CONTINUOUS INTERNAL ASSESSMENT-1

CONTRACT LAW – II

CASE ANALYSIS: CONTRACT OF INDEMNITY

Case of,

STATE BANK OF INDIA AND ORS.

VS.

MULA SAHAKARI SAKHAR KARKHANA LTD.

Submitted by,
DRUTHI V KANNMBADI
2250247
4 BA LLB B
 IN THE SUPREME COURT OF INDIA
CIVIL APPEAL NO. 2801 OF 2006 (ARISING OUT OF SLP (C) NO. 22576 OF 2005)
“STATE BANK OF INDIA AND ORS. VS. MULA SAHAKARI SAKHAR KARKHANA LTD. (2006) 6
SCC 293”
FACTS:

The Cooperative society known as Mulla Sahakari Sakhar Karakhana Ltd. operates a Sugar
Factory and engaged in a contract with M/s Pentagon Engineering Pvt. Ltd. (referred to as
"Pentagon"). The purpose of this contract was the turnkey installation of a paper plant in the
village of Sonai, allowing the utilization of leftover sugarcane material called 'bargesse.' The
total contract value amounted to Rs 3.4 Crore, and Pentagon provided a performance guarantee
for the machinery supplied.

Within the contract, there was a clause specifying the retention of 10% of the contract price by
the Cooperative society, outlined as follows:

“1. After satisfactory commissioning and three months of plant operation, 5% of the
contract amount shall be payable.

2. Following the satisfactory commissioning and continuous successful operation for six
months (as per clauses 8 and 9), another 5% shall be payable.”

Pentagon, however, proposed a modification to waive the 10% retention clause and suggested a
letter of credit, providing a bank guarantee. The Cooperative society accepted the modification,
emphasizing that Pentagon must submit the performance guarantee at 10% of the contract price.
If the guarantee was not received, the Karkhana had the right to recover from the balance
payment.

Pentagon, in response to a letter dated 16-04-1985, agreed to the proposal, stating:

"As per the agreement, you have to open an L/C for retention of 10%, which is still not done by
you. As soon as you open the L/C, the bank guarantee for retention of money will be sent to you."

On approximately 04-09-1985, the appellant provided the bank guarantee/indemnity, and

relevant clauses included:
“1. Bank guarantee No. 85/17 dated 04-09-1985 issued by SBI, Bombivil Industrial Estate
branch, Dombivil.

2. The guarantee is in accordance with the paper project agreement dated 25.9.1983,
covering 10% retention amount of Rs. 34 lacs.

3. An amount of Rs. 13,76,285/- is retained from the Proforma Invoices of the material
reached at the site.

4. Kindly release the amount of Rs. 13,76,285/- to be retained by you immediately upon
receipt of this guarantee and oblige.”

ISSUE:

The cooperative society terminated Pentagon's contract through a notice dated July 17, 1987, and
concurrently raised a claim of Rs. 3,23,28,209.10. Pentagon, in response, not only refuted its
obligation to pay the stated amount but also asserted, through a letter dated July 18, 1987, that an
amount of Rs. 4,66,73,300/- was owed to it.

Subsequently, the cooperative society invoked the Bank Guarantee. The Appellant resisted the
cooperative society's demand, arguing that they had executed an indemnity agreement.
According to this agreement, only losses, claims, damages, actions, and costs suffered by the
Appellant were covered. The contention was that the transaction in question did not constitute a
Bank Guarantee. Therefore, it was argued that unless the cooperative society could demonstrate
any loss or damage related to design, performance, workmanship, or the supply of defective
material through a competent court or authority, the Appellants were not obligated to pay the
specified amount.

LEGALITY:

The questions before the court in this case were two i.e Whether the company is liable for bank
guarantee in this case? and Whether such a claim be honoured by the bank? In order for the
Hon’ble Supreme Court to have ordered this question a few sections must be kept in mind during
the adjudication of the case. They are:

- SECTION 124 CONTRACT ACT

- SECTION 125 CONTRACT ACT
- SECTION 91 & 92 EVIDENCE ACT
Sections 124& 125 are the sections of relevance for this case analysis which explains the term
"contract," indicating that a contract of indemnity must encompass all essential elements of a
valid contract. Among these elements, consideration is deemed necessary as per Section 10 of
the Contract Act.

In line with the criteria outlined in Section 124, even agreements lacking consideration are
acknowledged as valid contracts. Despite the opening phrase 'A contract,' the section exclusively
addresses the commitment of one party, excluding other aspects. While contracts are typically
bilateral, the term within this context pertains solely to the obligations of one party, specifically a
particular type of duty. Additionally, Sections 124 and 125 refer to the 'promisor' and 'promisee,'
respectively, with Section 125(1) specifically mentioning the 'promise to indemnify.'

One plausible interpretation of Section 124 suggests the requirement for the existence of a
contract between the parties to fall under its provisions. In other words, a genuine offer must be
accepted, and both parties must receive consideration. Subsequently, if the loss is attributable to
a human agent, the contract would be labelled as an indemnification contract.

ANALYSIS:

This case unfolded at two levels. First before the High Court, an order issued on February, 1988,
mandated that the specified amount be withheld by the Appellant, contingent upon the condition
that if the lawsuit were to be granted, the mentioned sum would be disbursed along with interest
at a rate of 12% per annum. Despite the dismissal of the lawsuit, the cooperative society lodged
an appeal with the High Court. Following an examination of the agreement dated September 25,
1983, the High Court categorized it as a Bank Guarantee and ruled in favor of the cooperative
society, instructing the Appellant (State Bank of India) to remit the designated sum of Rs.
34,00,000/- along with interest at a rate of 14% per annum. A subsequent appeal was filed
against the High Court's decision before the Hon’ble Supreme Court of India.

Subsequently when submissions were made before the Hon’ble Supreme court, it was
contended by the Appellants that an error was made by High Court in considering the oral
evidence adduced by the parties. However when the same was rebutted by the Respondents in
this case, they contended that the interpretation of the clauses of the contract must not be
gathered from one document but from other circumstances too. The Respondents also heavily
relied on the case of S. Chattanatha Karayalar v. The Central Bank of India and Ors. (AIR
1965 SC 1856) and P.L. Bapuswami v. N. Pattay Gounder (AIR 1966 SC 902), implying that
the High Court committed a clear mistake in its interpretation of the agreement, asserting that it
was a contract of guarantee rather than indemnity. Additionally, the court introduced certain
words into the agreement that were originally absent. For instance, in paragraph 31 of the
challenged judgment, it included the term "unequivocal condition," a phrase not present in the
original document.
The Supreme Court, in its judgment, emphasized that the interpretation of the bank guarantee
should not consider other alleged documents and should stand alone. While a contract can
indeed be articulated through multiple documents, these documents must be integral to the
contractual agreement between the involved parties.

CONCLUSION:
In this current case, a dispute has arisen involving the cooperative society and Pentagon, even
though the contract in question, whether classified as indemnity or guarantee, was originally
between Pentagon and the appellant. The exchanged correspondences did not occur between the
present parties, the appellant and the cooperative society, as part of the same transaction. The
appellant's understanding was that it would act as a surety, not as a guarantor.

It is unquestionably clear that a bank guarantee should be interpreted based on its own terms,
constituting a distinct transaction. If one were to accept the cooperative society's suggestion that
the bank guarantee must be construed in conjunction with other documents, it would create a
situation where a banker could argue that an unequivocal bank guarantee should be interpreted
as conditional, taking into account certain circumstances.

In the current scenario, the document in question, whether characterized as a contract of

indemnity or guarantee, does not explicitly reference any specific clause in the contract between
the cooperative society and Pentagon. In reality, the contract between the cooperative society
and Pentagon lacks any clause mandating Pentagon to provide a bank guarantee; it was, in fact,
a contract of indemnity.