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Resolving the Legal Quagmire with respect to Bank Guarantee Enforcements, during the COVID-19 pandemic

The article aims to decode the legal quagmire in relation to interference with bank guarantees during the pandemic which has recently made its way into the courts.

Chintan Chinnappa

With COVID- 19 having been declared a pandemic by the World Health Organisation, the lockdown that ensued has disrupted industries all across the globe and impacted existing contractual obligations. Given the disruption of supply chains, many contracts will be delayed, interrupted, or even cancelled. The pandemic and consequent lockdown have instigated a debate the world over on various principles of contract, especially the force majeure clause. While this debate has preoccupied the legal industry, another interesting issue in relation to interference with bank guarantees during the pandemic has made its way into the courts and has supposedly resulted in contrasting approaches. This article aims to decode this legal quagmire.

Over the years, courts have largely been hesitant to interfere with the enforcement/invocation of unconditional and irrevocable bank guarantees on the ground that the bank guarantee is divorced from the underlying contract between its customer and the third-party beneficiary. The bank extending such guarantee is bound to honour it as per its terms, irrespective of any dispute raised by its customer.

In a catena of decisions, the Supreme Court reiterated the principle originally laid down by the Court of Appeal in England [1] that encashment of bank guarantees “must be allowed to be honoured free from interference by the courts”, failing which trust in internal and international commerce would be irreparably damaged.[2] However, while doing so, the Supreme Court also recognised two exceptions to this fundamental principle and interfered only when the aggrieved party established a strong prima facie case of a) fraud of an egregious nature as to vitiate the underlying transaction, or b) irretrievable harm or injustice to one of the parties concerned.

However, in 1979 in Texmaco Ltd. vs State Bank Of India And Ors.,[3] Justice Sabyasachi Mukharji while in the Calcutta High Court proposed another exception, “in the form of special equities arising from a particular situation which might entitle the party to an injunction restraining the performance of bank guarantee.” Interestingly, several years later, the Supreme Court in U.P. Co-Operative Federation Ltd. vs. Singh Consultants & Engineers (P) Ltd.[4] relied on this judgment and adopted the exception of special equities. But it was gratuitously qualified in its application and was read along with the second exception of irretrievable injustice, though there was no such qualification laid down by the propounder. This was reiterated and applied by the Supreme Court in several judgments that soon followed.[5]

In 1996, in Ansal Engineering Projects Ltd. vs. Tehri Hydro Development Corporation Ltd. and Anr.,[6] the three-judge bench of the Supreme Court adopted the exception of special equities, while clarifying it to include special circumstances as well, provided it was “prime facie made out in the case as triable issue by strong evidence”. Though this position seemed to hold the field for some time, in 2019 in Standard Chartered Bank vs Heavy Engineering Corporation Ltd.,[7] the Supreme Court appears to have recognised special equities as the third exception while inter alia stating:

“…………………

The dispute between the beneficiary and the party at whose instance the bank has given the guarantee is immaterial and is of no consequence. There are, however, exceptions to this Rule when there is a clear case of fraud, irretrievable injustice or special equities. The Court ordinarily should not interfere with the invocation or encashment of the bank guarantee so long as the invocation is in terms of the bank guarantee.”

This introduction of special equities as the third exception may end up being quite contentious, because the Supreme Court had previously and consistently qualified special equities with irretrievable injustice/injury. Nevertheless, with this third unqualified exception, the Supreme Court has perhaps unknowingly reverted to the original theory propounded by Justice Sabyasachi Mukerjee in the Texmaco case.

Be that as it may, the special equities exception assumes significance during the pandemic and the consequent lockdown, which is in force to date. In fact, on April 08, 2020, the Bombay High Court refused to restrain the invocation of certain letters of credit in Standard Retail Pvt. Ltd vs Gs Global Corp and Ors.[8] In this case, several steel importers had contended that their contracts with South Korea based Hyundai Corp and GS Global stood terminated as unenforceable, on account of frustration and impossibility. Due to the pandemic and the consequent lockdown, the steel importers were unable to receive the steel shipments. As a result, they moved the Bombay High Court to restrain the bank Wells Fargo from encashing the letters of credit. The Bombay High Court inter alia held that the letters of credit were independent transactions with the bank and the underlying dispute between the importer and the South Korean sellers does not concern the bank. This was a unique case wherein the force majeure clause in the contract was wholly one-sided and was only applicable to the South Korean exporter. Incidentally, the exporter had also complied with its obligations and shipped the goods. Though the Petitioner had not advanced the argument/exception of special equities, the unique facts and circumstances did not warrant interference in the encashment of the letters of credit by the Bombay High Court.

A few days later, the Delhi High Court in Halliburton Offshore Services Inc. v. Vedanta Limited & Anr.,[9] restrained the enforcement of eight (8) bank guarantees. Pursuant to a tender, the Petitioner was required to develop three fields for the Respondent No. 1. Though the project was delayed, the parties mutually extended the period for completion to March 31, 2020, when the lockdown was in force. Owing to the same, the Petitioner was unable to complete the project, and the Respondent No. 1 proceeded to invoke the bank guarantees. The Delhi High Court granted an interim order of injunction, till the next date of hearing.

After the Halliburton order, the Delhi High Court in Indirajth Power Private Limited v. UOI & Ors,[10] refrained from injuncting the invocation of the bank guarantee by the Union Government, with regard to a mining project in Maharashtra. In this case the Petitioner was in non-compliance of the project milestones since April-June 2018 and despite an extension of 12 months that was granted in its favour, the Petitioner remained non-compliant. As a result, the lockdown was merely an excuse for the Petitioner to seek restraining of the invocation of bank guarantees and the exception of special equities was not extended to it.

These three orders may at first glance appear to be contrasting and incongruous approaches by the High Courts. But a closer look will reveal that each of the orders are sustainable on law and on facts. In the Standard Retail case, the Bombay High Court was justified in rejecting the request to restrain the letters of credit, even if the argument of special equities was advanced, because a) the force majeure clause in the contract was wholly one-sided, b) the exporter had complied with its obligations under the contract and therefore the lockdown did not hinder the contract.

In the Halliburton case, the parties agreed to extend the term of the contract and the breach which resulted in the invocation of the bank guarantees arose during the lockdown. Therefore, aggrieved party was justifiably prevented to carry out his obligations during the lockdown and the exception of special equities was rightly extended to it. On the other hand, in Indirajth Power Private Limited case, the breach/default that led to the invocation of the bank guarantee was much prior to the lockdown and multiple opportunities were afforded to comply with its obligations. Therefore, there was no case made out to extend special equities as an exception.

The Covid-19 pandemic and consequent lockdown is an exceptional circumstance which has had far reaching effects across the globe. It should most certainly qualify as a ‘special circumstance’ resulting in a presumption of ‘special equities’ in favour of the party aggrieved by the invocation of the bank guarantee or letter of credit. But it is important for Courts to take into consideration the timeline of the breach/default that resulted in the invocation. If the breach/default occurred during the lockdown, then a presumption of special equity ought to be extended to the aggrieved party, subject to rebuttal. However, if the breach/default occurred before the lockdown and it was only the act of invocation that occurred during the lockdown, then in my view, no special equities ought to be extended.

The High Courts of Bombay and Delhi have passed sustainable orders in the given facts and circumstances and the supposed legal quagmire resolves itself with just a deeper analysis.

The author is Chintan Chinnappa, Co-Founder and Litigation & Dispute Resolution Partner at Spectrum Legal, Bengaluru.

[1] Hamzeh Melas & Sons v. British Imex Industries Ltd., [1958] 2 Q.B.D. 127; Edward Owen Engineering Ltd. v. Barclays bank international ltd. and Umma bank., [1978] 1 Lloyd's Rep. 166.

[2] UCO Bank v. Bank of India., 1981(3) SCR 300; Centax (India) Ltd. v. Vinmar Impex Inc., 1986(4) SCC 136; State of Maharashtra v. National Construction Co., (1996) 1 SCC 735.

[3] AIR 1979 Cal 44.

[4] (1988) 1 SCC 174

[5] General Electric Technical Services Company Inc. vs Punj Sons (P) Ltd., 1991 SCC (4) 23; Hindustan Steelworks Construction Ltd. vs Tarapore & Co. & Anr., 1996 SCC (5) 34.

[6] 1997 88 CompCas 149 SC.

[7] (2019) SCC Online SC 1638.

[8] Commercial Arbitration Petition (L) No. 404 of 2020, High Court of Bombay.

[9] Order dated April 20, 2020 in OMP (I) (Comm & IA 3697/2020).

[10] Order dated 28/04/2020 in W.P.(C) 2957/2020 & CM Nos. 10268-70/2020, High Court of Delhi.

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