Bakshi BANKGUARANTEES 1995

BANK GUARANTEES
Author(s): P.M. Bakshi

Source: Journal of the Indian Law Institute , January-March 1995, Vol. 37, No. 1
(January-March 1995), pp. 109-111
Published by: Indian Law Institute
Stable URL: https://www.jstor.org/stable/43951593
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BANK GUARANTEES
ONCE MORE, the Supreme Court has reiterated the proposition th

absence of fraud and irretrievable injury, injunction cannot be granted agai
unconditional bank guarantee. The court so held in Swenska Handelsb
Indian Charge Chrome.1 After an exhaustive review of earlier decisio
court, it emphasised that in the case of a confirmed bank guarantee or irre
letters of credit, enforcement cannot be interfered with, unless there is fr
irretrievable injustice involved in the case and fraud has to be establish
Referring to U.P. Co-operátive Federation Lid. v. Singh Consult
Engineers Ltd.,2 the court observed that the fraud must be of the beneficia
not of any one else. The fraud must be of an ' 'egregious nature as to v
entire underlying transaction". An interesting feature of the 1994 judgmen
Supreme Court is a number of foreign cases cited in arguments. Amongst t
so cited were the following :
(i) Itek Corporation v. First National Bank of Boston;3

(ii) Handerson v. Canadian Imperial Bank of Commerce and Peat Ma
Ltd.A' and
(Hi) N.M.C. Enterprises Inc. v. Columbia Broadcasting System Inc.5
The court pointed out that in all these cases, the plaintiff had made out
sufficient showing of fraud to justify grant of an injunction. Th situation is
different if fraud is not established. The reasoning of the Supreme Court can be
best understood if one bears in mind, (a) the object of the so-called bank
guarantee; ( b ) the terms of the documents; and (c) commercial practice and
assumptions.
The modern documentary credit has its origin from letters of credit. The letter
of credit has developed over hundreds of years of international trade. It was
intended to facilitate the transfer of goods between distant and unfamiliar buyer
and seller. It was intended to facilitate the transfer of goods between distant and
unfamiliar buyer and seller. It was found difficult for a buyer to pay for goods
prior to their delivery. The bank's letter of credit came to bridge this gap. In such
transactions, the seller (beneficiary) receives payment from the issuing bank when
he presents a demand as per the terms of the documents. The bank must pay if the
documents are in order and the terms of credit are satisfied. The bank, however,
was not allowed to determine whether the seller had actually shipped the goods
l^A.I.R. 1994 S.C. 626 at 642, 646-8.

2. (1988) 1 S.C.C. 174.
3. 566 Fed. Sup. 1210 (U.S. District Court, Massachusetts).
4. 40 B.C. 318 (Berger J.).
5. 14 U.C.C. Reporting Service 1427 (New York Supreme Court) (Fein, J.).

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lio JOURNAL OF THE INDIAN LAW INSTITUTE [Vol. 37 : 1
or whether they conformed to requirements of the contract. Any

seller and buyer must be settled between themselves. The cou
carving out an exception to this rule of absolute independence,
has been a "fraud in the transaction", the bank could dishonour
demand for payment. The courts have generally permitted dish
fraud of the beneficiary, not that of someone else.
In modern commercial transactions, various devices are used
formance by contracting parties. The traditional letter of credi
meaning. Stand-by letters of credit are also used in business cir
and guarantee bonds are also devices increasingly adopted in tr
have treated such documents as analogous to letters of credit.
Whether it is a traditional letter of credit or a new device, l
bond or performance guarantee, obligation of the bank appears
Since it pledges its own credit, involving its reputation, it has
in the case of fraud. The nature of the fraud that courts talk abou
an ' 'egregious nature as to vitiate the entire underlying transaction
of the beneficiary, not that of someone else. The bank cannot
honour the credit in such cases. Here, it would be proper for th
buyer to approach the court for an injunction. The court, how
lightly interfere with the operation of irrevocable documentary cr
restrain the operation of irrevocable letter of credit, performance
tee, there should be (/) a serious dispute to be tried; and (it) a g
act of fraud.
Sound banking system may require more caution in the issu
cable documentary credit. It would be for banks to safeguard them
means, and, generally, not for courts to come to their rescue
unless there is established fraud.
The problem has arisen because of use of the word "guarantee", in a sense
which is somewhat different from its ordinary connotation. In its general sense,
"guarantee" is an accessory contract whereby one party undertakes to be answer-
able for the debt or default of another, who is primarily liable to a third party.6
The surety's liability does not arise, until the principal debtor has committed a
default.
Section 126, Indian Contract Act defines a contract of guarantee as a contract

to perform the promise or discharge the liability of a third person in case of his
default. It follows, that the liability under a guarantee is collateral.7
But the position in the case of unconditional bank guarantees is radially
different. The so-called bank guarantee, when it is couched in an unconditional
and unqualified form, is really an independent agreement. It is not dependent
upon, or subordinate, to the agreement between the beneficiary of the guarantee
(i.e., the person entitled to recover thereunder) and the person at whose instance
the guarantee haš been given. There are really two separate agreements, where the
6. Walker, Oxford Companion to English Law 542 (1980).

7. Maiiabir Shams/ier v. Lloyds Bank , A.I.R. 1968 Cal. 371; Nagpur Kagrik Sahakari Bank Ltd. v.
Union of India, A.I.R. 1981 A.P. 1537.

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1995] BANK GUARANTEES 111
bank guarantee is an uncondit

independent debtor to the bene
P.M. Bakshi*
* Former Director, Indian Law Institute and former Member. Law Commission of India. New Delhi.

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BANK GUARANTEES

Author(s): P.M. Bakshi

Stable URL: https://www.jstor.org/stable/43951593

This content downloaded from

ONCE MORE, the Supreme Court has reiterated the proposition th

(i) Itek Corporation v. First National Bank of Boston;3

l^A.I.R. 1994 S.C. 626 at 642, 646-8.

This content downloaded from

or whether they conformed to requirements of the contract. Any

Section 126, Indian Contract Act defines a contract of guarantee as a contract

6. Walker, Oxford Companion to English Law 542 (1980).

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bank guarantee is an uncondit

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