COVID19-XVII: Invocation of Bank Guarantees in the Times of COVID-19

Anoushka Ishwar and Palak Kumar

This is the 17th post of our COVID-19 series.

With the outbreak of the lethal COVID-19 and the World Health Organization declaring it a global pandemic, territorial and extra-territorial business operations have suffered a major setback. With almost half of the globe facing a lockdown, economies fearing the threat of recession, unprecedented loss to industries, unemployment, and the stock market facing an all-time low, the entire human cycle has come to a standstill. This situation of hustle and panic with the public health crisis has caused uncertainty to businesses, with industrial units and warehouses having been closed until the 17th of May. For businesses, it essentially means that they face the apprehension of fulfilling their obligations under myriads of commercial contracts that they have ventured into. This has led to parties invoking the force majeure clause to safeguard themselves from the performance of their bank guarantee obligations.

One such instance of invoking the force majeure clause has been the case of M/S Halliburton Offshore Services Inc.v Vedanta Limited & Anr wherein the Hon’ble Delhi High Court decided the question of whether the respondent can invoke bank guarantees against the petitioner particularly in case of preventive force majeure delay. The authors have attempted to analyse the judgement, review the precedent to examine the trend followed by courts on the question of invocation of bank guarantees, and compare them with the case at hand.

In the present case, a contract was executed between the two parties for the construction of three wells. Pursuant to this contract, the petitioner sought an interim injunction under Section 9 of the Arbitration and Conciliation Act, 1996 fearing the cancellation of the same, and consequent invocation of bank guarantees by the respondent. The petitioner contended that the nationwide lockdown enforced on the movement of goods and people affected the completion of the project scheduled for March 31, 2020. However, there lay certain disagreement concerning the postponement of the completion deadline of the project which originally was June 2019. The respondent had opposed this notion that any condonation was granted to the petitioner, stating that the multiple extensions in the deadline were done by the petitioner on his own accord. Hence, the question of whether judicial interference for an interim stay against the bank guarantees could be permitted arose in this case.

This judgement comprehensively traces the jurisprudence of the Supreme Court concerning the invocation of bank guarantees. The Court places reliance on a plethora of cases, the U.P. State Sugar Corporation case and the landmark Itek Corp. to discuss the position of law, which is now well settled. Placing reliance on these cases, the Court acquiesced that judicial interference is required to be exercised within a limit and with caution. Banks are required to honour the guarantee provided despite the relationship dynamics between the parties or any extraneous circumstances. The High Court clarified the two exceptions to such invocation, one being egregious fraud. The second exception was concerning special equities, which result in irretrievable harm or injury to the parties involved. Although the Supreme Court has regularly characterised special equities wherein exceptional injury or harm occurs, the Delhi HC herein modified this interpretation by relying on a recent 2018 judgement.

The case, Standard Chartered Bank v. Heavy Engineering Corporation, distinguishes between special equities and irretrievable harm, thus creating three wide categories of exception. Although this does find a little backhanded support in few Supreme Court judgements, it mostly strays far from the interpretation provided in landmark cases. Relying on such a nascent construction, the Court held that the commencement of the lockdown in March 2020 restricted substantially the movement of workmen leading to an evident stoppage in construction. The Court held that the unprecedented manner in which COVID-19 has thrown commercial workings in a lurch, entitles it to be considered as a special equity deserving of interim relief on the invocation of the bank guarantees. It is necessary at this stage to trace back to the fact that the petitioner requested for interim relief based on an apprehension of the respondent’s cancellation. The judgement highlights that courts have consistently found that special equities do not include circumstances of speculative harm, but one of an immediate nature. Interference can only be justified if the guarantor has no possible manner in which he can reimburse himself if he eventually succeeds. Although, the Delhi High Court acknowledges that the petitioner stands at a position to recover such sum in the arbitration, it extends this protection without substantive reasons.

The judgement attracts criticism on three major points. Firstly, that time is of essence, particularly in case of construction contracts. Courts have repeatedly interpreted commercial contracts, reading into it the importance of time, especially when there were for construction. Due to the ever-changing economic conditions, the Court has always maintained a rigid stance concerning time and its relation to the construction of immovable property to protect the parties from prejudice.

Secondly, the delay in the completion of the contract was attributable to the petitioners, and was a preventive force majeure delay. To appreciate this point it is pertinent to understand the interpretation of the term preventive force majeure delay. Delay in the performance of contractual obligations in construction contracts can be of two types “unavoidable force majeure delay” or “preventive force majeure delay”. Unavoidable force majeure delay is when the force majeure event occurs during the original period of the contract while preventive force majeure delay is when the force majeure event occurs after the completion of the contract period. In the former case, any force majeure event that occurred beyond the control of both the parties during the contract period gives a legitimate reason to allow the non-performing party an extension of time to fulfil their obligations without imposing any compensatory dues. On the other hand, in case of preventive force majeure delay the parties have to bear the brunt of the force majeure event because of the delay in completion of contract beyond the original contract period. If the contract was performed within the decided window, the force majeure delay could have been prevented.

Such PFMD is likely to affect not only the scheduled time of the project but also the cost of the entire project. In such cases, the delay is caused due to the negligence on the part of one party in performing the contract because of which the contract could not be concluded within the original contract period. This would entitle the innocent party to claim against the delay caused by the negligence of the other party. The rationale behind this is that the innocent party should not suffer because of the delay or lost profits due to the acts of the other party.

Lastly, the contract of guarantee or letter of credit is a separate transaction and the bank has nothing to do with the dispute between the parties. The court’s interference is uncalled for unless there is a case of egregious fraud, or irretrievable harm will be caused to the party.

In the present set of facts, it is clear that it was incumbent on the petitioner to complete the construction of the three wells by June 2019. The contention that allowing the invocation of bank guarantees would cause irreparable harm to the petitioner stands negated considering the fact that he had been given ample time to complete the contract but kept stretching the timeline. Now, the petitioner seeks to fall back on the situation of mayhem created by COVID-19 and the subsequent lockdown to trigger the force majeure clause and thereby, free himself from his contractual liability.

The authors stand opposed to this idea of deeming this set of circumstances as exceptional due to the consequent repercussions it shall cause. The Delhi High Court, through this judgment, not only widens the scope of judicial interference in invocations of bank guarantees, but simultaneously broadly terms COVID-19 as a special equity deserving exceptional treatment. Further, it gives little attention to the fact that the petitioner contributed to the circumstance of delay themselves, thus creating a legal limbo concerning the invocation of bank guarantees in such circumstances. The Courts have always been restrictive in their construction because excessive judicial say shall negatively affect the independence of bank guarantees, the functioning of banks with respect to the same, and thus, commercial relationships in the country. It must be pointed out that following a sympathetic approach towards the petitioner is likely to put the respondent to the perils of injustice with absolutely no fault on their part. Thus, such a nonchalant change in a well-settled position of law has the power to open the floodgates for numerous prejudicial claims.

The authors are students at the National Law Institute University, Bhopal.

Click on the book images below to make your Amazon purchases. All affiliate commissions earned are donated to Stranded Workers Action Network.


Categories: COVID-19