Holding

An injunction to restrain the invocation of an irrevocable bank guarantee cannot be granted absent fraud or a clear case of irretrievable injustice; thus the High Court's injunction was erroneous.

Summary

The Uttar Pradesh Cooperative Federation Ltd. (appellant), a state enterprise, contracted with Singh Consultants & Engineers (P) Ltd. (respondent) to supply and install a vanaspati plant, requiring the respondent to furnish two irrevocable bank guarantees. The plant was not completed within the stipulated time, and the appellant invoked the guarantees, encashing them. The respondent sought an injunction under Section 41 of the Arbitration Act, 1940 to restrain the appellant from invoking the guarantees. The Civil Judge dismissed the injunction, but the Allahabad High Court allowed it, restraining the appellant while keeping the guarantees alive during arbitration. The Supreme Court held that irrevocable bank guarantees are independent contracts that courts cannot interfere with unless fraud or a risk of irretrievable injustice is shown. Consequently, the High Court's injunction was set aside and the Civil Judge's order restored.

Issues considered

The court may grant an injunction restraining a party from invoking an irrevocable bank guarantee.
Whether a bank guarantee is an independent contract separate from the underlying contract.
Whether the presence of fraud or risk of irretrievable injustice justifies interference with a bank guarantee.

Legislation cited

Arbitration Act, 1940s. 41
Code of Civil Procedure, 1908s. Order 39 Rule 1, s. Order 39 Rule 2

Subjects

bank guaranteeperformance guaranteeinjunctionirrevocable guaranteearbitrationfraudirretrievable injusticecontract lawcommercial law

Judgment

U.P. CO-OPERATIVE FEDERATION LTD.
A
v.
SINGH CONSULTANTS & ENGINEERS (P) LTD.

NOVEMBER 19, 1987

B [SABYASACHI MUKHARJI AND K. JAGANNATHA
SHETTY, JJ.]

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 injunc-
tion against. /~~~
c
The appellant, a State Government enterprise, on or about May
17, 1983, entered into a contract with the respondent, a pritate limited
company, for the supply and installation of a vanaspati manufacturing
plant at a place in the district of Nainital. The contract bond contemp-
D lated guaranteed performance of the work at various stages in accord-
ance with the time schedule prescribed and provided for completion
and commissionin~ of the plant after trial run by May 15, 1984. Accord-
ing to the appellant, the time was essentially and indisputably the ess-
ence of.the contract.

E 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
F 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 thereaf-
G ter proceeded to have the plant completed, etc. According to the appel-
lant, the plant could actually be commissioned for commercial produc·
tion inJuly/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 '
H Judge, praying for an injunction restraining the appellant from realis·
1124
U.P. CO-OPT. FEDERATION v. SINGH CONSULTANTS 1U5

ing and encashing the bank guarantees. The Civil Judge dismissed the A
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 appel-
lant that the performance guarantees constituted independent and sepa-
rate contracts between the guarantor bank and the beneficiary and
created independent rights, liabilities and obligations under the B
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,
c
HELD: Per Sabyasachi Mukharji, J.

Under the terms agreed to between the parties, there is no scope
of injunction. The High Court procee(ied on the basis that this was not
an injunction sought against the bank but against the appellant. But the D
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 reseondent 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 E ·
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 princi-
ple of the law in England. This is also the well-settled principle of law in F
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 G
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 H
1126 SUPREME COURT REPORTS [ 1988) I S.C.R.

A 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
strongprima 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
B order of the Civil Judge restored. [1141A·B; 11420-H)

Per K. JagannathaShetty, J. (concurring):

The crux of the matter relates to the obligation assumed by the
bank under a performance guarantee. [1143B)
c Whether the obligation is similar to the one arising under a letter .
of credit? Whether the Court could interfere in regard to such obliga·
tion, and if so, under what circumstances? These are the questions
raised in the appeal. [1143B-C)

D 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 res-
E trained 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
p 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
G international trade. It was intended to facilitate the transfer of goods
between distaitt 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 (be-
neficiary) receives payment from the issuing bank when he presents a
demand as per the terms of the documents. The bank must pay if the
H documents are in order and the terms of credit are satisfied. The bank,
U.P. CO-OPT. FEDERATION v. SINGH CONSULTANTS 1127

however, was not allowed to determine whether the seller had actually
A
shipped the goods or whether the goods conformed to the re4uirements
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 permit- B
ted dishonour only on the fraud of the beneficiary, not the fraud of
somebody else. [1145C, E-H; 1146A)

l
'-·
In modern commercial transactions, various devices are used to
ensnre performance by the contracting parties. The traditional letter of
- credit has taken a new meaning. Stand-by letters of credit are also used C
in business circles. Performance bond and guarantee bond are also
devices increasingly adopted in transactions. The Courts have treated
such documents as analogous to letter of credit. [l148E)

Whether it is a traditional letter of credit or a new device, like
performance bond or performance guarantee, the obligation of the D
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 E
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 goodprimafacie act of fraud. [1149E-H; 1150A) F

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 es-
tablished fraud. The appeal must be allowed, and the order of the civil G
judge, restored. [11500-E)

Hamzeh Me/as & 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. National Westminster H
1128 SUPREME COURT REPORTS [ 1988] I S.C.R.

Bank Ltd. and Ors., [1977] 2 All England Law Reports 862; Edward <:
A
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 & Ors., [1982] 2 All England
Law Reports 720; Taxmaco Ltd. v. State Bank of India & Ors., Am
1979 Calcutta 44; State Bank of India v. The Economic Trading Co.
B S.A.A. & Ors., AIR 1975 Calcutta 145; B.S. Auila Company Pvt. Ltd. I
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
j
v, Mis. V/o Tractors Export, Moscow & Anr., [1969] 2 SCR 920;
United Commercial Bank v. Bank of India & Ors., [1981] 3 SCR 300;-·
c Centax (India) Ltd. v. Vinmar lmpex 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.

D 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. \..

E 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

F SABYASACHI MUKHARJI, J. Special Leave granted.

In the Special Leave Petition notice was issued on 13th of July,
!987 and it was directed that the matter would be dispose"d of at the
notice stage. After hearing the rival contentions, we grant leave to
appeal and dispose of the appeal by the ordeJ hereunder.
G
This is an appeal from the judgment and order of the learned
single judge of the Allahabad High Court (Lucknow Bench) in Revi- t
sion 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 sup-
H ply and installation of a Vanaspati manufacturing plant at Harducharu
U.P. CO-OPT. FEDERATIONv. SINGHCONSULTANTS1MUKHARJI, J.l 1129

in the District of Nainital, in the State of Uttar Pradesh. The contract
A
bond contemplated, according to the appellant, guaranteed perform-
ance 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, J984. The appellant
contends that time was essentially and indisputably the essence of the
contract. B

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
c
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 D
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 appel-
lant thereafter on 15th March, 1985 proceeded to have the plant comp- E
leted and the plant was formally inaugurated. The appellant contends
.... that the plant could actually be commissioned for commercial produc-
tion 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
~ prayin~ for an order restraining the appellant from realising and F
. encashmg 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 G
Allahabad High Court, by the impugned judgment of 20th February,
' -r 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 indepen-
dent and separate contracts between the guarantor bank and the
beneficiary and created independent rights, liabilities and obligations H
1130 SUPREME COURT REPORTS (1988) 1 S.C.R.

A 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:

B "WHEREAS THE PCF (the appellant herein) has decided
to set up a Vanaspati Plant of 62.5 M.T. per day Vanaspati r
Capacity, comprising of 70 M. T. per day hardening capac-
ity based on 95% usage of soyabean oil as raw oil 62.5 M.T. 1
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 Dis-~
c tribution Equipments Oil Storage Section Electrification
and Distribution Equipments Automatic Weighing filling
and packing/sealing equipments and fire-fighting equip-
ments etc, at Halducharu, District Nainital (UP) lying at
Bareilly-Haldwani road about 3.5 Kms. from Lalkuan
D 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
E 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.
F
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
G extent as hereinafter provided.

AND WHEREAS the contract price hereinafter men- r
tioned 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 Comp-
H lex fails to give the guaranteed performance as hereinafter
-U.P. CO-OPT. FEDERATION v. SINGH CONSULTANTS (MUKHARJI, J.] 1131

specified, the contract price shall stand reduced to the A
eY,tent 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 perform-
ance specified in the agreement. This clause further stated: B

"The seller shall be deemed to have completed the erection
and commissioning after giving successful trial runs for con-
tinuous period of 15 days with all the Plants working
simultaneously. However, the seller should fulfil the War-
rantees of individual plants separately also as given in the C
specifications. The complete Warrantees/Performance
guarantees shall be demonstrated by the seller over a con-
tinuous 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 · D
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 addi- E

- tional expenses so incurred by the P.C.F. shall be recover-
able 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, P
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 exclusioO:/inclusion within two months from
the date of signing of the agreement. The said price of G
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 H
1132 SUPREME COURT REPORTS [ 1988] I S.C.R.

numbered 17/16 provided, inter alia, as follows:- -<;-
A
"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
B reference to the seller on the seller's failure to fulfil the tenns
of the sale on the following terms and conditions r
(emphasis supplied)

A) The sole judge for deciding whether the seiler has
failed to fulfil the terms of the sale, shall be the PCF. . -.-..
c
B) This guarantee shall be valid upto twelve months from
the date of issue, i.e. upto 24.6.84.

C) Cl~ims, if any, must reach to be Bank in writing on or
D before expiry date of this guarantee after which the Bank
will no longer be liable to make payments to the PCP.

D) Bank's liability under this guarantee deed is limited to
Rs.16.5 lacs (Rupees sixteen lacs fifty thousand only).
\....
E E) This guarantee shall not be revoked by the Bank in any
case before the expiry of its date without written permis-
sion of the Federation."

The Bank guarantee No. 17/15 of the said date f!H'ther went on to
provide as follows:-
F
"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
G Federation.

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 uncondi-
H tionally immediate payment to the Federation at its office
U.P. CO-OPT. FEDERATION v. SINGH CONSULTANI'S [MUKHARJl,J.] 1133

~ at Lucknow of the sum of Rs.33 Jacks (Rupees thirty three
A
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:-
B
y (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 .
c
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, D
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- E

--
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.
F
?"- 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 G
encashed. The High Court was of the view that even otherwise it
cannot be doubted that the appellant cannot be permitted to take
7
,r 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 H
1134 SUPREME COURT REPORTS [ 1988] I S.C.R.

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
B be invoked. The High (:ourt was of the view that it was not a question
of restraining the performance of any bank guarantee. r
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. Refei;,ence had also been made to some of the English ,, ~ ..
c decisions. So far as the position of English law is concerned, the princi-
ples 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
D 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
E 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
F the Court had wide jurisdiction to grant injunction, this was not a case . w
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
G 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 r
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
H Jenkins L.J. observed that a vendor of goods selling against a con-

'
U.P. CO-OPT. FEDERATION v. SINGH CONSULTANTS IMUKHARJI, J.I 1135

' firmed letter of credit was selling under the assurance that nothing
would prevent it from receiving the price. That was of no me.an
A
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 B
y
guarantee.

.c: The Court of Appeal in England had occasion once again to
consider this question in Elian and Rabbath (Trading a&i:lian & Rab-
bath). v. Matsas and Matsas & Ors., (1966] 2 Lloyd's List Law Reports
.-/~· 495. In that case injunction was granted to prevent irretrievable c
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 D
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 E

-- exercised and claimed to enforce guarantee. Plaintiff claimed declara-
tion 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
';I'- grant an injunction to prevent what might be irretrievable injustice. F
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 G
for breach of their promise express or implied, to release the goods.'
_-r 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 injunc-
tion should be granted. Lord Denning, M.R. went on to observe that H

'
I 136 SUPREME COURT REPORTS I 1988) l S.C.R.
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 sup-
pose that the goods would be held for another lien? It can well be
B argued that the guarantee was given on the understanding that the lien
was raised and no further lien imposed, and that when the shipowners, r
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 Den-
ning, M.R. treated this as a very special case and in later decision he
expressed his views on this matter. .· · -.<,
c
This question was again considered by the Queen's Bench Divi-
sion 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
D 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,
E just as in the case of a confirmed Ie1ter 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
--
F under the guarantees and the plaintiffs had not established
that the demands were fraudulent or other special circums-
tances, there were no grounds for continuing the injunc-
tions.

"ii) It was right to discharge the injunctions against the
G 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 con-
siderations applied in favour of the discharge of the injunc-
tions against the Egyptian defendants, and their failure to
participate in the proceedings did not preclude the court
H from discharging the injunctions against them."

,
U.P. CO-OPT. FEDERATIONv. SINGH CONSULTANTS [MUKHARJI, J.] 1137

7 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 Interna-
tional Ltd., [1978] 1 All England Law Reports 1976. English suppliers,
entered into a contract with Libyan buyers to supply goods to them in B
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
petformance guarantee for the sum of £ 50,203. Acting on those
instructions the defendants requested a bank in Libya to issue a
c
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 isc•1ed a
letter of guarantee for £ 50,203 to the buyers. The contract between
the plaintiffs and the buyers provided for payment of the price of the D
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 neverthe-
less claimed on the guarantee gi.ven by the Libyan bank who in tum E
claimed against the defendants on the guarantee they bad 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 dis-
charged the injunction. The plaintiffs appealed to the Court of Appeal F
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 G
only exception to that rule was where fraud by one of the parties to the
underlying contract bad been established and the bank bad notice of
the fraud. Accordingly, as the defendants' guarantee provided for pay-
ment on demand without proof or conditions, and was in the nature of
a promissory note payable on demand, and the plaintiffs bad not
established fraud on the part of the buyers, the defendants were re- H
1138 SUPREME COURT REPORTS [ 1988] I S.C.R.

quired to honour their guarantee on the demand made by the Libyan '1
A Bank. It followed that the judge had been right to discharge the in-
junction and that the appeal would be dismissed.

Lord Denning, M.R. held that Justice Kerr was right in discharg-
ing the injunction and reiterated that the bank must honour its com-
B mitment. The principle must be that upon that basis trade and com-
merce are conducted. Lord Denning, M.R., in_dicated at page 984 that r
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. /,,,.._. ,
c
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.
D 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 \,.-
E case in which injunction should be granted. An irrevocable commit-
ment 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
--
F 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 injustice was involved.

G 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 irrevoc-
able documentary credits had been developed in international trade
'-I was to give the seller of goods an assured right t9 be paid before he
U.P. CO-OPT. FEDERATIONv. SINGH CONSULTANTS [MUKHARJI,J.I 1139

..,. parted with control of the goods without risk of the payment being
refused, reduced or deferred because of a dispute with the buyer.·11 A
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. B
y 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
"6: 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 accu-
/.·~·- rate. These principles must in my opinion apply in case of bank
guarantees in internal trade within a country. c
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.LR.
1979 Calcutta 44, one of us (Sabyasachi Mukharji) held that in the
absence of special equities arising from a particular situation which D
might entitle the party on whose behalf guarantee is given to an injunc-
tion 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 E

--
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 F
"'~
( '
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 contesta-
tion, the bank had obliged itself to P-.'.1Y irrespective of any dispute as to
whether there had been performance in an orderly manner of the G
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 H
1140 SUPREME COURT REPORTS [1988] 1 S.C.R.

A Rabbath (Trading as Elian & Rabbath) v. Matsas and Matsas & Ors. ~
(supra).

The same view was more or Jess 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.LR. 1975 Calcutta 145.
B See also a decision in the case of B.S. Aujla Company Pvt. Ltd. v.
Ka.luram Mahadeo Prasad and Others, A.LR. 1983 Calcutta 106. In -r
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 com- ,.,..,,,,
C pany 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
D 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.LR.
E 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
F serious question to be tried and further the balance of convenience was
also a relevant factor. If the element of framl 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,
G 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
H decision that there should be a prima facie case. In order to restrain
U.P. CO-OPT. FEDERATIONv. SINGH CONSULTANTS [MUKHARJI,J.] 1141

the operation either of irrevocable letter of credit or of confirmed
A
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.
B
In Tarapore & Co. Madras v. Mis V/o Tractors Export, Moscow
and Anr. [1969] 2 S.C.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 repercus-
sions on the international tra,(le of this country. The Court reiterated
c
that the autonomy of an irrevociib,le 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 D
upon bank guarantee revolves many of the internal trade and transac-
tions 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 E

--
respondent bank. This Court reiterated that Courts usually refrain
from granting in junction to restrain the performance of the contractual
obligations arising out of a letter of credit, or a bank guarantee bet-
ween 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 re- F
serve 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 G
pay. The banker was not bound or entitled to honour the bills of
exchange drawn by the seller unless they and such accompanying docu-
ments 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 H
1142 SUPREME COURT REPORTS !1988] 1 S.C.R.

(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 com-
pany 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 10 the contract, at the request of the appellant the
Allahabad Bank opened a letter of credit, it favour of the respondent.
B The respondent thereupon despatched the goods covered by the bills
of lading. r
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 ~'
c 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 negotiat-
ing bank, acting on behalf of the beneficiary against a document of
guarantee, indemnity at the instance of the beneficiary.
D
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
'y
case of fraud or in case of irretrievable injustice be done, the Court
should interfere.
-
E
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 appel-
!ant was allowed to enforce the bank guarantee, damage would be
done. He submitted before us that appellant could not be permitted to

·'
F
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 in justice would be done by enforcement of
bank guarantee. This is also not a case where a strongprimafacie case
of fraud in entering into a transaction was made out. If that is the
G
position, then the High Court.should not have interfered with the bank
guarantee.
r
In the aforesaid view ,-,f 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
H
dated 8.8.86 restored.
U.P. CO-OPT. FEDERATIONv. SINGH CONSULTANTS [SHETfY,J.I 1143

In the facts and circumstances of the case parties will bear their A
own costs of this appeal.

JAGANNATHA SHETTY, J. I agree respectfully with the judg-
ment 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 B
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:
c
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 D
two bank guarantees for proper construction and successful com-
missioning 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 E
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 abso- F
lute 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 G
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 contend-
ing inter-alia, that there was no default in the construction or delivery
of possession of the plant. But the UPCOF Ltd. had a different ver-
sion. It contended that the construction was not within the time
schedule and performance of the plant was not up to the mark. It also H
1144 SUPREME COURT REPORTS [ l988] I S.C.R.

A 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
B prima facie case. It has prima facie proved that the plant was delivered
after a trial run and commercial production had started. So stating, r
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. ~
c
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
D 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
E Inc. & Ors. [1986] 4 SCC 136. Mr. V.M. Tarkunde, learned counsel
for the respondent or the other hand, urged that both the said deci-
sions 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
F construction contract. But the issues to be determined in the suit do
not relate to the obligations of the bank unde.r 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.
G
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.
H also cannot be restrained from invoking the guarantees. What applies
U.P. CO-OPT. FEDERATION v. SINGH CONSULTANTS (SHETfY, J.I 1145

to the bank must equally apply to UPCOF Ltd. Therefore, the frame A
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 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 B
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'-tradi-
tionally a seller of goods-on demand if the beneficiary
presents whatever documents may be required by the let- D
ter. 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." E

--
!
The Jetter 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
,...._ cistant and unfamiliar buyer and seller. It was found difficult for F
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 G
satisfied. The bank, however, was not allowed to determine whether
the seller had actually shipped the goods or whether the goods con-
formed 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 independ-
en.;e. The Courts held that if there has been "fraud in the transaction" H
1146 SUPREME COURT REPORTS [1988] 1 S.C.R.

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
B by Shientag, i. 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 docu-
ments, the bank would pay for the shipment. Somehow Mr. Sztejn
discovered that the shipment made was not crates of bristles, but
C 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
D he sought an injunction. Now in 1941 people just did not get injunc-
tions 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 comp-
laint were taken as true, and those allegations were gross fraud that \,.....
the holders in due course were involved. On those facts, the court
E issued an in junction 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
F (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] 1 All E.R. 976 and (iv) UCM (Invest-
ment) v. Royal Bank of India, [1982] 2 All E.R. 720. The last case is of
the House of Lords where Lord Qiplock in his speech said (at p. 725):

G "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
H used as a ground for non-payment or reduction or defer-
ment of payment.
U.P. CO-OPT. FEDERATION v. SINGH CONSULTANTS (SHEITY. J.] 1147

"To this general statement of principle as to the con- A
tractual 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 pre-
sents 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 B
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] 31NYS2d
631. This judgment of the New York Court of Appeals was
referred to with approval by the English Court of Appeal in C
Edward Owen Engineering Ltd. v. Barclays Bank Interna-
tional 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 D
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."
E
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 F
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.
G
"It is somewhat unfortunate that the High Courr
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 oflndia in
~erms of the letter of guarantee or indemnity executed by
tt. The courts usually refrain from granting injunction to H
1148 SUPREME COURT REPORTS [1988] 1 S.C.R.

A 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
B 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. --Y

"In view of the banker's obligation under an irrevoc-
able letter of credit to pay, his buyer-customer cannot in-
struct him not to pay."
c ..··~
In Centax (India) Ltd., [ 1986] 4 SCC 136, this Court again speak-
ing through A.P. Sen, J. following the decision in the United Commer-
cial Bank case said: "We do not see why the same principles should not
apply to a banker's letter of indemnity."
D
It is true that both the decisions of this Court dealt with a con-
tract 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
E 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
F
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
G 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 pay-
H ing on the guarantee. On appeal Lord Denning M.R. said:
U.P. CO-OPT. FEDERATION v. SINGH CONSULTANTS [SHEITY, J.l 1149

"So as on takes instance after instance these
A
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." B

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 c
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 D
stipulated, without proof or conditions, The only exception
is when there is a clear fraud of which the bank has
noticed."
_, I

Whether it is " traditional letter of credit or a new device like
performance bond or performance guarantee, the obligation of banks E
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 F
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 underly-
) ing transaction". It is fraud of the beneficiary, not the fraud of some-
body else. If the bank detects with a minimal investigation the fraudu-
lent 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 G
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 opera-
tion of irrevocable documentary credit. I agree with my learned H

t
1150 SUPREME COURT REPORTS (1988] 1 S.C.R.

A brother that in order to restrain the operation of irrevocable letter of ~
credit, performance bond or guarantee, there should be serious dis-
pute 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 Man-
na/tan Bank & Ors. [1984] 1AllE.R.351at352:
B
"The wholly exceptional case where an injunction
may be granted is where it is proved that the bank knows --r'
that any demand for payment already made or which may
thereafter be made will clearly be fraudulent. But the evi-
dence must be clear both as to the fact of fraud and as to
the bank's knowledge. It ,}ould certainly not normally be
c 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 applica-
tion by the bank to have it discharged."
D
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
E 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.

(