Author Image

REEDLAW

Editor

Share this Article:

Mail%20Icon_edited.png
Twitter.png
WhatsApp Green.png
Copy%2520Icon_edited_edited.png

Irretrievable prejudice would be done if bank guarantee is allowed to be encashed

Irretrievable prejudice would be done if bank guarantee is allowed to be encashed

A Bank Guarantee (BG) is a common method of securing payment of money in commercial transactions because the beneficiary is entitled to receive the entire amount under the guarantee following its terms, regardless of any pending dispute between the people on whose behalf the guarantee was given and the beneficiary. Both parties are obligated by the conditions of the BG because it is an independent contract between the bank and the beneficiary. As a result, the invocation must be in line with the conditions of the assurance; otherwise, the invocation would be illegal.


Unconditional BGs and Conditional BGs are the two forms of BGs. Unconditional BGs guarantee payment to the beneficiary "unconditionally and irrevocably" on the beneficiary's first demand once the guarantee is invoked. The Conditional BG has specific criteria that must be met before it may be used by the beneficiary. Even though certain guarantees include the phrases "unconditionally and irrevocably," they always include a condition or a scenario that triggers the underlying guarantee's encashment. As a result, the terms of the guarantee are crucial.


In a recent case, the Bombay High Court, REED 2021 Bom 08560 stated that an unconditional bank guarantee can only be interfered with when fraud is proved or the dread of irretrievable injustice is demonstrated.


While the encashment or realization of a bank guarantee has a localized adverse effect on the bank, the larger adverse effect on country-wide commerce of the grant of an injunction must be set against, and weighed against, the larger adverse effect on country-wide commerce of the grant of an injunction itself, according to the Bench of Justice G. S. Patel.


"Therefore, to successfully obtain an injunction, the localized injustice to the bank and its customer must be shown to be so grave, so monumental and so catastrophic, that the ill-effects or wider ramifications of an injunction would pale in comparison," added the Court.


BACKGROUND


In the year 2011, one SKS Power entered into various agreements with Cethar Constructions Limited and Cethar Limited to set up a power project (build a 1200 MW (4x300 MW) power plant)in Raigarh District, Chhattisgarh. These agreements required Cethar to furnish advance and performance bank guarantees and at its request, in February 2012, the Canara Bank issued five Bank Guarantees in favour of SKS Power in the sum of Rs.121,65,00,000/- on the 16th and 17th of February 2012, at Cethar's request. All five Bank Guarantees are unconditional and are payable on demand. Its initial period of validity was still 31 January 2014. All the bank guarantees were extended periodically. All bank guarantees have a jurisdiction clause granting exclusive jurisdiction to courts in Mumbai, where at least a portion of the cause of action manifests itself.


Cethar requested that Canara Bank extend the bank guarantees on 6 March 2017; as a result, on 30 June 2017, the Bank extended the bank guarantees until 30 September 2017.


Meanwhile, the NCLAT in Chennai accepted an application against Cethar Limited on 16 June 2017 and ordered the start of a Corporate Insolvency Resolution Process, or CIRP, which resulted in an immediate moratorium. The NCLT named Mr. V Nagarajan ("Nagarajan") as the Resolution Professional/Interim Resolution Professional (RP/IRP) on 19 July 2017.


SKS Power, on the other hand, invoked the Bank Guarantees and requested Canara Bank to remit the entire sums on 5 September 2017, however, neither Cethar nor Nagarajan (representing Cethar) filed a lawsuit seeking an injunction against the invocation of the Bank Guarantees or payment.


On September 9, 2017, Canara Bank requested and was granted an ex parte injunction against invocation from District Court in Trichy. This was despite an exclusive jurisdiction clause in the suit guarantees that gave exclusive jurisdiction to courts in Mumbai. Nagarajan was named as a defendant in the Canara Bank case.


This ruling was challenged in the Madras High Court by SKS Power. The Madras High Court let Canara Bank drop the Trichy complaint on 7 November 2019, two years after the invocation and authorized it to file a suit in Mumbai before a jurisdictionally competent court. Canara Bank was required to get a return of the plaint from the District Court in Trichy within seven days and deliver it to the jurisdictionally competent court in Mumbai by 10 December 2019. The status quo was maintained by the Madras High Court till the Plaint was returned. Nagarajan was also included as a respondent in this High Court case.


Canara Bank dropped the Trichy action on 19 November 2019. The ex-parte injunction, which had been in place for two years, was now lifted.


SKS Power wrote to Canara Bank on November 19th, 2019, stating that now that there is no injunction, the bank must pay. Canara Bank, on the other hand, did not. On 4 December 2019, SKS Power sent Canara Bank an advocate's notice. Canara Bank wrote to SKS Power on the 16th of December 2019, stating that it had until the 10th of December 2019 to file suit in Mumbai, and that the status quo would be maintained until then.


However, the Canara Bank did not pay SKS power and therefore, on 4th February 2020, SKS Power filed the instant suit (summary suit on Bank Guarantee) and then took out the Summons for Judgment against Canara Bank for invocation of Bank Guarantee.


Now, when SKS Power moved the Bombay High Court (against Canara Bank), Nagarajan (as the liquidator of Cethar) moved his Interim Application for impleadment in the suit, claiming that Cethar was, if not a necessary party, at least a proper party.


ANALYSIS


There are two different cases in this case. Both are defendants in a Commercial Summary Suit over a series of unconditional Bank Guarantees. The Interim Application is an impleadment action brought by the primary debtor (“Cethar”), who provided the Bank Guarantees in dispute. The plaintiff in the case (“SKS Power”), the beneficiary of the Bank Guarantees, has issued a Summons for Judgment. The suit's lone Defendant is the issuing bank ("Canara Bank"). It was in charge of issuing Bank Guarantees and renewing them regularly.


Canara Bank's response to the Summons for Judgment and Cethar's Interim Application for Impleadment, both plead fraud; each taking a slightly different approach.


SKS Power was once a subsidiary of SKS Ispat. SKS Power was purchased by Agritrade Resources, a Singapore-based business, in a one-time settlement agreement in November 2018, and the SKS Ispat group ceased to exist as a result. Not the Summons for Judgment, but this point has relevance to the impleadment Interim Application.


COURT'S ORDER ON THE IMPLEADMENT APPLICATION OF NAGARAJAN


With his Interim Application for Impleadment, Nagarajan enters the battle. Mr. Subramanian, representing Nagarajan (as Cethar's liquidator), claims that Cethar (via its liquidator) is, if not a required party, at least a legitimate party. Mr. Subramanian maintains that Canara Bank's payment will be "wrongful." If this is the case, Section 145 of the Indian Contract Act will limit the Liquidator's powers against Canara Bank. Nagarajan now claims to be in a position to prove that Cethar and SKS Ispat engaged in "fraud and collusion."


SKS Ispat is now the former parent of SKS Power. The whole lawsuit against SKS Power's former parent and grandparent is based on the alleged fraud (the holding company of SKS Power). The fraud case goes somewhat like this.


Cethar and one Compact Agencies Private Limited signed an agreement on March 15, 2011. It was not a party to which SKS Power was a party. Compact Agencies would receive a Rs. 250 crore advance from Cethar. Compact Agencies was then tasked with arranging the purchase of 7.5 percent of SKS Ispat, the parent company of SKS Power. If Compact Agencies were unable to do so, the advance was to be repaid in three equal yearly payments with a 12 percent interest rate. As part of that arrangement, Cethar advanced Rs.228 crores to Compact Agencies. After that, Cethar and Compact Agencies signed a Supplemental Agreement on April 6, 2016. Compact Agencies was to arrange for certain shares of SKS Ispat and some shares of Ambition Commosales to be given to Cethar under this Supplemental Agreement. But, before the shares could be obtained, Cethar agreed to sell them to a company called Labheshwari Limited for Rs.4.58 crores. Labheshwari Limited is accused of defrauding investors.


Nagarajan applied for a stay against SKS Power with the NCLT Chennai in the Insolvency and Bankruptcy Code (IBC) proceedings. Amounts owed to Cethar were allegedly transferred to a company called Shrikrishna Structure Pvt. Ltd. This is SKS Power's long-lost grandparent. The NCLT denied Nagarajan any relief on December 31, 2019. Nagarajan took his case to the NCLAT, which rejected it on July 13, 2020. Nagarajan has since filed a Civil Appeal with the Supreme Court. The Supreme Court has yet to provide a stay or any other form of relief. SKS Power, according to Nagarajan, has committed fraud.


The Bench observed that no element of the alleged fraudulent transactions has anything to do with SKS Power, which is now a completely separate entity. They have nothing to do with the power plant's construction contract. The bank guarantees are given by the project's agreements.


At the outset, the Court observed that a bank guarantee is an independent contract and in enforcing the same, the principal debtor (Cethar) is never a necessary party and that the beneficiary of a guarantee (SKS Power) may, at his option, join both the principal debtor and the guarantor or may choose to proceed only against the guarantor or only against the principal debtor. Mr. Subramanian's attempts to rely on several rulings in a variety of sorts of procedures involving the joinder of parties failed miserably. Based on paragraphs 16 and 17 of Kasturi v Iyyamperumal and Ors. (2005) 6 SCC 773, a suit for a particular performance, the Bench observed that reference to the case is a misinterpretation of the scope of the current case. Just because Mr. Nagarajan claims to have anything to say, he must be considered to have a direct and legal interest in answering the issue. Moreover, the bench observed that this was a summary suit and a suit on a bank guarantee. The law has been established. A bank guarantee is a separate agreement. The primary debtor is never a required participant in enforcing a guarantee. The beneficiary of a guarantee has the choice of joining both the primary debtor and the guarantor or proceeding exclusively with either the guarantor or the principal debtor. Mr. Subramanian's reliance on the passages in Kasturi case and other judgements would not help. In reality, Mr. Subramanian's argument is fully refuted by the judgement in Ramesh Hirachand Kundanmal v Municipal Corporation of Greater Bombay And Others, (1992) 2 SCC 524.


The motion for intervention or impleadment at the request of the primary debtor's Liquidator is completely unsustainable. The Liquidator is free to pursue any legal action he sees fit in a court of competent jurisdiction. He cannot be permitted to intervene or be named as a defendant in a guarantee contract enforcement action. Therefore, noting that the application for intervention or the impleadment at the instance of the Liquidator of the principal debtor was wholly unsustainable, the Court dismissed the interim application.


COURT'S ORDER ON SUMMONS FOR JUDGMENT


Regarding the Summons for Judgment, the bench separated Mr. Seksaria's attempts on behalf of Canara Bank to bolster Mr. Subramanian's arguments for the time being. It is not the role of Canara Bank to advocate for the primary debtor. Mr. Seksaria tries valiantly — but futilely — to claim that the NCLT Chennai ruling was "never brought to Canara Bank's attention." As a result, the extension granted by Canara Bank on June 30, 2017 (without which the claim would not be able to proceed) is "fraudulent and void." He contends that it was either Cethar or SKS Power's responsibility to inform Canara Bank that Cethar was now subject to a CIRP, that a moratorium had been imposed, and that an RP/IRP had been appointed. Canara Bank responded to Cethar Limited's request for an extension dated 6 March 2017.


Mr. Seksaria claims that Canara Bank's Affidavits in Reply reveal a tenable or bona fide defence which the bench disagree. Those Affidavits in Reply raise a lot of counter-arguments. Mr. Seksaria has sensibly decided not to pursue any of the other arguments raised in the Affidavits in Reply. He did not dispute while the order was given in the open court. One reason, for example, is that the Summary Suit is not founded on a formal agreement. Another argument is that this isn't a commercial issue under the Commercial Courts Act's Section 2(c). Then there's also a section on pages 16 and 17 of the affidavit that argues that while Cethar owes a big sum to a group of banks, the amounts of the Bank Guarantees aren't considered debts.


Cutting through all of this, Canara Bank's fundamental issue appears to be this: given that Cethar Limited is in liquidation, if Canara Bank is forced to make payment under these bank guarantees, it will have tremendous trouble recovering the money.


This leads Mr. Seksaria to believe that this is a source of irretrievable prejudice, one that favours him. Importantly, before the Court, the Canara Bank claimed that now that the Cethar Limited (principal debtor) is in liquidation, and so, if the Bank is required to make payment (to SKS Power) under the bank guarantees, it would have great difficulty in the recovery of the amount.


However, this is not the law. That phrase has come to indicate that there is no hope of recovery; for example when healing is only conceivable in a country where the action is impossible. Second, the irretrievable prejudice must be inflicted on the primary debtor, generally the plaintiff in an injunction case, rather than the bank. The judge observed that he was yet to come across a situation where the issuing bank claims that paying under a bank guarantee will irretrievably harm it. This makes no sense from a business standpoint. When a bank offers a Bank Guarantee, it makes just that deal.


LAW RELATED TO BANK GUARANTEES


In this backdrop, the Court referred to the case of U.P. Co-op. Federation Ltd. v. Singh Consultants and Engineers (P) Ltd., the Bank agreed to repay the money 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 and the party on whose behalf guarantee was given." Regardless of any dispute between the parties, the Hon'ble Supreme Court decided that the Bank was required to pay once a demand was made without objection or contestation. In such a scenario, the person on whose behalf the guarantee was issued was not entitled to an injunction preventing the bank from performing its guarantee, according to the Hon'ble Court.


Even in the matter of Hindustan Steelworks Construction Ltd v Tarapore & Co & Anr (1996) 5 SCC 34, in which, the Apex Court had held as follows:


"the commitment of banks must be honoured free from interference by the courts and it is only in exceptional cases, that is to say, in case of fraud or in a case where irretrievable injustice would be done if bank guarantee is allowed to be encashed, the court should interfere."


Now, in the context of the instant case, the Court observed that there was no fraud shown in

  • The underlying power plant construction contract; or

  • The issuance of the bank guarantees; or

  • The invocation.

It was also contended by the Canara Bank that the party invoking the bank guarantee had a reference pending against it before the Board of Industrial and Financial Reconstruction under the then Sick Industrial Companies (Special Provisions) Act, 1985 and thus, it was argued, even if the respondent succeeded in arbitration, it would not be able to realize its claim.


In this backdrop, the Court also observed thus:


"In order to invoke these special equities, that is to say, that the person against whom invocation is made would never be able to recover the amount under the bank guarantees, it must be shown decisively to the satisfaction of the Court that there is no possibility — i.e. not the slightest possibility at all — of restitution in this amount."


To invoke these special equities, it must be demonstrated conclusively to the satisfaction of the Court that the person against whose invocation is made would never be able to recover the sum under the bank guarantees. Again, showing that Cethar is in a precarious financial condition, the Court added, or that it is in liquidation is insufficient for this purpose, what must be demonstrated must be something far clearer than a mere apprehension."


CONCLUSION/ FINAL ORDER


As a result, the Summons for Judgment becomes absolute and the Summary Suit was decreed in favour of the Plaintiff in the amount of Rs.121.65 lakhs with interest at 6% per annum from the date of the decree till payment or realization.


Even though this is a matter in the Commercial Division and governed by the Commercial Courts Act, 2015, the Judge declined to impose a costs order due to the amount of the claim and the fact that the Defendant is a public sector bank. The Summons for Judgment and the Suit are resolved.

RECENT ARTICLES

Role of Banking Ombudsman in India - An Analysis

REEDLAW

Sep 3, 2021

Section 7 Application of IBC cannot be allowed if Petition filed collusively

K. Bavana

Sep 3, 2021

"Preferential Transaction" and "Relevant Time" under Section 43 of IBC

R. Haritha

Sep 1, 2021