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Bank Guarantee

Bank Guarantee

A Bank Guarantee is commonly a mode of securing payment of money, which involves commercial dealing as the beneficiary, under the guarantee, is entitled to claim the whole amount under that guarantee in terms thereof, irrespective of any pending dispute between the person on whose behalf the guarantee was given and the beneficiary. There is an established fact that Bank Guarantee represents an independent contract between the bank and the beneficiary, both the parties are bound by the terms thereof. The invocation, thus, has to be in accordance with the terms of the guarantee, or else, the invocation itself would be bad in law.


The two types of Bank Guarantee are: Firstly, Unconditional Bank Guarantee; & secondly, Conditional Bank Guarantee. Elaborating the same, an Unconditional Bank Guarantee ensures the payment to the beneficiary “unconditionally and irrevocably” on the beneficiary's first demand upon invoking the guarantee wherein there shall be certain conditions, which should be fulfilled before it can be invoked by the beneficiary. In such circumstances, the Bank Guarantee in question would be categorized as a Conditional Bank Guarantee. Therefore, the terms of the guarantee are extremely material.

For an unconditional bank guarantee, there will be contentions of Fraud or the need for special equities that are required to be specifically pleaded and proved. In addition, Mere assertion or allegation or conjecture of fraud, without any evidence, would not be sufficient. Most importantly, All the necessary and clear evidence in the proof of fraud must be necessarily pleaded and produced, which shall have an evident value wherein the facts of the case should depict that fraud committed by the beneficiary is of such nature that it destroys the entire underlying transaction. There should also be a serious dispute involved and a prima facie case of fraud. Conclusively, it is necessary that at the time of the invocation of the Bank Guarantee, the Bank should have the notice of the fraud. Moreover, such a fact of notice along with its evidence has to be averred in the petition.

In the matter for conditional bank guarantee, the facts and circumstances where the conditions as stated or referred to in the conditional bank guarantee have not been fulfilled must be pleaded in the petition seeking an injunction which shall have an evidentiary value. There shall be sufficient evidence with regards to such unfulfilled conditions that must be pleaded and produced. Conclusively, A case highlighting the prejudice which would be caused if the payment under Bank Guarantee is permitted must be made out.


The Bank Guarantee can be invoked by the beneficiary on or before the expiry date of the guarantee. Illustratively, when the bank does not receive any claim on ore before the validity mentioned, the Bank is discharged from its liability. The beneficiary needs to send a letter to the Bank stating the circumstances that arose leading to the encashment of the guarantee. However, how can the party on whose behalf the guarantee was drawn injunct the beneficiary from encashing the guarantee? For this very purpose, there has been a catena of judgments which are briefly discussed hereinbelow.


In few matters, some bank guarantees make the beneficiary a sole judge in regard to invocation and enforcement of bank guarantee, which leaves the decision of invocation to the absolute discretion of that beneficiary which means that the guarantor must pay without having any regard to the dispute pertaining to the main contract and in that particular, the court would be precluded from embarking on an enquiry pertaining to the prima facie nature of the respective claim of litigating parties relating to the main dispute. 

In U.P. Co-op. Federation Ltd. v. Singh Consultants and Engineers (P) Ltd., 1988 AIR 2239, 1988 SCR Supl. (2) 859, 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 between the party in whose favour guarantee was given and the party on whose behalf guarantee was given.” The Hon'ble Supreme Court held that the Bank was obligated to pay the moment a demand was made without protest and contestation, irrespective of any dispute between the parties. The Hon'ble Court further held that in such a case, the party on whose behalf the guarantee was given was not entitled to an injunction restraining the bank in the performance of its guarantee.

A New York Supreme Court case was referred to in U.P. Co-op. Federation Ltd., wherein an act that constituted as fraud was dealt with. In the matter of Stijn v. J. Henry Schroder Banking Corp., 177 Misc. 719, 31 N.Y.S.2d 631 (Sup. Ct. 1941), which was a case wherein the facts were as follows:

  • the Claimant's action before the New York Supreme Court was to restrain the payment or presentment for payment of drafts under a letter of credit issued to secure the purchase price of Hob Bristles bought by the Claimant from the beneficiary of the credit;

  • the beneficiary shipped some material and presented drafts and other related documents for payment by the issuing bank;

  • the Claimant alleged that the material shipped was not Hog Bristles but cow hair and other worthless material, rubbish. Although the documents tendered appeared to conform to the credit, they contained materially false representations of facts;

  • the defendant bank had brought a Motion to Dismiss the Complaint on the ground that the facts did not constitute a cause of action (for the purposes of the motion, the allegations in the complaint were deemed to be established).

The New York Supreme Court held that there was a fraud (pertaining to the documents tendered for invocation) that disclosed a cause of action which entitled the party to an injunction to stop payment. This was, therefore, a case where the beneficiary knew and believed he had shipped rubbish/ worthless material but nevertheless made a false representation to the bank that he was entitled to payment for hog bristles.

In light of such stringent law, there are only two narrow exceptions where injunction on invocation of unconditional bank guarantee can be granted viz:

  1. Fraud of an egregious nature as to vitiate the entire underlying transaction, of which the bank has noticed, and

  2. Special equities in the form of preventing irretrievable injustice between the parties.


If a bank guarantee is conditional, the beneficiary cannot have unfettered right to invoke the guarantee and the court can issue an injunction against the invocation of the guarantee in view of the facts of the case. Where a bank guarantee is a conditional one, the invocation thereof would have to be in strict conformity with the conditions on which the guarantee is issued.

In the matter of Hindustan Construction Co. Ltd. v. State of Bihar and Ors., 1999 (3) SCR 554, the bank guarantee in question had used the expression “agree unconditionally and irrevocably” to guarantee payment to the beneficiary on his first demand without any right of objection. But the said expression was immediately qualified by a condition that referred to the original contract between the parties. The condition stipulated that if certain obligations under the contract are not fulfilled by the party on whose behalf the Bank Guarantee was issued, then a right would accrue to the beneficiary to claim recovery of the whole or part of the guarantee amount.

The Hon'ble Supreme Court in the aforesaid matter held that in case of conditional guarantee, the beneficiary could not be said: “to have an unfettered right to invoke that guarantee and demand immediate payment thereof.” It further held that the condition stated in the bank guarantee needs to be fulfilled in order for the beneficiary to invoke the conditional bank guarantee. The Supreme Court then reversed the judgment and order passed by the Division Bench of the Hon'ble Bombay High Court to the extent where it is vacated the injunction order granted by the Ld. Single Judge in respect of the conditional bank guarantee.


As we have seen that the bank guarantees secure the third party as in case of default by the debtor all the liabilities of the debtor will be discharged by the Bank but the liability of the bank is secondary which means that the Bank can only be held liable in the case of default of the Debtor, in the only above-mentioned case Banks can be held liable and can be exercised independently even if any disputes pending in the matter of transaction between Creditor and Debtor. Various recent judgements from the Supreme court and High Court made circumstances vivid, where there is a need for Judicial Intervention. The Supreme Court in the case of Tarapore and Co. v. VO Tractors Export, AIR 1970 SC 891, held that the contract created between the creditor and the bank is separate from the original contract between the buyer and the seller because of that bank's undertaking to the creditor is absolute and unconditional, so there is no need of any interventions form courts as interventions from court may destroy the very essence of Bank guarantee. A Bank guarantee enables individuals to recover their debts by avoiding the long strands of legal proceedings and if there will always be any judicial intervention then it will defeat its very purpose. Also, in the case of United Commercial Bank v. Bank of India, AIR 1981 SC 1426, the Supreme Court has ruled that the conditions wherein the banks cannot intervene as the Courts ought not to intervene in the of Bank Guarantee as more intervention may lead to delays and can affect the transaction procedure. Moreover, there are some instances where the intervention becomes a necessity. As in the case of Fraud and Irretrievable harm or injustice as discussed above. The intervention is necessary otherwise, trust in international and domestic commerce would be vitiated. 

In Union of India & Anr v. M/s IndusInd Banked Ltd & Anr., CA No 9087-9089/2016, 15 September 2016, the Hon’ble Supreme Court of India held the 1997 Amendment to be a substantive change in law not having retrospective effect. Accordingly, the bank guarantees in question were held to be valid under the unamended Section 28. The Supreme Court, deeming it irrelevant, did not assess the impact of section 28(b) on the bank guarantee in question. However, it did make the following observation in passing, in relation to the 2013 Amendment:

‘It may only be noticed, in passing, that Parliament has to a large extent redressed any grievance that may arise qua bank guarantees in particular, by adding an exception by an amendment made to Section 28 in 2012, with effect from 18 January 2013. Since we are not directly concerned with this amendment, suffice it to say that stipulations like the present would pass muster after 2013 if the specified period is not less than one year from the date of occurring or non-occurring of a specified event for extinguishment or discharge of a party from liability.’

The Delhi High Court in D. Pal & Co v. MCD, ILR (2007) Supp (6) Delhi 175, while interpreting section 28(b) of the Contract Act held that prescriptive clauses which restrict a party’s right to initiate legal proceedings or provide for the discharge of liability by a time period less than what has been statutorily provided, shall be void. Reference was also made to the judgment of the Supreme Court of India in National Insurance Co. Ltd. v. Sujit Ganesh Nayak & Co.,(1997) 4 SCC 366, where restraint on approaching a judicial forum within a period of time less than is statutorily provided, was held to be void under section 28. It is relevant to note that, earlier judgments of Food Corporation of India v. New India Assurance Co. Ltd., 1994) 3 SCC 324 and H.P. State Forest Co Ltd v. United India Insurance Co Ltd., OP No. 95 of 1994.


The different set of parameters for granting an injunction to the invocation of a conditional bank guarantee and an unconditional bank guarantee, as set out by the judiciary, is apparent from the above review of various judgments. Barring the exceptions in the case of the unconditional Bank Guarantee and barring the non -fulfilment of conditions in the case of the conditional Bank Guarantee, the Banks are obligated to honour the demand for the guaranteed amount made by the beneficiary. Because the opposite would cause irreparable damage to the trust in commerce and would deprive vital oxygen to the money supply which is necessary for economic growth.

A Bank guarantee is the undertaking by the bank that if there is a failure on the part of the debtor or creditor, the bank will indemnify the party who has suffered the loss. It should be unconditional so that it can be claimed easily but, conditional gives an assurance more particularly security. A bank guarantee is formed with a contract between the Bank, creditor and debtor all these contracts are independent of each other. Conclusively, the parties must be allowed to fulfil their obligation according to the terms of the contract and there should be minimum intervention from the judiciary. The banking system is the backbone of any economy and if the bank guarantees are not encashed by the parties themselves without judicial intervention the whole foundation of the bank guarantee system will collapse and the people will lose faith in it over the course of time.


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