Invocation Of Bank Guarantees And Principle Of Unjust Enrichment

Purbasha Panda

051320015647

Introduction

In the backdrop of a nationwide lockdown, business entities are knocking doors of courts with multitudes of contractual disputes. One such kind of dispute relates to the question of grant of an injunction by courts on the invocation of unconditional performance bank guarantees. Indian courts have mostly ruled in favour of the autonomous existence of unconditional performance bank guarantees and have allowed its invocation on demand. They have maintained a fair amount of restraint in interfering with encashment of performance guarantees and have limited themselves to the exception of fraud and irretrievable harm. This article primarily challenges the principle of autonomy of unconditional performance guarantees.  Further, it attempts to explore the question that is ‘How far the Indian judicial approach has been successful in negating the risk of unjust enrichment in cases of invocation of performance bank guarantees?’

Principle of autonomy of unconditional performance bank guarantees

Scope of Judicial Intervention with respect to unconditional performance guarantees

Over the years, through a catena of judgements, Indian courts have mostly ruled against the grant of injunction on encashment of bank guarantees. A landmark decision of the Apex Court on this question is, Hindustan Steel Construction Ltd v. Tarapore & Co.& Anr. In this case, the Apex Court has ruled that unconditional guarantees are always to be issued on demand. Unconditional bank guarantees are independent of the underlying contract or inter se disputes between parties and have an autonomous existence. It further held that courts should exercise restraint in interfering with the invocation of bank guarantees and it is only in exceptional circumstances that the courts should interfere. It further carved out two exceptions to the rule of invocation of bank guarantees on demand which are fraud and irretrievable harm.

Inadequacy of exceptions to the principle of autonomy of bank guarantees and unjust enrichment

Irretrievable harm exception and Unjust Enrichment

In some cases where the exception of ‘irretrievable harm’ is pleaded, it is often seen that such a plea is followed by an argument that, allowing invocation of bank guarantees on-demand irrespective of inter se disputes between the parties might allow for some scope of ‘unjust enrichment’ to one party at the cost of the other. The concept of ‘unjust enrichment’ stems from the English law principle of ‘Nemo debet locupetari ex aliena jactura’ which essentially means that no man should grow rich out of another person’s loss, therefore a person who has unjustly enriched himself at the expense of another is required to make restitution.

Let us understand how this principle comes into the picture in cases of injunction on the invocation of bank guarantees. Let’s take a situation where two parties have entered into a contract for supply of specific kind of goods and one party alleges that there has been a default of performance of the contract, however, the other party negates the same. Later, the party alleging the default of performance goes on to invoke the bank guarantees which is subsequently paid by the bank and the bank further gets indemnified from the party who had furnished those bank guarantees under the contract. Thus, at this stage a party is paying a certain amount without verification of the claim of alleged default which has ultimately led to the invocation of those bank guarantees, such invocation can sometimes prove to be a major blow to a party which might be trying hard to perform a contract. Sometimes, parties might even use an invocation of bank guarantees as a strategy to create undue financial distress on the opposite party. Later, in the above example if separate arbitration proceedings commence with respect to the alleged default of performance of the contract, then two kinds of legal circumstance might arise, the party negating the alleged default might get an award in its favour or it might turn out that the award is not in its favour, in case it gets an award in its favour, there might be some form of restitution at its disposal but in case the award is not in its favour there would not be any scope of restitution especially with respect to the amount paid by it for the purposes of bank guarantees. Therefore, the question that arises here is ‘How far the legal interpretation adopted by courts in India traces and prevents this scope of unjust enrichment with respect to invocation of bank guarantees?

In the case of Klen & Marshall Manufacturers v. Reserve Bank of India the Delhi High Court has dealt with the application of the principle of ‘unjust enrichment’ with respect to invocation of bank guarantees. This case essentially dealt with a contract entered between two parties for supply for certain equipment. The plaintiff who was engaged in the supply of certain equipment had also furnished two bank guarantees for due delivery of goods and advance payments. During the term of the contract, the defendant had invoked the guarantees and the bank had refused to pay, post which the defendant had approached the ‘Banking Ombudsman’ and the ‘Banking Ombudsman’ had passed an award asking the bank to pay the guarantee under demand. In response to which, the plaintiff had filed an application before the Delhi High Court seeking an injunction and thereby restricting the defendants from invoking the bank guarantees on the ground of irretrievable harm. The plaintiff had essentially argued that for the goods that they had supplied, the defendant had not made any payment and had rather invoked the guarantees in order to unjustly enrich himself at the expense of the plaintiff, they also pleaded that the invocation of the bank guarantees could probably even lead to an absolute shut down of the plaintiff’s business. The court, in this case, turned a blind eye to all these factual considerations and ruled in favour of independent existence of bank guarantees irrespective of inter se disputes between the parties. In the opinion of the author, such an approach of courts aimed solely towards preserving the inviolability of the principle of autonomy of unconditional bank guarantees overlooks the fact that in certain circumstances allowing invocation of bank guarantees might alter equities in favour of one party leading to irretrievable injury to the other. The equity jurisdiction of a court is invoked in an application for injunction wherein an equitable remedy is prayed to prevent injustice, one of the essentials for grant of an injunction is the satisfaction of the ‘Balance of Convenience’ test. Under this test, the court tries to balance the harm that would be meted out to both the parties as a result of its decision. Thus, it is imperative that in these kinds of cases the court should not just stop at applying the precedents rather it should go a step ahead. The judicial approach adopted by courts in India somehow has not been very equipped to trace a situation where there might be fraudulent invocation of bank guarantees which is used by a party to get unjustly enriched, rather the Apex Court in the case of Dwarikesh Sugar Industries Ltd v. Prem Heavy Engineering Work, has held that the principle of undue enrichment cannot be applied in cases of invocation of bank guarantees.

FraudIn the case of,  State Trading Corpn. Of India Ltd v Jain sons Clothing Corpn , the Apex Court has interpreted the exception of fraud to be of egregious nature which vitiates the entire underlying transaction, the Apex Court has ruled that fraud would attract an injunction only if it occurred in, entering into the underlying contract with the reference bank or in formation or execution of the bank guarantee. This exception takes due consideration of those circumstances where fraud has been played out on the instrument of performance guarantee. For example, in the case of Adani Exports Limited v. Marketing Services the Gujarat High Court made a deviation from strict adherence to the principle of autonomy of letters of credit and restrained invocation on the ground of existence of ‘fraud’. In this case, the court found out that fraud was played out with respect to transactions aimed towards performance of the contract. The case essentially dealt with a contract for shipment of goods between parties residing at two different parts of the world. One party had invoked the letters of credit on the ground of default with respect to the performance of the contract and the other party filed an injunction application to restrain the invocation of the letters of credit on the ground that, the alleged default with respect to the performance of the contract was a result of fraud carried out by the other party. The contract for shipment of goods provided for a specific date within which the shipment of goods would have to be completed and the terms of the contract provided that the ‘letters of credit’ could only be invoked only after a specific period of time after one of the party is in delivery of the goods. The court found out that to avail the opportunity to invoke those letters of credit one of the parties to the contract had fraudulently misrepresented the date on which the shipment of goods was completed. Thus, the fraud had played out on the underlying transaction between the parties, thus the court deviated from the principle of autonomy of letters of credit and allowed an injunction on invocation of letters of credit. The treatment of this exception by Indian courts suggests that though the exception covers overt attempts of fraudulent invocation of bank guarantees but does not cover furtive attempts by one party to unduly invoke bank guarantees and get unjustly enriched.

Conclusion

If we take a panoramic view of the Indian judicial approach on the question of injunction on performance bank guarantees, it is quite evident that Indian courts have exercised a fair amount of restraint in granting an injunction. The fraud exception is not very wide-ranging in terms of covering those conducts where a party uses performance guarantees to unjustly enrich itself. The irretrievable harm exception gives some leeway to the courts to take consideration of the underlying factual circumstances relating to the contract, however, while deciding on the applicability of this exception Indian courts have refused to apply the principle of unjust enrichment. Invocation of guarantees must be used to ensure the performance of contractual obligations and must not be allowed as a tool for parties to unjustly enrich themselves.


The author is a student at the National University of Study and Research in Law, Ranchi.

Picture Credits: Construction Executive


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