
speaking for the Court, said (pages 323 and 324):
"The rule is well established that a bank
issuing or confirming a letter of credit is not
concerned with the underlying contract between the
buyer and seller. Duties of a bank under a letter
of credit are created by the document itself, but
in any case it has the power and is subject to the
limitations which are given or imposed by it, in
the absence of the appropriate provisions in the
letter of credit.
"It is somewhat unfortunate that the High
Court should have granted a temporary injunction,
as it has been done in this case, to restrain the
appellant from making a recall of the amount of
Rs.85,84,456 from the Bank of India in terms of
the letter of guarantee or indemnity executed by
it. The courts usually refrain from granting
injunction to
1148
restrain the performance of the contractual
obligations arising out of a letter of credit or a
bank guarantee between one bank and another. If
such temporary injunctions were to be granted in a
transaction between a banker and a banker,
restraining a bank from recalling the amount due
when payment is made under reserve to another bank
or in terms of the letter of guarantee or credit
executed by it, the whole banking system in the
country would fail.
"In view of the banker's obligation under an
irrevocable letter of credit to pay, his buyer-
customer cannot instruct him not to pay."
In Centax (India) Ltd., [1986] 4 SCC 136, this Court
again speaking through A.P. Sen, J. following the decision
in the United Commercial Bank case said: "We do not see why
the same principles should not apply to a banker's letter of
indemnity."
It is true that both the decisions of this Court dealt
with a contract to sell specific commodities or a
transaction of sale of goods with an irrevocable letter of
credit. But in modern commercial transactions, various
devices are used to ensure performance by the contracting
parties. The traditional letter of credit has taken a new
meaning. In business circles, standby letters of credit are
also used. Performance bond and guarantee bond are also the
devices increasingly adopted in transactions. The Courts
have treated such documents as analogous to letter of cedit.
A case involving the obligations under a performance
guarantee was considered by the Court of Appeal in Edward
Owen Engineering Ltd. v. Barclay's Bank International Ltd.,
[1978] 1 All E.R. 976. The facts in that case are these:
English sellers entered into a contract to supply and erect
glass-houses in Libya. The Libyan buyers were to open an
irrevocable letter of credit in favour of the sellers. The
sellers told their English bank to give a performance
guarantee. The English bank instructed a Libyan bank to
issue a performance bond in favour of the buyers for a
certain sum and gave their guarantee payable on demand
without proof or conditions to cover that sum. The Libyan
bank issued a bond accordingly. The sellers received no
confirmed letter of credit and refused to proceed with the
contract. The sellers obtained in interim injunction to
prevent the English bank from paying on the guarantee. On
appeal Lord Denning M.R. said:
1149
"So as on takes instance after instance these
performance guarantees are virtually promissory
notes payable on demand. So long as the Libyan
customers make an honest demand, the banks are
bound to pay and the banks will rarely, if ever,
be in a position to know whether the demand is
honest or not. At any rate they will not be able
to prove it to be dishonest. So these will have to
pay. "
And said:
"All this leads to the conclusion that the
performance guarantee stands on a similar footing
to a letter of credit. A bank which gives a
performance guarantee must honour that guarantee
according to its terms. It is not concerned in the
least with the relations between the supplier and
the customer: nor with question whether the
supplier has performed his contractual obligation
or not; nor with the question whether supplier is
in default or not. The bank must pay according to
its guarantees, on demand if so stipulated,
without proof or conditions. The only exception is
when there is a clear fraud of which the bank has
noticed. "
Whether it is a traditional letter of credit or a new
device like performance bond or performance guarantee, the
obligation of banks appears to be the same. If the
documentary credits are irrevocable and independent, the
banks must pay when demand is made. Since the bank pledges
its own credit involving its reputation, it has no defence
except in the case of fraud. The bank's obligations of
course should not be extended to protect the unscrupulous
seller, that is the seller who is responsible for the fraud.
But, the banker must be sure of his ground before declining
to pay. The nature of the fraud that the Courts talk about
is fraud of an "egregious nature as to vitiate the entire
underlying transaction". It is fraud of the beneficiary, not
the fraud of somebody else. If the bank detects with a
minimal investigation the fraudulent action of the seller,
the payment could be refused. The bank cannot be compelled
to honour the credit in such cases. But it may be very
difficult for the bank to take a decision on the alleged
fraudulent action. In such cases, it would be proper for the
bank to ask the buyer to approach the Court for an
injunction.
The Court, however, should not lightly interfere with
the operation of irrevocable documentary credit. I agree
with my learned
1150
brother that in order to restrain the operation of
irrevocable letter of credit, performance bond or guarantee,
there should be serious dispute to be tried and there should
be a good prima facie acts of fraud. As Sir John Donaldson
M.R. said in Bolivinter oil SA v. Chase Mannattan Bank &
ors. [1984] 1 All E.R. 35 1 at 352:
"The wholly exceptional case where an
injunction may be granted is where it is proved
that the bank knows that any demand for payment
already made or which may thereafter be made will
clearly be fraudulent. But the evidence must be
clear both as to the fact of fraud and as to the
bank's knowledge. It would certainly not normally
be sufficient that this rests on the
uncorroborated statement of the customer, for
irreparable damage can be done to a bank's credit
in the relatively brief time which must elapse
between the granting of such an injunction and an
application by the bank to have it discharged."
From the above discussion, what appears to me is this:
The sound banking system may, however, require more caution
in the issuance of irrevocable documentary credits. It would
be for the banks to safeguard themselves by other means and
generally not for the court to come to their rescue with
injunctions unless there is established fraud. In the
result, this appeal must be allowed. The judgment and order
of the Allahabad High Court dated February 20, 1987 must be
set aside and the order of learned Civil Judge, Lucknow
dated August 8, 1986 restored.
S.L. Appeal allowed.
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