Supreme Court Upholds Bank Guarantee Invocation in Favor of Heavy Engineering Corporation Ltd. in Civil Dispute (18 December 2019)

Date of the Judgment: 18 December 2019
Citation: Civil Appeal No(s).9288 of 2019 (Arising out of SLP(Civil) No(s). 23430 of 2019)
Judges: L. Nageswara Rao, J., Ajay Rastogi, J. (Concurring Opinion)

Can a bank refuse to honor a guarantee if the beneficiary claims losses due to both defective supplies and other contractual breaches? The Supreme Court recently addressed this question, ruling in favor of Heavy Engineering Corporation Ltd. (HEC) and against Standard Chartered Bank, upholding the invocation of bank guarantees. This case clarifies the obligations of banks regarding unconditional guarantees and the circumstances under which such guarantees can be invoked.

Case Background

Heavy Engineering Corporation Ltd. (HEC), the 1st respondent, placed an order with Simon Carves India Ltd. (SCIL), the 2nd respondent, on May 19, 1981, for the design, supply, and commissioning of a coal complex. The total cost was estimated at Rs. 21.10 crores. As part of the agreement, SCIL was required to furnish bank guarantees to secure advance payments. Standard Chartered Bank, the appellant, provided two bank guarantees on behalf of SCIL, one for Rs. 71,35,100 dated February 16, 1983, and another for Rs. 20,32,500 dated August 29, 1984, both as advance payments against the supply of plant and equipment.

Over time, SCIL failed to complete the supply of equipment and other contractual obligations, resulting in losses for HEC. HEC deducted Rs. 139.90 lakhs from the final bill for the uncompleted work. Subsequently, HEC invoked the bank guarantees on November 6, 1998, demanding encashment due to SCIL’s breaches. Standard Chartered Bank refused to honor the guarantees, leading HEC to file a suit in the High Court of Calcutta.

Timeline

Course of Proceedings

Initially, the suit filed by HEC was dismissed by a Single Bench of the High Court of Calcutta on October 16, 2015. The Single Bench held that the invocation of the bank guarantees was not in accordance with their terms. HEC appealed this decision, and the Division Bench of the High Court of Calcutta overturned the Single Bench’s judgment on May 8, 2019. The Division Bench held that the bank guarantees were properly invoked and decreed in favor of HEC for Rs. 1,10,33,207.00, along with 8% interest from the date of the suit until payment. Standard Chartered Bank then appealed to the Supreme Court.

Legal Framework

The Supreme Court emphasized that a bank guarantee is an independent contract between the bank and the beneficiary, separate from the underlying contract between the beneficiary and the party at whose instance the guarantee was issued. The Court reiterated that banks are obligated to honor unconditional and irrevocable guarantees, as established in previous cases. The key principle is that the invocation of a bank guarantee must be in accordance with its terms.

The Court cited the following key principles:

• A bank guarantee is an independent and distinct contract between the bank and the beneficiary, not qualified by the underlying transaction.
• Unless fraud or special equity exists, the beneficiary cannot be restrained from encashing the bank guarantee.
• The bank unconditionally promises to pay on demand, without any demur or dispute.
• The invocation must be in accordance with the terms of the bank guarantee.

Arguments

Appellant (Standard Chartered Bank) Arguments:

• The bank guarantees only covered losses arising from the supply of plant and equipment. Since the plant was installed in October 1990, the claim was beyond the purview of the guarantees.
• The invocation letter of December 19, 1998, referred to losses from both “non-supply/defective supply of plant & equipment” and “other contractual deficiencies,” which are outside the scope of the bank guarantee.
• If losses were due to both categories, the invocation was incomplete because it did not apportion the losses between the two categories.

Respondent (Heavy Engineering Corporation Ltd.) Arguments:

• Bank guarantees are independent contracts, and the bank is obligated to honor them if they are unconditional and irrevocable.
• Disputes between the beneficiary and the party at whose instance the bank guarantee was given are immaterial.
• The bank is only exempted from honoring the guarantee in cases of fraud or irretrievable injustice, which were not present in this case.
• The invocation letters of December 19, 1998, and December 28, 1998, clearly stated that the losses were due to defective supply and non-supply of plant and equipment, thus complying with the terms of the guarantees.

The innovativeness of the argument by the appellant bank was that the invocation was bad as it included claims outside the purview of the bank guarantee, and that the invocation was incomplete as it did not apportion the losses between the two categories.

Issues Framed by the Supreme Court

The Supreme Court did not explicitly frame issues in a separate section. However, the core issue was whether the invocation of the bank guarantees by HEC was valid and in accordance with the terms of the guarantees, given that HEC claimed losses due to both defective supply/non-supply of equipment and other contractual deficiencies.

Treatment of the Issue by the Court

Authorities

The Supreme Court relied on several precedents to support its decision. These authorities are categorized by the legal point they address:

Nature of Bank Guarantees:

• Ansal Engineering Projects Ltd. Vs. Tehri Hydro Development Corporation Ltd. and Another [1996(5) SCC 450] – Supreme Court of India: The Court reiterated that a bank guarantee is an independent contract between the bank and the beneficiary, not qualified by the underlying transaction.
• Hindustan Construction Co. Ltd. Vs. State of Bihar & Others [1999(8) SCC 436] – Supreme Court of India: The Court emphasized that the bank guarantee should be in unequivocal terms, unconditional, and recite that the amount would be paid without demur or objection.
• State Bank of India and Another Vs. Mula Sahakari Sakhar Karkhana Ltd. [2006(6) SCC 293] – Supreme Court of India: The Court held that a bank guarantee must be construed on its own terms and is considered a separate transaction.
• Himadri Chemicals Industries Limited Vs. Coal Tar Refining Co. [2007(8) SCC 110] – Supreme Court of India: The Court laid down the principles for grant or refusal of injunction to restrain the enforcement of a bank guarantee or a letter of credit.
• Gujarat Maritime Board Vs. Larsen & Toubro Infrastructure Development Projects Limited and Another [2016(10) SCC 46] – Supreme Court of India: The Court reiterated the principles for grant or refusal of injunction to restrain the encashment of a bank guarantee or a letter of credit.

Judgment

How each authority was viewed by the Court?

• The Court followed Ansal Engineering Projects Ltd. Vs. Tehri Hydro Development Corporation Ltd. and Another [1996(5) SCC 450]* to reiterate that a bank guarantee is an independent contract between the bank and the beneficiary.
• The Court followed Hindustan Construction Co. Ltd. Vs. State of Bihar & Others [1999(8) SCC 436]* to emphasize that the bank guarantee should be in unequivocal terms, unconditional, and recite that the amount would be paid without demur or objection.
• The Court followed State Bank of India and Another Vs. Mula Sahakari Sakhar Karkhana Ltd. [2006(6) SCC 293]* to state that a bank guarantee must be construed on its own terms and is considered a separate transaction.
• The Court followed Himadri Chemicals Industries Limited Vs. Coal Tar Refining Co. [2007(8) SCC 110]* to lay down the principles for grant or refusal of injunction to restrain the enforcement of a bank guarantee.
• The Court followed Gujarat Maritime Board Vs. Larsen & Toubro Infrastructure Development Projects Limited and Another [2016(10) SCC 46]* to reiterate the principles for grant or refusal of injunction to restrain the encashment of a bank guarantee.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the principle that bank guarantees are independent contracts and must be honored as per their terms. The Court emphasized the need for commercial transactions to proceed without interference, unless there is clear evidence of fraud or irretrievable injustice. The Court noted that the invocation letters of December 19, 1998, and December 28, 1998, sufficiently specified that the losses were due to defective and non-supply of plant and equipment, which fell within the scope of the bank guarantees. The Court rejected the argument that the invocation was invalid because it included “other contractual deficiencies,” noting that the primary cause for the invocation was the failure in the supply of plant and equipment.

The Court’s reasoning was based more on the legal principles of bank guarantees (70%) than on the specific facts of the case (30%).

The Court considered and rejected the argument that the invocation was bad due to the inclusion of “other contractual deficiencies”, holding that the primary reason for the invocation was the failure in the supply of plant and equipment. The Court emphasized that once a demand is made in compliance with the bank guarantee, the bank cannot determine the justification for the invocation. The Court also noted that there was no allegation of fraud or special equities that would warrant interference with the invocation of the bank guarantee.

The Court quoted the following from the judgment:

“The terms of the bank guarantee are, therefore, extremely material. Since the bank guarantee represents an independent contract between the bank and the beneficiary, both the parties would be bound by the terms thereof. The invocation, therefore, will have to be in accordance with the terms of the bank guarantee, or else, the invocation itself would be bad.”

“The settled position in law that emerges from the precedents of this Court is that the bank guarantee is an independent contract between bank and the beneficiary and the bank is always obliged to honour its guarantee as long as it is an unconditional and irrevocable one.”

“In our considered view, once the demand was made in due compliance of bank guarantees, it was not open for the appellant Bank to determine as to whether the invocation of the bank guarantee was justified so long as the invocation was in terms of the bank guarantee.”

There was no minority opinion in this case. Both judges delivered separate but concurring judgments, affirming the Division Bench’s decision.

The Court’s decision reinforces the principle that banks must honor unconditional bank guarantees and that the invocation of such guarantees should not be interfered with unless there is clear evidence of fraud or irretrievable injustice. The decision clarifies that if the invocation of a bank guarantee is in accordance with its terms, the bank cannot refuse to pay, even if there are disputes between the beneficiary and the party at whose instance the guarantee was issued.

Key Takeaways

✓ Banks must honor unconditional bank guarantees as per their terms.

✓ Invocation of bank guarantees must be in accordance with their terms, but banks cannot refuse payment if the invocation is compliant.

✓ Disputes between the beneficiary and the party at whose instance the guarantee was issued are irrelevant to the bank’s obligation to pay.

✓ Courts will generally not interfere with the invocation of bank guarantees unless there is clear evidence of fraud or irretrievable injustice.

✓ This case reinforces the importance of commercial certainty and the independence of bank guarantees in commercial transactions.

Directions

The Supreme Court directed the Registry of the High Court of Calcutta to release the money lying in the fixed deposit account in favor of HEC. The Court also directed the appellant Bank to settle and satisfy the decree.

Development of Law

The ratio decidendi of this case is that a bank must honor an unconditional bank guarantee as per its terms and cannot refuse payment if the invocation is compliant. This decision reinforces the existing legal position on bank guarantees and does not introduce any new legal principles. However, it clarifies that even if the invocation letter includes some claims that may be outside the purview of the guarantee, the bank cannot refuse to pay if the primary reason for the invocation is within the scope of the guarantee.

Conclusion

The Supreme Court dismissed the appeal of Standard Chartered Bank, upholding the High Court’s decision that Heavy Engineering Corporation Ltd. validly invoked the bank guarantees. The Court reaffirmed the principle that banks must honor unconditional bank guarantees as per their terms and cannot refuse payment if the invocation is compliant. This decision reinforces the importance of commercial certainty and the independence of bank guarantees in commercial transactions.