Supreme Court of India

HINDUSTAN STEELWORKS CONSTRUCTION LTD.versusTARAPORE AND CO. AND ANR.

Citation: 1996 INSC 722
Decided: 9 July 1996
Disposal: Appeal(s) allowed
Bench: S C AGRAWAL

Holding

An irrevocable bank guarantee is an independent, unconditional contract that must be honoured without court interference except in cases of fraud or where irretrievable injustice would result.

Summary

Hindustan Steelworks Construction Ltd. (HSCL) awarded a construction contract to Tarapore & Co. (the contractor) and obtained fourteen unconditional bank guarantees from Bank of India, each stipulating that HSCL was the sole judge on breach and loss. After the contractor failed to complete the work, HSCL rescinded the contract and demanded payment under the guarantees; the contractor sought injunctions, arguing that the disputes were pending before arbitrators and the guarantees should not be encashed until a breach was determined. The High Court granted the injunctions, holding that the guarantees were enforceable only after a court or arbitrator quantified damages, and that the “sole judge” clause was invalid. On appeal, the Supreme Court reaffirmed that an irrevocable bank guarantee is an independent, unconditional contract whose obligations must be honoured without court interference, except in cases of fraud or where irretrievable injustice would result. The Court found the contractor’s alleged special equities insufficient to constitute an exceptional case and set aside the High Court’s injunctions, staying enforcement of the guarantees only until 31 July 1996. The appeals were allowed, and costs were awarded to the appellant.

Issues considered

The nature of an unconditional bank guarantee and whether it is independent of the underlying contract.
Whether a court may restrain the beneficiary from encashing an irrevocable bank guarantee in the absence of fraud.
Whether the presence of pending arbitration and disputes constitutes ‘special equities’ justifying injunction.

Legislation cited

Arbitration Act, 1940s. 41(b), s. Schedule II

Subjects

bank guaranteeirrevocable letter of creditinjunctionarbitrationfraudirretrievable injusticecontract lawperformance guarantee

Judgment

A HINDUSTAN STEELWORKS CONSTRUCTION LTD.
v.
TARAPORE AND CO. AND ANR.

JULY 9, 1996
B
(S.C. AGRA WAL AND G.T. NANA VAT!, JJ.]

Bank Guarantee-Enforcement of-Commitments of banks must be
honoured free from inte1fcrence by courts--Powers of courts to inter-
fere-Lin1itations.
c
The appellant awarded a contract to the contractor for construction
of civil works. Some disputes arose between the appellant and the contrac-
tor. Two arbitrators were appointed by the parties for deciding those
disputes. The appellant rescinded the contract as the contractor did not
D complete the work. Bank of India has given 14 guarantees on different
dates in favour of the appellant at the instance of the contractor. By these
bank guarantees, bank had undertaken to indemnify the appellant against
any loss or damage caused to or suffered by it by reason of any breach by
the contractor, stating that appellant shall be the sole Judge on the
question as to whether the contractor had committed any breach of the
E contract and also regarding the extent of loss and damage. The bank had
nndertaken to pay the appellant any amount pay.able by the contractor
without any demur and protest and such demand by the appellant had to
be required as conclusive and binding on the bank notwithstanding any
difference between the appellant and the contractor. On the day on which
F the appellant rescinded the contract, the appellant called upon the bank
to pay to it the amount of loss/damage it has suffered as the contractor
had failed to fulfil its obligations under the contract and had committed
breach of its terms and conditio~,S' The contractor prayed for an injunc-
tion restraining the appellant froin encashing the bank guarantees alleging
that there were genuine disputes between the parties and those disputes
G had been referred to the Arbitrators for adjudication. Both the petitions
were dismissed as the court refused to grant injunction holding that the
bank guarantees were unconditional. The contractor filed revision peti-
tions against the judgment contending that the bank guarantees were given
by way of security for due performance of the contract and for the purposes
H connected therewith and therefore they would be encashable only when,the
396
HINDUSTAN STEELWORKS CONSTN. LTD. v. TARAPORE AND CO. 397

arbitrators decide that the contractor had committed a breach of the A
contract and the amount of loss or damage caused to or suffered by the
appellant was quantified and that as the dispute in this behalf were
pending before the arbitrators the demand for encashment of the bank
guarantees was premature. Allo\\ing the revisions, the High Court held
that in absence of any detern1ination by the Court or the arbitrator no
B
amount could be said to be payable by the contractor to the appellant by
way of damages. Therefore, it will be just and proper to restrain the
appellant from enforcing the bank guarantees; that any term in the agree-
ment that one of the parties shall be the sole judge to quantify the same
has to be held as invalid and that it is for the Court or the arbitrator to
decide as to who bad committed the breach and till the liability was C
ascertained, it could not be said that there was a 'debt due or debt owing'
and that the interest of the appellant could be safeguarded by directing
the contractor to go on extending the bank guarantees till the matter was
settled by the arbitrators. This appeal had been filed against the judgment
of the High Court. D
The appellant submitted that in the matter of encashment of a bank
guarantee the Court should not as a rule interfere unless it is a clear case
of fraud and is likely to result in frretrievable injustice. The respondent
contended that though fraud is an established exception to the general rule
regarding interference with the autonomy of irrevocable letter of credit or E
a bank guarantee that is not the only exception and the Court can and
should interfere where special circumstances or special equities exist and
they are likely to resultin irretrievable injustice.

Allowing the appeals, this Court p

HELD 1.1. An irrevocable letter of credit is a contract between the
banker and the beneficiary and is independent of and unqualified by the
contract of sale or other underlying transaction and that obligation of a
·.bank in such a case is absolute, as a letter of credit constitutes the sole G
contract with the bank and the bank issuing the letter of credit has no
concern with any question that m·ay arise between the seller and the
purchaser of the goods; The Courts usually refrain from granting injunc-
tion to restrain the performance of the contractual obligations arising out
of a letter or credit or a bank guarantee between the bank and another. In
case of an unconditional bank guarantee the nature of obligation of the H
398 SUPREME COURT REPORTS IJ996] SUPP. 3 S.C.R.

A bank is absolute and not dependent upon any dispute or proceedings
between the party at whose instance the bank guarantee is given and the
beneficiary. \Vhether the bank guarantee is towards security deposit or for
due performance of the contract if the same is unconditional and if there
is a stipulation in the bank guarantee that the bank should pay on demand
B \Vithout a demur and that the beneficiary shall be tht' sole judge not only
on the question of breach of contract but also with respect to the amount
of loss or damages, the obligation of the bank would remain the same and
that obligation has to be discharged in the manner provided in the bank
guarantee. [404-A-E, 405-C, 406-C-D, F-G]

C 1.2. Commitments of hanks must be honoured free from interference
by the courts and it is only in exceptional cases that is to say in case of
fraud or in case of irretrievable injustice would be done the courts should
interfere. Fraud cannot be said to be the only exception. In a case \vhere
the party approaching the Court is able to establish that in view of special
D equities in his favour if injunction as restricted is not granted then he
would suffer irretrievable injustice, the Court can and would interfere.
l'raud which is recognised as an exception is the fraud by one of the parties
to the underlying contract and which has the effect of vitiating the entire
underlying transaction. A demand by the beneficiary under the bank
guarantee may become fraudulent not because of any fraud committed by
E the beneficiary while executing the underlying contract but it may become
so because of subsequent events or circumstances. The Courts should
restrain a person making such a fraudulent demand from enforcing a bank
guarantee. [409-C-E]

F 13. In this case fraud has not been pleaded and the relief for
injunction was sought by the contractor/Respondent 1 on the ground that
special equities or the special circumstances of the case required it. The
special circumstances and/or special equities which have been pleaded in
this case >"ere that there was a serious dispute on the question as to who
had committed breach of the contract, that the contractor had a counter
G claim against the appellant, that the disputes between the parties had been
referred to the arbitrators and that no amount could be said to be due and
payaLie by the contractor to the appellant till the arbitrators declared their
award. These factors were not sufficient to make this case an exceptional
case justifying interference by restraining the appellant from enforcing the
H bank guarantees. [411-F-H, 412-A]
HINDUSTANSTEELWORKSCONSfN. LID." TARAPOREM<DCO. [NANAVATI.J.J 399

Tarapore & Co. v. Tractor Export, Moscow, [1969) 2 SCR 920; United A
Commercial Bank v. Bank of India, (1981) 3 SCR 300; Centax (India) Ltd.v.
Vinmar Impex Inc., [1986] 4 SCC 136; UP. Cooperative Federation Ltd. v.
Singh Consultants and Engineers (P) Ltd., (1988] 1 SCC 174; General
Elec(lic Technical Se1vices Co. Inc. v.Punj Sons (P) Ltd., (1991] 4 SCC 230;
La1o·en & Toubro Ltd. v. Maharashtra State Elect1icity Board, [1995) 6 SCC
B
68; Hindustan Steel Workers Construction Ltd. v. G.S. Atwal & Co. (En-
gineers) Pvt. Ltd., [1995) 6 SCC 76 and Svenska Handelsbanken v. Mis.
Indian Charge Chrome, [1994) 1 SCC 502, relied on.

Elian and Rabbath v. Matsas and Matsas, [1966] 2 Llyod's Rep 495;
Handerson v. Canadian Impe1ial Bank of Commercie and Peat Marwick Ltd., C
40 British Columbia LR 318 and Itek Corporation v. The First National Bank
of Boston, 566 FED Supp 1210, referred.

CIVIL APPELLATE JURISDICTION: Civil Appeal Nos. 4713-14
of 1990.
D
From the Judgment and Order dated 28.12.89 of the Andhra Pradesh
High Court in C.R.P. Nos. 3865 and 3866 of 1989.

Dr. Shankar Ghosh, Badar Durrez Ahmed, for the Appellant.

G.L. Sanghi, K.R. Nambiar and R. Murari for the Respondents. E

The Judgment of the Court was delivered by

NANAVATI, J. These two appeals, by special leave, are directed
against the Judgment and Order passed by the Andhra Pradesh High Court F
in Civil Revision Petition No. 3865 and 3866 of 1989. The High Court
allowed the revision petitions, set· aside the common order passed by the
subordinate Judge, Visakhapatnam in O.P. No. 456 and 457 of 1988 and
passed an order of injunction restraining Hindustan Steelwork Construc-
tion Ltd. (the appellant and for short referred to as HSCL) from encashing G
, the bank guarantees given by Bank of India in its favour at the instance of
M/s. Tarapore & Co. (Respondent No.land hereinafter referred to as tlie
contractor).

The HSCL awarded a contract to the contractor for construction of
civil works in its Visakhapatnam Steel Plant. On 16.3.84 a letter of intent H
400 SUPREME COURT REPORTS [1996] SUPP. 3 S.C.R.

A was issued and the formal contract was signed on 25.10.84. It was a
lumpsum contract for Rs. 19,21,36,804 and was to be completed on or
before 15.11.1985. The contractor was not able to complete the work within
the stipulated time and at its request the time for completion of the work
was extended till 31.3.87. Even during this extended period the contractor
B could not complete the work. It appears that some disputes arose between
the appellant and the contractor and on 28.8.1986 the contractor appointed
an arbitrator and called upon the appellant to appoint its arbitrator for
deciding those disputes. Now those disputes are pending before the two
mbitrators appointed by the parties. In August, 1988 by mutual agreement
the contract work was reduced and the contract price was fixed at Rs. 4.5
C crores. This reduced work also was not completed within the extended time
and at the request of the contractor the time for completing the work was
extended till 30.9.1988. As the contractor did not complete the work by
that time the HSCL rescinded the contract on 17.10.1988.

D In between 30.1.84 and 8.12.87, Bank of India gave 14 guarantees in
favour of HSCL at the instance of the Contractor. Bank guarantee No. 3/21
was furnished on 28.1.84 and 3/39 on 21.2.84 for Rs. 10 lacs and 40 lacs
respectively towards mobilisation advances. Bank guarantee No. 3/58 dated
28.3.84 for Rs. 17,04,580 was towards security deposit. Bank guarantee No.
6/175 given on 31.7.87, initially for Rs. 45 lacs and subsequently reduced to
E 36,25,000, was to secure the working funds provided by HSCL to the
contractor and also for due performance of the contract. Rest of the bank
guarantees were furnished on different dates as and when security deposits
were released by HSCL. By these bank guarantees, except bank guarantee
No. 6/175, bank has undertaken to indemnify HSCL against any loss or
F damage caused to or suffered by it by reason of any breach by the
contractor of any term and condition of the contract. It is also stipulated
in the bank guarantees that HSCL shall be the sole Judge on the question
as to whether the contractor has committed any breach of the contract and
what is the extent of loss or damage. It is further stipulated therein that
the decision of HSCL in this behalf shall be treated as final and binding
G on the bank. By furnishing bank guarantee 6/175 the bank has undertaken
to pay HSCL on demand any amount payable by the contractor without
any demur and protest, without any reference to the contractor and such
demand by HSCL has to be regarded as conclusive and binding on the
bank notwithstanding any difference between the HSCL and the contrac-
H tor.
HIN DUSTAN STEELWORK' CONSTN. LTD. v. TARAPORE AND CO. !NANAVATI, 11 401

On the very day on which the appellant rescinded the contract, that A
is on-17.10.88, HSCL by three separate demand letters informed the bank
that the contractor has failed to fulfil its obligations under the contract and
has committed breach of its terms and conditions and by reasons thereof
it has suffered loss/damage far exceeding the amount guaranted by the
bank, but for the purpose of invoking the bank guarantees it has assessed B
such 'loss/damage at Rs. 1,49,76,580. By those letters it also called upon the
bank to pay to the appellant the said sum without any demur or protest.

The contractor on coming to know of this demand filed O.P. No.
456/88 and 457/88 under Section 41(b) read with Schedule II of the
Arbitration Act in the Court of Principal Subordinate Judge at Visakhapat- C
nam and prayed for an injunction restraining HSCL from encashing the
bank guarantees. O.P. No. 457/88 was in respect of bank guarantees No.
3/21 and 3/39 and O.P. No. 456/88 for the other bank guarantees. The
ground urged for granting the injunction was that there are genuine dis-
putes between the parties and those disputes have been referred to the D
Arbitrators for adjudication. The court finding that the bank guarantees
are unconditional refused to grant injunction and dismissed both the
petitions by a common judgment:

The contractor thereupon filed two revts10n pet11Ions before the
Andhra Pradesh High Court. CRP No. 3865/89 was filed against the E
Judgment and order passed in O.P. 456/88 CRP No. 3866/89 was filed
against the judgment and order passed in O.P. No. 457/88. It was con-
tended on behalf of the contractor that the bank guarantees were given by
way of security for. due performance of the contract and for the purposes
connected therewith and therefore they would be encashable only when F
the arbitrators decide that the contractor has committed a breach of the
contract and the amount of loss or damage caused to or suffered by HSCL
is quantified. It was submitted that as the disputes in this behalf are
pending before the arbitrators the demand for encashment of the bank
guarantees was premature. After referring to this contention the High
Court observed as under : G

"It is now well established that unless there is fraud or special
circumstances or equities exist, the beneficiary cannot be
restrained from encashing the letter of crediti even if there are
disputes between the beneficiary and the person at whose instance H
402 SUPREME COURT REPORTS [1996] SUPP. 3 S.C.R.

A the letter of credit was given by the Bank. The same principle is
extended in regard to the performance guarantees or performance
bonds executed by the banks in favour of the beneficiaries. So
injunctions have to be refused restraining the beneficiary from
encashing the letter of credit or performance guarantee or bond
and the only exceptions are in cases of fraud or where special
B
equities exist or where special circumstances warrant issued of
injunction to prevent irretrievable injustice being caused."

The High Court after taking a note of the fact that fraud is not pleaded in
this case, went on to examine whether there were special equities or special
C circumstances justifying granting of an injunction. It then considered the
reasons why the courts refuse to grant injunction against encashment of
confirmed letter of credit and the case law on the point. Thereafter it
referred to Edward Owen v. Barclays Bank Intemational, (1978) 1 A.E.R.
976 wherein it is held that performance guarantee stands on the same
D footing as a confirmed letter of credit and then observed that principles
underlying the letters of credit are made applicable in England even in
regard to performance guarantees or bonds. IL distinguished the decision
of this Court in UP.CF. Ltd. v. Singh Consultants and Enginem· (P) Ltd.,
[1988] 1SCC174 on the ground that "it is not a case where it was observed
that in our country also the performance guarantee shonld be treated which
E is like confirmed letter of credit in order to consider whether injunction
has to be refused or granted." After noticing that bank guarantees in this
case except bank guarantee Nos. 3/21, 3/39 and 6/175 were given towards
security deposits only it observed that "Neither of the learned counsels had
dra\vn attention of this court to any decision granting or refusing injunction
F in regard to a bank guarantee given by way of security deposit to indemnify
against any loss or damage caused by breach of the terms and conditions
of the contract." It then considered the position of law with respect to
liquidated damages in our country and observed that "Hence there cannot
be any agreement in regard to the amount that has to be allowed except
the upper limit that can be fixed, in case of breach". Relying upon the
G decision of this Court in Union of India v. Raman Iron Factory, AIR (1974)
SC 1265 the High Court held that any term in the agreement that one of
the parties shall be the sole judge to quantify the same has to be held as
invalid." According to the High Court liability to pay damages would arise
only after it is established that there is a breach of the contract and it is
H for the court or the arbitrator to decide as to who has committed the
HINDUSTAN STEELWORKS CONSIN. LTD. "· TARA PORE AND CO. (NANA VATI, J.] 403

breach. Till the liability is ascertained, it cannot be said that there is a "debt A
due or debt owing". On these grounds the High Court rejected the conten-
tion raised on behalf of HSCL that it was the sole judge to decide as to
whether the contractor has committed a breach of the contract and what
is the extent of damage caused to it. It also held that in absence of any
determination by the Court or the arbitrator no amount can be said to be
B
payable by the contractor to HSCL by way of damages and, therefore, it
will be .iust and proper to restrain HSCL from enforcing the bank guaran-
tees. It also held that no irretrievable injustice would be caused to HSCL
as it can recover damages from the bank and the contractor in case it
succeeds in the case and that the interest of HSCL can be safeguarded by
directing the contractor to go on e>.1ending the bank guarantees till the c
matter is settled by the arbitrators. The High Court therefore allowed both
the revision petitions and by an order of injunction has restrained HSCL
from enforcing the bank guarantees, except bank guarantee no. 6/175, till
the arbitrators pass an award in its favour. As regards bank guarantee no.
6/175 also it has restrained HSCL from encashing the said guarantee till D
the balance of the amounts advanced together with interest and the value
of the material supplied is ascertained. For ascertaining the amount <lue,
the High Court has remanded O.P. 456/88 to the lower court.

What was contended by Dr. Shankar Ghosh, learned senior counsel
for the appeilant, was that the High Court has not stated nor applied the E
law correctly. He submitted that in the matter of encashment of a bank
guarantee the Court should not as a rule interfere unless it is a clear case
of fraud and is likely to result in irretrievable injustice. The law is so
declared, according to him, by the decisions of this Court in United
Commercial Bank v. Bank of India, [1981) 3 SCR 300, Centax (India) Ltd. F
v. Vinmar Impex Inc., [1986] 4 SCC 136, U.P. Cooperative federation Ltd. v.
Singh Consultants and Engineers (P) Ltd., [1988) SCC 174. The learned
counsel for the respondents, on the other hand, contended that though
fraud is an established exception to the general rule regarding interference
with the autonomy of irrevocable letter of credit or a bank guarantee that G
is not the only exception and the Court can and should interfere where
special circumstances or special equities exist and they are likely to result
in irretrievable injustice.

With respect to an irrevocab]e letter of credit this Court in the case H
404 SUPREME COURT REPORTS [1996] SUPP. 3 S.C.R.

A of Tarapore & Co. v. Tractors Export, Moscow, [1969] 2 SCR 920 pointed
out that such a contract between the banker and the beneficiary is inde-
pendent of and unqualified by the contract of sale or other underlying
transaction and quoted with approval the following observations made by
Jenkins L.J. in Hamzeh Malas and Sons v. British Imex lndusnies Ltd.,
B [1958] 2 Q.B. 127:

"We have been referred to a number of authorities, and it seems
to be plain enough that the opening of a confirmed letter of credit
constitutes a bargain between the banker and the vendor of the
goods, which imposes upon the banker an absolute obligation to
c pay, irrespective of any dispute there may be between the parties
as to whether the goods are up to contract or not. An elaborate
commercial system has been built up on the footing that bankers'
confirmed credits are of that character, and in my judgment, it
would be wrong for this Court in the present case to interfere with
that established practice"
D
In United Commercial Bank v. Bank of India, [1981] 3 SCR 300 this
Court again emphasised that obligation of a bank in such a case is absolute,
as a letter of credit constitutes the sole contract with the banker and the
bank issuing the letter of credit has no concern with any question that may
E arise between the seller and the purchaser of the goods. Therein the
following passage from the judgment of Kerr. J. in R.D. Harbottle (Mercan-
tile) Ltd. v. National Westminster Bank Ltd., (1977) 3 W.L.R. 752 was
quoted as a correct statement of law on the point :

F "It is only in exceptional cases that the courts will interfere with
the machinery of irrevocable obligations assumed by banks. They
are the life-blood of international commerce. Such obligations are
regarded as collateral to the underlying rights and obligations
between the merchants at either end of the banking chain. Except
possibly in clear cases of fraud of which the banks have notice, the
G courts will leave the merchants to settle their disputes under the
contracts by litigation or arbitration as available to them or stipu-
lated in the contracts. The courts are not concerned with their
difficulties to enforce such claims; these are risks which these
merchants take. In this case the plaintiffs look the risk of the
H unconditional wording of the guarantees. The machinery and com-
HINDUSTANSJEELWORKSCONSIN. LTD.'· TARAPOREANDCO.[NANAVATI.J.I 405

mitments of banks are on a different level. They must be allowed A
to be honoured, free from interference by the courts. Otherwise,
trust in international commerce could be irreparably damaged."

Jn United Commercial Bank's case (supra) the High Court had
granted a temporary injunction restraining the United commercial Bank
from making a recall of the amount paid by it under reserve against the B
relative bills of exchange drawn against the Jetter of credit issued by it, from
the Bank of India, and in terms of the letter of guarantee or indemnity
executed by that Bank. While allowing the appeal this Court observed that
the courts usually refrain from granting injunction to restrain the perfor-
mance of the contractual obligations arising out of a Jetter of credit or a C
bank guarantee between one bank and another.

In Centax (India) Ltd. (supra) it has been held in clear terms that a
bank guarantee resembles and is analogous to a letter of credit and the
same considerations which apply to a Jetter of credit in the matter of
interference by the court should apply to a bank guarantee. D

In U.P. Cooperative Federation Ltd. (supra) also Mukherji, J. m
paragraph 21 of his judgment has observed as under :

An irrevocable commitment either in the form of con-
n ••••••
E
firmed 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, .............. "
F
It is, therefore, difficult to appreciate the attempt of the High Court
to distinguish that decision and to raise a doubt whether in India also the
same principles apply in case of a performance guarantee issued by a bank.
In our opinion, the High Court was not right either in its attempt to
distinguish that decision or to raise a doubt regarding the correct position G
of law.

The High Court also committed a grave error in restraining the
appellant from invoking bank guarantees on the ground that ii). India only
a reasonable amount can be awarded by way of damages even when the
parties to the contract have provided for liquidated damages and that a H
406 SUPREME COURT REPORTS [1996] SUPP. 3 S.C.R.

A term in a bank guarantee making the beneficiary the sole judge on the
question of breach of contract and the extent of loss or damages would be
invalid and that no amount can be said to be due till an adjudication in
that behalf is made either by a court or an arbitrator, as the case may be.
In taking that view the High Court has overlooked the correct position that
a bank guarantee is an independent and distinct contract between the
B
bank and the beneficiary and is not qualified hy the underlying transaction
and the primary contract between the person at whose instance the bank
guarantee is given and the beneficiary. What the High Court has observed
would be applicable only to the parties to the underlying transaction or the
primary contract but can have no relevance to the bank guarantee given by
C the bank, as the transaction between the bank and the beneficiary is
independent and of a different nature. In case of an unconditional bank
guarantee the nature of obligation of the bank is absolute and not depend-
ent upon any dispute or proceeding between the party at whose instance
the bank guarantee is given and the beneficiary. The High Court thus
D failed to appreciate the real object and nature of a bank guarantee. The
distinction which the High Court has drawn between a guarantee for due
performance of a \Vorks contract and a guarantee given lO\Vards security
deposit for that contract is also unwarranted. The said distinction appears
to be the result of the same fallacy committed by the High Court of not
E appreciating the distinction between the primary contract between the
parties and a bank guarantee and also the real object of a bank guarantee
and the nature of bank's obligation thereunder. Whether the bank guaran-
tee is towards security deposit or mobilisation advance or working funds
or for due performance of the contract if the same is unconditional and if
there is a stipulation in the bank guarantee that the bank should pay on
F demand without a demur and that the beneficiary shall be the sole judge
not only on the question of breach of contract but also with respect to the
amount of loss or damages, the obligation of the bank would remain the
same and that obligation has to be discharged in the manner provided in
the bank guarantee. In General Electric Technical Se1vices Company Inc. v.
G Punj Sons (P) Ltd., [1991] 4 SCC 230 while dealing with a case of bank
guarantee given for securing mobilisation advance it has been held that the
right of a contractor to recover certain amounts under running bills would
have not relevance to the liability of the bank under the guarantee given
by it. In that case also the stipulations in the bank guarantee were that the
H bank had to pay on demand without a demur and that the beneficiary was
HINDUSTANSIBELWORKSCONSIN. LTD.>. TARAPDREANDCC.jNANAVATI,J.I 407

to be the sole judge as regards the loss or damage caused to it. This Court A
held that notwithstanding the dispute between the contractor and the party
giving the contract, the bank was under an obligation to discharge its
liability as per the terms of the bank guarantee. Larsen and Toubro Limited
v, Maharashtra State Electricity Board, [1995] 6 SCC 68 and Hindustan Steel
Workers Constntction Ltd. v. G.S. Atwal & Co. (Enginem) Pvt. Ltd,, [1995] B
6 sec 76 were also cases of work contracts wherein bank guarantees were
given either towards advances or release of security deposits or for due
performance of the contract. Jn both those cases this Court held that the
bank guarantees being irrevocable and unconditional and as the beneficiary
was made the sole judge on the question of breach of performance of the
contract and the extent of loss or damages an injunction restraining the c
beneficiary from invoking the bank guarantees could not have been
granted. The above referred three subsequent decisions of this Court also
go to show that the view t;k~n by the High Court is clearly wrong.

In view of the settled legal position and unsustainable view taken by D
the High Court, the learned counsel for the contractor has rightly not
attempted to defend the judgment of the High Court except on the ground
that in view of the exceptional circumstances and special equities of this
case, it was justified in granting the injunction, He submitted that fraud is
not the only ground requiring interference by courts and if it is made out E
that exceptional circumstances creating special equities exist then the court
can and should restrain the beneficiary from encashing the bank guarantee.
On the other hand the learned counsel for the appellant contended that
interference by courts is permissible only when fraud is pleaded and prima
facie established and it is further shown that irretrievable injustice would
otherwise be caused. In support of his contention, the learned counsel for F
the appellant has heavily relied upon the following observations, made by
Mukherji, J, in paragraph 28 and by Shetty, J, in paragraph 53 of the
judgment in U.P. Cooperative Federation Ltd. (supra) :

"28 ....... In order to restrain the operation either of irrevocable G
letter of credit or of confirmed letter of credit or of bank guaran-
tee, there should be serious dispute and there should be good p1ima
facie case of fraud and special equities in the form of preventing
irretreivable injustice between the parties . .......................... 11 (Em-
phasis supplied) H
408 SUPREME COURT REPORTS (1996] SUPP. 3 S.C.R.

A "53 ..................... Since the bank pledges its own credit involving
its reputation, it has 110 defence except in Oie 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 ......... The nature of the fraud that the courts talk about is
fraud of an "egregious nature as to vitiate the entire underlying
B
transaction". It is fraud of the beneficiary, not the fraud of some-
body else ..... "

(Emphasis supplied)

C On the basis of these observations the learned counsel submitted that
the law laid down by this Court is that except in case of fraud and that too
when it creates special equities in the form of irretrievable injustice, the
courts should not interfere by restraining the beneficiary from cncashing
the bank guarantee. We have carefully gone through the judgments
delivered by Mukherji and Shelly, J.l. and in our opinion that is not the
D ratio of the judgment. In that case the court was not called upon to decide
\Vhether apart from fraud there can be any other valid ground for inter-
ference. Moreover, the said observations cannot be read like a text of a
statute or out of context. Observations made by Mukherji, .T. in other parts
of his judgment (See paragraphs 24 and 34) and his opinion stated in
E paragraph 21, with which Shetty, J. also agreed, do not support that
submission. Mukherji, J. in paragraph has stated his opinion as under :

21 . ......... An irrevocable con1mitment either in the form of con-
11

firmed bank guarantee or irrevocable letter of credit cannot be
interfered with except in case of fraud or in .case of question of
F apprehension of in·et1ievable injustice has been 'made out." (Em-
phasis supplied)

Mukherji, J. referred to the following paragraph from the judgment
in R.D. Harbottle (Mercantile) Ltd. v. National Westminster Bank Ltd.,
G [1977] 2 All ER 862 and then stated that in his view the said view represents
the correct state of law :

"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
H confirmed letter of credit, the bank was only concerned to ensure I

l
HINDU~AN STEELWORKS CONS!N. LTD. "·TARAPGRE AND CD. [NANA VATI. J.] 409

that the terms of its mandate and confirmation had been complied A
with and was in no way concerned with any contractual disputes
which might have arisen between the buyers and sellers. Accord-
ingly, since demands for payment had been made by the buyers
under the guarantees and the plaintiffs had not established that the
deniands were fraudulent or other special circianstances, there were
B
no grounds for continuing the injunctions ......... "

(Emphasis supplied)

What Mukhcrji, J. has staled in paragraph 34 of his judgment,
namely, that "ll is only in exceptional cases that is to say in case of fraud c
11
or in case irretrievable injustice be done the courts should intcrfere is
really the ratio of the decision of this Court in UP. Cooperative Federation
Ltd. (supra). Therefore, fraud cannot be said to be the only exception. In
a case where the party approaching the court is able to establish that in
view of special equities in his favour if injunction as requested is not D
granted then he would suffer irretrievable injustice, the court can and
would interfere. It may be pointed out that fraud which is recognised as an
exception is the fraud by one of the parties to the underlying contract and
which has the effect of vitiating the entire underlying transaction. A
demand by the beneficiary under the bank guarantee may become
fraudulent nol because of any fraud committed by the beneficiary while E
executing the underlying contract but it may become so because of sub-
sequent events or circumstances. We sec no good reason Why the courts
should nol restrain a person making such a fraudulent demand from
enforcing a bank guarantee.
F
The learned coun.'el for the appellant also drew our attention to a
3-Judge bench decision of this Court in General Electric Technical Services
Company Inc. (supra) to which Shetty, J. was also a party. The learned
counsel submitted that after referring to the observations of Mukherji, J.
in paragraph 28 and that of Shelly, J. in paragraph 53 of the judgment in
UP. Cooperative Federation Ltd. (supra) this Court in para 9 of that G
judgment has observed that what is stated therein is the settled position of
law. What is overlooked by the learned counsel is that in that very para-
graph the opinion of Mukherji, J. that "It is only in exceptional cases that
is to say in face of fraud or in case irretrievable injustice be done the courts
should interfere" is also quoted. (Emphasis supplied) Moreover, while H
410 SUPREME COURT REPORTS [1996] SUPP. 3 S.C.R.

A dealing with the facts of the case this Court in paragraph 10 of the
judgment has stated that "The bank cannot be interdicted by the court at
the instance of Respondent 1 in the absence of fraud or special equities in
the form of irretrievable injustice between the parties". (Emphasis sup-
plied) This observation would clearly go to show that the 3-Judge Bench
B has approved the view that fraud and other exceptional circumstances
leading to irretrievable injustice are exceptions to the rule.

Lastly, the learned counsel for the appellant relied upon the follow-
ing observations made in paragraph 60 of the 3-Judge Bench decision of
this Court in Svenska Handelsbanken v. M/s. Indian Charge Chrome, (1994)
c 1 sec so2:

"60. We have referred to the observations of both Sabyasachi
Mukherji as well as Shetty, JJ. in extenso to emphasise that in case
of confirmed bank guarantee/irrevocable letters of credit, it cannot
be interfered with unless there is fraud and irretrievable injustice
D involved in the case and fraud has to be an established fraud."

In that case the question which fell for consideration was whether
the High Court was right in taking the view that while deciding an applica-
tion for interim relief against enforcement of a bank guarantee general
E principles of injunction on lenders should be applicable and not the
principles of injunction in relation to bank guarantee. This Court was not
called upon to decide whether apart from the case of fraud there can be
any other exceptional case wherein the court can interfere in the matter of
encashment of a bank guarantee. It is also significant to note that the said
observation in paragraph 60 has been made after quoting the following
F observation made by Mukherji, J. in paragraph 21 of his judgment in U.P.
Cooperative Federation Ltd. (supra) :

"............. 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
G
apprehension of irretrievable injustice has been made out. This is
the well-settled principle of law in England. This is also the
well-settled principle of law in India. No fraud and no question of
11
irretrievable injustice was involved in the case.

H Therefore, we cannot attach mnch importance to the use of the word
HINDUSTAN STEEL\VORKo:;; CON.':i'TN. LTD. \.: TARA PORE Ai.\'D CO. !NANA VATI. J. J 411

and 11 in the observation that '1it cannot be interfered with unle.ss there is A
11

fraud and irretrievable in.iusticc involved in the case ....... 11 • It is also sig-
nificant to note that in that case this Court referred to the decision of Court
of Appeal in England in the case of Elian and Rabbath v. Matsas and
Matsa.1', [1966] 2 Lloyd's Rep 495 and distinguished it by stating that the
facts of that case were peculiar but did not state that the view taken in that
B
case is not correct. The decision in Handerson v. Candian Jn1perial Bank
of eommercie and Peat Manvick Ltd., 40 British Columbia LR 318 was also
referred to and distinguished on the ground that the facts of that case were
peculiar but with respect to the decision in that case also it has not been
stated that it does not represent the correct position of law. That was not
a case of that type of fraud which has been recognised as an exception to c
the rule though the request by the beneficiary for payment was considered
fraudulent in the circumstances because there was no right to payment.
This Court also referred to the case of Itek Co1pn. v. 77te First National
Bank of Boston, 566 Fed Supp 1210. In that case the underlying contract
had become impossible of performance, because of 'force majeure'. It was D
an event subsequent to the execution of the contract. Yet injunction was
granted by the court on the ground that the plaintiff had no adequate
remedy at law and the allegations of irreparable harm were not speculative
but genuine and immediate and the plaintiff would have suffered ir-
reparable harm if the request for relief was not granted. Though this Court
observed that "this judgment is based on peculiar facts" has not disap- E
proved the view taken in that ease.

We are, therefore, of the opinion that the correct position of law is
that commitment of banks must be honoured free from interference by the
courts and it is only in exceptional cases, that is to say, in case of fraud or F
in a case where irretrievable injustice would be done if bank guarantee is
allowed to be encashed, the court should interfere. In this case fraud has
not been pleaded and the relief for injunction was sought by the contrac-
tor/Respondent No. 1 on the ground that special equities or the special
circumstances of the case required it. The special circumstances and/or G
special equities which have been pleaded in this case are that there is a
serious dispute on the question as to who has committed breach of the
contract, that the contractor has a counter claim against the appellant, that
the disputes between the parties have been referred to the arbitrators and
that no amonnt can be said to be due and payable by the contractor to the
appellant till the arbitrators declare their award. In our opinion, these H
412 SUPREME COURT REPORTS [1996] SUPP. 3 S.C.R.

A factors arc not sufficient to make this case an exceptional case justifying
interference by restraining the appellant from enforcing the bank guaran-
tees. The High Court was, therefore, not right in restraining the appellant
from enforcing the bank guarantees.

These appeals are, therefore, allowed. The judgment and order
B passed by the High Court arc set aside. However, in view of the fact that
no stay was granted by this Court during the poodency of these appeals
and in view of the statement made by learned counsel for Respondent No.
1 that the arbitrators are likely to declare the award within a short lime,
we direct that the appellant shall not call upon the bank, Respondent No.
C 2 to discharge its obligations under the bank guarantees till 31st July, 1996.
If by that time, the arbitrators declare the award then obviously the parties
will have to reconsider their position in the light of the correct legal
position and the observations made in this judgment. The respondent No.
1 shall pay the cost of these appeals to the appellant.

R.A. Appeals allowed.

Search Indian case law

Ask in plain English, not just keywords. 25,000 AI words free, no card.

Try "bank guarantee"Sign in to search