DR. RAM MANOHAR LOHIYA
NATIONAL LAW UNIVERSITY,
LUCKNOW
CONTRACTS PROJECT
BANK GUARANTEE
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SUBMITTED TO -
DR. VISALAKSHI VEGESNA
ASSOCIATE PROFESSOR
(LAW)
SUBMITTED BY -
AMAN KUMAR
III SEMESTER
170101020
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DR. RAM MANOHAR LOHIYA
NATIONAL LAW UNIVERSITY,
LUCKNOW
CONTRACTS PROJECT
BANK GUARANTEE
SUBMITTED TO -
DR. VISALAKSHI VEGESNA
ASSOCIATE PROFESSOR
(LAW)
SUBMITTED BY -
AMAN KUMAR
III SEMESTER
ACKNOWLEDGEMENT
I take this opportunity to express my profound gratitude and deep regards to my guide Dean (Academics), Professor C.M.Jariwala and ASSOCIATE Professor Dr. VISALAKSHI VEGESNA for their exemplary guidance, monitoring and constant encouragement to give shape to this project. The blessing, help and guidance given by them time to time shall carry me a long way in the journey of life on which I am about to embark. I also take this opportunity to express a deep sense of gratitude to my respected seniors who share their cordial support, valuable information and guidance, which helped me in completing this task through various stages. Lastly, I thank the almighty, my parents, brother, sister and friends for their constant encouragement without which this assignment would not have been possible.
INTRODUCTION A guarantee is a promise to answer for the payment of some debt, or the performance of some duty, in case of the failure of another party, who is in the first instance, liable to such payment or performance. A guarantee is an accessory contract by which the promisor undertakes to be answerable to the promisee for the debt, default or miscarriage of another person, whose primary liability to the promise must exist or be contemplated. 1 Guarantee, is an undertaking to be collaterally responsible for the debt default or miscarriage of another. In a banking context it is an undertaking given by the guarantor to the banker accepting responsibility for the debt of the principal debtor if he defaults, the guarantor may or may not be a customer. A contract of guarantee is thus a secondary contract, the principal contract being between the creditor and the principal debtor themselves. If the promise or liability in the principal contract is not fulfilled or discharged only then the liability of the surety arises. Definition Section 126 of Indian Contract Act, 1872 defines a contract of guarantee as a contract to perform the promise, or discharge the liability, of a third person in case of his default. The section further provides that the person who gives the guarantee is called the “Surety”, the person in respect of whose default the guarantee is given is called the “principal debtor”, and the person to whom the guarantee is given is called “Creditor”. A guarantee may either be oral or written. For example, A takes a loan from a bank. A promises to bank saying that if a does not repay the loan “then I will pay”. In this case A is the principal debtor, who undertakes to repay the loan; B is the surety, whose liability is secondary because he promises to perform the same duty in case there is default on the part of A. The bank, in whose favour the promise has been made, is the Creditor. The object of a contract of guarantee is to provide additional security to the creditor in the form of a promise by the surety to fulfil a certain obligation, in case the principal debtor fails to do that. In every contract of guarantee, there are three parties, the creditor, the principal debtor, and the surety. There are three parties in a contract of guarantee. Firstly, the principal debtor himself makes a promise in favour of the creditor to perform a promise, etc. Secondly, the surety undertakes to be liable toward the creditor if the principal debtor makes a default. Thirdly, an implied promise by the principal debtor in favour of the surety that in case the surety has to discharge the liability on default of the principal debtor, the principal debtor shall indemnify the surety for the same.
The contract of guarantee is no doubt tripartite in nature but it is not necessary or essential that the principal debtor must expressly be a party to that document. In a contract of guarantee, the principal debtor may be a party to the contract of implication.Thus there is a possibility that a person may become a surety without the knowledge and consent of the principal debtor. In such a case, the rights of the surety are given in sections 140, 141 and 145 of Indian Contract Act, 1872 viz, the right of subrogation, right to securities with the creditor and the right of indemnity against the principal debtor, respectively. In English Law a guarantee is defined as “a promise to answer for the debt, default or miscarriage of another”. It is a collateral engagement to be liable for the debt of another in case of his default. “Guarantees are usually taken to provide a second pocket to pay if the first should be empty. According to section 126 of Indian Contract Act, 1872 a Guarantee may be either oral or written.On this point the position in India is different from the England. According to English Law, for a valid contract of Guarantee, it is necessary that it should be in writing and signed by the party to be charged therewith. Essential features of guarantee The essential features or elements of a valid contract of Guarantee are
- There must be a debt existing, which should be recoverable.
- There must be three parties’ i.e. principal debtor, creditor and surety.
- The contract of Guarantee may be either oral or written.
- There must be a distinct promise, oral or written, by the surety to pay the debt. In case of default, committed by the principal debtor.
- There should be no misrepresentation or concealment of any material facts concerning the transaction.
- Sometimes a contract of Guarantee is implied also from the Special^ Circumstances.For example the endorser of a bill of exchange is liable to pay the amount of the bill to the payee in case of the acceptor of the bill defaults to fulfil his promise.
- The principal debtor must be primarily liable. Surety’s Liability arises only in case of default of the principal debtor.
- There should be some consideration. Benefit to the principal debtor is sufficient consideration.
- The liability under Guarantee must be legally enforceable.
The right of the beneficiary under a bank guarantee is governed by the bank guarantee itself and not by the terms and conditions of the original contract. The bank guarantee is a contract separate from the original contract. The bank guarantee is not a party to the original contract. The party at whose instance the bank guarantee is furnished pursuant to the original contract is not a party to the guarantee. Whether it is a financial guarantee, a performance guarantee or a letter of credit established by a bank, it is a contract under section 126 of Contract Act 1872 to perform the promise or discharge the liability of a third person on that third person’s default. In the case of non-performance or short performance of obligations by its constituents, the bank will be called upon to make good the monetary loss arising out of non - fulfilment of the guarantee obligations to the extent stipulated in the guarantee, to the beneficiary. Nature Of Contract A bank guarantee contract is distinct and independent from the underlying contract that subsists between the beneficiary and the creditor. This is extremely important in determining the liability of the banks in the event of default by the debtor. In the case of Syndicate Bank v. Vijay Kumar^1 the Court was required to enforce the bank guarantee simpliciter without probing into the nature of the transactions between the Bank and the customer that led to the furnishing of the bank guarantee. The Supreme Court has further reiterated in the case of Ansal Engineering projects Ltd v. Tehri Hydro Development Corporation Ltd (^2) that a bank guarantee is an independent and distinct contract between the Bank and the beneficiary and is not qualified by the underlying transaction and the validity of the primary contract between the person at whose instance the bank guarantee is given. As the bank unconditionally and unequivocally promised to pay, on demand, the Court thus held that the liability of the bank was absolute and unconditional and could not be circumvented in any manner. ! 1 ("Syndicate Bank vs Vijay Kumar And Others on 5 March, 1992", 2018) Syndicate Bank vs Vijay Kumar And Others on 5 March, 1992. (2018). Retrieved from https://indiankanoon.org/doc/143/ (^2) ("Ansal Engineering Projects Ltd vs Tehri Hydro Development ... on 31 July, 1996", 2018) Ansal Engineering Projects Ltd vs Tehri Hydro Development ... on 31 July, 1996. (2018). Retrieved from https:// indiankanoon.org/doc/514858/
Operative clause The operative clause in bank guarantees is reproduced below: We, ..... Bank, hereby agree and undertake that, if in your opinion, any default is made by (constituent) in performing any of the terms and conditions of order or if in your opinion, they have committed any breach of the contract or there is any demand by you against....(Constituent), then on notice by you, we shall, on demand and without demur and without reference to ............ (Constituent). Immediately pay in any manner in which you may direct a sum of Rs..............or such portion thereof as may be demanded by you not exceeding the said sum and as you may from time to time require. Our liability to pay is not dependent or conditional on your proceedings against ........and we shall be liable to pay the aforesaid amount as and when demanded by you merely on a claim being raised by you and even before any legal proceedings are taken against the constituent. Unless extended, this guarantee shall expire on .......... Notwithstanding anything continued herein above our liability shall be limited to Rs......... This clause gives unfitted rights to the beneficiary of the guarantee, and the bank has no option but to make the payment of eh same on its being invoked. The courts have observed in numerous cases that the liability of the bank under the guarantee is absolute and they would not generally interfere with the contractual obligations of the banker by issuing any injunction against the payment when the guarantee is validity invoked. In enunciating the general principle of non-intervention by the courts in respect of the guarantees and letter of credit the courts intend that trade and commerce should function smoothly without interference from the judiciary. At the sometime, the courts expect businesses to honour their respective commitments and maintain business honesty. In bank guarantee the bank binds itself to pay, unconditionally and unequivocally without protest or demur or performance by principal debtor. The bank that has issued the guarantee is not concerned with the relationship between the seller and the customer, nor with the question whether the seller performed its contractual obligation or not. The bank must be allowed to honour its commitments in a bank guarantee, otherwise, trust in international commerce will be irreparably damaged respectability and reliability of the assured made of payment through bank guarantees is necessary for the growth and promotion of trade. In Basant Rlymers Alwar Vs State Chemical and
The following cases further illustrate this point in detail: In the case of Bolvinter Oil SA v. Chase Metropolitan^4 it was stated that an injunction may be granted where it is proved that the bank knows that any demand for payment already made or which may thereafter be made will clearly fraudulent; though the evidence must be clear as to the fact of fraud and as to the bank’s knowledge, and it cannot rest on the uncorroborated statement of the customer or else irreparable damage can be done to a bank’s credit. The Supreme Court affirming long standing jurisprudence on the subject in the aforementioned case of UP State Sugar Corporation v. Sumac International Ltd 5 stated that whenever a bank guarantee is sought to be encashed by the beneficiary, the bank is bound to honour the guarantee irrespective of any dispute raised by the customer against the beneficiary. This is however subject to two exceptions that is, a fraud committed in the notice of the bank which would vitiate the very foundation of the guarantee or encashment of the bank guarantee would result in irretrievable harm or injustice of the kind which would make it impossible for the guarantor to reimburse himself. Injunction of restrain payment under a bank guarantee Where a bank gives a guarantee to pay on ‘first demand’ and ‘without contestation and ‘without reference to such party’ or notwithstanding any disputes between the parties .....the guarantee bank is obliged to pay according to the contractual obligation, and the court will not give an injunction restraining the bank for payment. Where the guarantee was enforceable on the importer’s failure to take delivery of goods, but it was also provided that the decision of the beneficiary as to whether the importer failed to carry out their obligation shall be final and binding on the bank, was held that the bank could not be restrained from making payment under the guarantee on the Importer’s plea that the goods contracted for were not offered for delivery. The fact that the guarantee issued by the bank is wider in terms, than that agreed between the bank and the debtor is also no reason to grant injunction restraining payment. Where however, there is no unconditional or irrevocable promise to pay in the guarantee in which it was only undertaken to indemnify the company from any loss or damage that was caused to it or was suffered by it by the act of the contractor, it was held that (^4) ("Bolivinter Oil SA v Chase Manhattan Bank NA: 1984 - swarb.co.uk", 2018) Bolivinter Oil SA v Chase Manhattan Bank NA: 1984 - swarb.co.uk. (2018). Retrieved from https://swarb.co.uk/bolivinter-oil-sa-v- chase-manhattan-bank-na-1984/ (^5) ("U.P. State Sugar Corporation vs M/S. Sumac International Ltd on 4 December, 1996", 2018) U.P. State Sugar Corporation vs M/S. Sumac International Ltd on 4 December, 1996. (2018). Retrieved from https:// indiankanoon.org/doc/1746106/
temporary injunction could be granted, restraining the company from realising the bank guarantee, since the guarantee sought to be enforced amounted to a contract of indemnity and the beneficiary had to show the loss or damage caused to it. It is settled law that a contract of guarantee is a complete and separate contract by itself. The law regarding enforcement of an on demand bank guarantee is very clear. If the enforcement is in terms of the guarantee, then courts must not interfere with the enforcement of bank guarantee. The court can only interfere if the innovation of on demand guarantee in accordance with its terms by looking at terms of the underlying contract. Exceptions Payment under a bank guarantee may be refused of restrained:
- Where the bank knows that the documents presented by the beneficiary for seeking enforcement are forged or fraudulent.
- Where a fraud by one of the parties to the underlying contract has been established and the bank has notice of the fraud.
- Where a case of apprehension of Irretrievable Injustice is made out.
- Where the guarantee is conditional and the condition has not been complied with.
- Where the conditions necessary for invoking a conditional bank guarantee have not arisen.
- Where the purpose for which a conditional guarantee was given has been accomplished.
- Where the period stipulated for innovation of the guarantee has expired. In BSES Ltd. (Now Reliance Energy Ltd) Vs Fanner India Ltd^6 .; it was held that as a general rule that a bank guarantee must be honoured in accordance with its terms there are however, two exceptions: The first is when there is clear fraud of which the bank has notice and a fraud of the beneficiary from which it seeks the benefit. The fraud must be of an egregious nature as to vitiate the entire underlying transaction. The second exception to the general rule of non-intervention is when there are special equities in favour of injunction, such as when irretrievable injury or irretrievable injustice would occur if such an injection were not granted. (^6) ("M/S Bses Ltd. (Now Reliance Energy ... vs M/S Fenner India Ltd. & Anr on 3 February, 2006", 2018) M/ S Bses Ltd. (Now Reliance Energy ... vs M/S Fenner India Ltd. & Anr on 3 February, 2006. (2018). Retrieved from https://indiankanoon.org/doc/1342691/
of margin money could range from ten to fifty percent of the value of the guarantees. The margin money will be released once the bank guarantee has expired and is returned to the bank duly discharged. Counter Guarantee In addition to fixing limits and taking ‘margin money’ as security, banks invariably obtain counter guarantees from the client’s for equal value before furnishing bank guarantees on their behalf. This document provides the basis for the bank to debit the clients’ accounts when it has to honour a bank guarantee invoked by the beneficiary, and to proceed legally against the client, if it is unable to fully reimburse itself of the amount from the client. Economic function of guarantee The function of a Contract of Guarantee is to enable a person to get a loan, or goods on credit or an employment. Some person comes forward and tells the lender, or the supplier or the employer that he (the person in need) may be trusted and in case of any default, “I undertake to be responsible”. Benefits of bank guarantee For government:
- Increases the rate of private financing for key sectors such as infrastructure.
- Provides access to capital markets as well as commercial banks.
- Reduces cost of private financing to affordable levels.
- Reduces government risk explore by passing commercial risk to the private sector. For private sector:
- Reduces risk of private transactions in emerging countries.
- Mitigates risks that the private sector does not control.
- Opens new markets.
- Improves project sustainability.
Difference between a bank guarantee and a usual guarantee Following are some points of difference between a bank guarantee and a usual guarantee (1) A usual guarantee is governed by section 126 of the Indian Contract Act, 1872.A bank guarantee is not directly governed by section 126 of the Indian Contract Act, 1872. (2) An ordinary guarantee is a tri-partite (3 parties) agreement involving the surety, the debtor and the creditor. But a bank guarantee is a contract involving two parties i.e. the bank and the beneficiary. (3) In an ordinary guarantee, the contract between the surety and the creditor arises as a subsidiary to the contract between the creditor and the principal debtor. The bank guarantee is independent of the main contract. (4) In an ordinary guarantee, the inter se disputes between the debtor and the creditor have a material effect upon the surety’s liability. However, the bank guarantee is independent of the disputes, arising out of the contract.
- An ordinary guarantee does not have any time limit before which the debt has to be claimed. Bank guarantees generally have a specific time within which they are functional.
REFERENCES
- Gupta, R.K., Banking law and practice. (2004 Ed.). Modern law publications.
- Handrson, Wade, Bank guarantee explained. http:ezinerticles.com.
- Mir, M.A., the law relating to bank guarantees in India. (1992 Ed.). Universal book traders.
- Moitra, A.C., Law of Contract and specific relief Act. (2005 Ed., 2006 reprint).
- Pollock & Mulla, Mulla on Indian contract and specific relief act (2006 Ed.).
- Prakash, Faq on bank guarantee. http://www.calclubindia.com. 6 th Dec, 2009.
- (^) Rajesh, Bank guarantee. http://www.calclubindia.com. 14 th July, 2009.
- Ramachandram, Jessy, Bank guarantee. http://www.american-charomical.com.
- Singh, A., Law of contract. (2002 Ed.). Eastern Book Company Lucknow.
- Sujan, M.A., Law relating to government contracts. (2000 Ed.). Universal Law Publishing company Pvt. Ltd.