A LEGAL PERSPECTIVE OF

BANK GUARANTEE SYSTEM IN INDIA

(Term paper towards partial fulfillment of the assessment in the subject of Specific Contracts)

Submitted By:

Submitted To:

Gajendra Bhansali & Samvid Shetty

Dr. Anjali Thanvi

B.A. LLB(Hons.)

Faculty of Law

Semester II

Specific Contracts

NATIONAL LAW UNIVERSITY, JODHPUR

WINTER SESSION
(JANUARY-MAY 2015)

ACKNOWLEDGEMENTS
On the completion of this project we find that there are many persons to whom we
would like to express our gratitude, since without their help and co-operation the
success of this educative endeavour would not have been possible.
We welcome this opportunity to express my sincere gratitude to my teacher and
guide, Dr. Anjali Thanvi, Faculty of Specific Contracts, who has been a constant
source of encouragement and guidance throughout the course of this work.
We are grateful to the IT Staff for providing all necessary facilities for carrying out
this work. Thanks are also due to all members of the Library staff for their help
and assistance at all times.
We are also grateful to all our friends and colleagues for being helpful in their
differences
and
for
their
constant
support.
We express our deepest gratitude to our parents, who have been the real driving
force for this work.

Gajendra Bhansali
Samvid Shetty

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RESEARCH METHODOLOGY
SUBJECT:

Specific Contracts

TOPIC:

A Legal Perspective of Bank Guarantee System in India.

The present study is doctrinal in nature. In this study, relevant statutory material has been
examined. The decisions of the Supreme Court regarding bank guarantee system published in
various journals have been analyzed. The various reporters, digests, journals and manuals have
also been intrepretede. The statutory material and the various decisions of the courts related to
bank guarantee system from various reference and text books have been analysed.

PREFACE TO THE PROJECT

The study examines the nature and scope of bank guarantee system in India. The present study is
concerned with the law relating to the bank guarantees particularly embodied in the Indian
Contract Act 1872. The present paper also puts light on the economic functions and benefits of
the bank guarantees. Besides that, this study also explains the various types of guarantees issued
by the banks in India. This study is a doctrinal study. For this research, relevant statutory material
has been examined. The decisions of the Supreme Court regarding bank guarantees have been
consulted. The purpose of this study is to make systematic evaluation of law and judicial
approach relating to bank guarantee system in India. The objectives of this study are to make
systematic evaluation of statutory law, Judicial Approach and Policies relating to bank guarantee
system in India.

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CONTENTS

Cover Page.......................................................................................................................................1
Acknowledgements..........................................................................................................................2
Research Methodology....................................................................................................................3
Preface To The Project.....................................................................................................................3
Contents...........................................................................................................................................4
Contract Of Guarantee In A Nutshell............................................................................................5
Essentials And Nature Of The Contract Of Guaranteee..................................................................7
Bank Guarantees An Analysis......................................................................................................8
Bank Guarantee The Need & Its Kinds.....................................................................................10
Bank Guarantees & Letter Of Credit Compared..........................................................................12
Contractual Obligation In Bank Guarantee : Judicial Intrepretation.............................................13
No Injunction To Restrain Payment Under A Bank Guarantee.....................................................20
Safeguards Taken By Banks..........................................................................................................22
Major Findings & Conclusions......................................................................................................23
Bibliography..................................................................................................................................26

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Nobody can really guarantee the future. The best we can do is size up the chances,
calculate the risks involved, estimate our ability to deal with them and make our
plans with confidence.
-

Henry Ford II

CONTRACT OF GUARANTEE IN A NUTSHELL

A contract is an agreement, enforceable by law, made between at least two parties by which
rights are acquired by one and obligations are created on the part of another.1 If the party, which
had agreed to do something, fails to do that, then the other party has a remedy. It is a voluntary,
deliberate, and legally binding agreement between two or more competent parties. 2 Contracts are
usually written but may be spoken or implied, and generally have to do with employment, sale or
lease, or tenancy.3
A guarantee can be many a things. It can be assurance of a particular outcome or that something
will be performed in a specified manner. A guarantee is a way of assuming responsibility for
paying anothers debts or fulfilling anothers responsibilities. It can be a promise for the
1 2(h), The Indian Contract Act, 1872.

2 The Indian Contract Act, 1872, Pollock & Mulla 721 (Lexis Nexis Butterwoths Wadhwa, 14th
Ed. 2012).

3 M.A.Sujan, Law Relating to Building Contracts 5 (Universal Law Publishing Co., Delhi,
1999).
5|Page

execution, completion, or existence of something. A guarantee can also be a promise or an

assurance attesting to the quality or durability of a product or service.4
The English law defines a guarantee as a promise to answer for the debt, default or miscarriage
of another.5
The Indian Law lays down that a Contract of Guarantee is a contract to perform the promise or
discharge the liability or a third person in case of his default. 6 Anything done, or any promise
made for the benefit of the principal debtor, may be sufficient consideration to the surety for
giving the guarantee.7
Surety, Principal Debtor & Creditor Primary Inter-Relationship :- Surety is the person
gives the guarantee, the Principal Debtor is one for whom the guarantee is given and the creditor
is the person to whom the guarantee is given. Contract Act uses the word surety which is same
as guarantor Prima facie, the surety is not undertaking to perform should the principal debtor
fail; the surety is undertaking to see that the principal debtor does perform his part of the bargain.

4 Indian Contract Act, 1872 Contract of Guarantee, Kanwarn Wordpress, (February 27, 2015). <
https://kanwarn.wordpress.com/2012/03/16/indian-contract-act-1872-contract-of-guarantee-part-1-of-3/>

5
Guarantee
or
Guaranty
Legal
Definition,
Duhaime.org
http://www.duhaime.org/LegalDictionary/G/GuaranteeorGuaranty.aspx>

6 126, The Indian Contract Act, 1872.

7 127, The Indian Contract Act, 1872.

6|Page

(February

28,

2015).

<

A contract of guarantee pre-supposes a principal debt or an obligation that the principal debtor
has to discharge in favour of the creditor.8
The most basic function of a contract of guarantee is to enable a person to get a job, a loan or
some goods as the case may be. Such an undertaking by a third person results in a contract of
Suretyship or Guarantee. Guarantee is security in form of a right of action against a third party
called the surety or the guarantor.9

ESSENTIALS AND NATURE OF

THE CONTRACT OF GUARANTEEE
Since Contract of Guarantee if a species of a contract, the General Principles governing contracts
are applicable here. There must be free consent, a legal objective to the contract, etc. Though all
the parties must be capable of entering into a contract, the principal debtor may be a party
incompetent to contract, ie., a minor. Secondly, a principal debt must pre-exist: A contact of
gurantee seeks to secure payment of a debt, thus it is necessary there is a recoverable debt. There
cant be a contract to guarantee a time barred debt.
The contract of guarantee has to be clear and unambiguous. A letter clearly stating the intention
to guarantee a transaction will go on smoothly or one will behave appropriately, conduct himself

8 Supra.note 3, p.9.

9 Avtar Singh, Law of Contract and Specific Relief, (Eastern Book Company 11th ed. 2006).
7|Page

at work place will suffice. But a promise to pay extra attention or to take care of it does not
constitute a guarantee.
In India, a contract of guarantee may be oral or written. It may even be inferred from the course
of conduct of the parties concerned. Under English Law, a guarantee is defined as a promise
made by one person to another to be collaterally answerable for the debt, default or miscarriage
of the third persons and has to be in writing.10
There are three parties in a contract of guarantee; the creditor, the principal debtor and the surety.
In a contract of guarantee, there are two contracts; the Principal Contract between the principal
debtor and the creditor as well as the Secondary Contract between the creditor and the surety.
The contract of the surety is not contract collateral to the contract of the principal debtor but is an
independent contract. Liability of surety is secondary and arises when principal debtor fails to
fulfill his commitments. Even an acknowledgement of debt by the principal debtor will bind the
surety.11
The object of a contract of guarantee is to provide additional security to the creditor in the form
of a promise by the surety to fulfill a certain obligation, in case the principal debtor fails to do
that.12 The contract of guarantee is no doubt tripartite in nature but it is not necessary or essential
10 Anil Rego, How Bank Guarantees Work, Business Standard, Mumbai, August 29, 2010. <http://www.businessstandard.com/article/pf/how-bank-guarantees-work-110082900033_1.html>

11 P.C. Markanda et. al., Unconscionable Clauses in Construction Contracts, XLV, Indian Council of Arbitration
Quarterly, 2, 6 (2009). <http://www.icaindia.co.in/icanet/quterli/july_to_sept_09.pdf>

12 Halsburys Laws of England, Guarantee and Indemnity, 4th edn., Reissue, Vol.20, para 101.
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that the principal debtor must expressly be a party to that document. In a contract of guarantee,
the principal debtor may be a party to the contract of implication. Thus there is a possibility that
a person may become a surety without the knowledge and consent of the principal debtor. In a
sense, it is a collateral engagement to be liable for the debt of another in case of his default.
Guarantees are usually taken to provide a second pocket to pay if the first should be empty.13

BANK GUARANTEES AN ANALYSIS

The banking system, which is an integral part of commerce, has steadily evolved from the simple
acceptance of deposits and lending to its highly developed state that it is today. Bank guarantees
as well as individual guarantees are common features of commercial transactions today. It is a
tripartite agreement between the banker, the beneficiary and the person or the customer, whereby
the bank gives an undertaking to pay the beneficiary a definite sum of money, or arrange the
performance of the obligations of the client in the possible event of his default. 14 Banks are
usually approached to give such guarantees, as they possess the financial capability to meet such
obligations.
Nature of the Contract :- A bank guarantee is a commercial document. It is a contract between
the issuing bank and the beneficiary in whose favour the guarantee has been furnished. It is an
13 Wood, Law and Practice of International, Finance, (1980) p. 295.

14 Amrita Ganguli, Bank Guarantee : An Analysis, Manupatra Article, March 01, 2015.
<http://www.manupatrafast.com/articles/PopOpenArticle.aspx?ID=70c1051d-5804-409a-a55b5e0243dfc004&txtsearch=Subject:%20Finance/Banking>
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act of trust to facilitate the fine flow of trade and commerce in internal and international trade or
business. Even though the genesis of a bank guarantee lies in the primary contract between the
parties, it is nevertheless, autonomous and independent. Though the bank guarantee may have
been issued by the Banker at the instance of his client, it is a contract between the banker and the
beneficiary in whose favour such bank guarantee has been issued. The party at whose instance
the guarantee has been furnished is, in a way, a stranger to the contract of bank guarantee. In a
bank guarantee, the bank binds itself to pay unconditionally and unequivocally without protest or
demur or performance by the principal debtor.15
The bank issuing the guarantee is not concerned with the relationship between the seller and the
customer nor it is concerned with the question whether the seller performed its contractual
obligation or not. The bank must be allowed to honour its commitments in a bank guarantee,
otherwise, the trust in international commerce will be irreparably damaged. 16 Respectability and
reliability of the assured mode of payment through bank guarantees is essential for the growth
and promotion of trade.

BANK GUARANTEE THE NEED & ITS KINDS

15 Mohd Yasin Wani & Rais Ahmad Qazi, A Legal Perspective of Bank Guarantee System in India, 3, International
Journal of Research in Commerce & Management, 161, 163 (2009). <file:///C:/Users/hp/Downloads/ijrcm-1-vol3_issue-9-art-30.pdf>

16 Sankalp Jain, Commercial Instruments : Bank Guarantee & Letter of Credit, March 05, 2015.
<file:///C:/Users/hp/Downloads/SSRN-id2460246.pdf>
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Bank guarantee is used to reduce many business transactions risks. It is a reliable security
instrument in both international and domestic trade. Many genuine business requirements like
obtaining goods, purchasing machinery can be fulfilled even when the enterprise does not have
enough money. It enables to use bank's creditworthiness to facilitate many genuine business
transactions.17 It provides immediate funds to the business in the form of payment guarantees. It
gives one ample time to make ones payments in case of deferred payment guarantees. It is a
quality security instrument which ensures a healthy business transaction and provides better
negotiable terms and conditions to the buyer and seller.18
There is a range of avatars of bank guarantee which are used in different spectrum of situations,
according to the need and purpose.
Tender bond is bank guarantee which is used in the export business for project tenders. They are
short term guarantees. Its purpose is to secure any claims by the party inviting the tender on the
tenderer in the event of withdrawal of the bid before its expiry date or if the bid is modified
unilaterally. It is also used if the tenderer, upon being awarded the contract, refuses to sign the
contract or provide further guarantees on request.
The Performance Bond Guarantees are used to secure any claims by the buyer on a seller
arising from default in delivery or performance of the terms of a contract e.g. construction,
assembly, execution. It is used in import-export businesses as well as in domestic commercial
17 A.C. Moitra, Law of Contract and specific relief Act (Universal Law publishing Co. Pvt. Ltd.,
7th edn., 2006 Reprint).

18 Bank Guarantee, Investopedia, March 06, 2015.< http://www.investopedia.com/video/play/bank-guarantee/>

11 | P a g e

business, trade and industry. The terms of the guarantee are intact until the contractual
obligations have been fulfilled.
The Bank Guarantee for Warranty Obligations is type of bank guarantee whose purpose is to
secure any claims by the buyer on the seller due to possible defects appearing after delivery in
the export-import or the inland domestic transactions. In the construction trade, the guarantee for
warranty obligation in the form of a simple guarantee or a joint and several guarantee is known
as a building (or works) contractor's guarantee.
The Payment Guarantees are used in the import-export business or in any circumstance where
payment of an obligation needs to be guaranteed. It is used to secure any claims by the seller on
the buyer for payment of the contract price by the agreed date. The use of this guarantee is to
secure any claims by the lender on the borrower due to a credit not being repaid in accordance
with the terms of the lending contract. The amount of the guarantee is the amount of the credit or
loan, and it usually includes a margin to cover accrued interest and incidental expenses. The term
of the guarantee is until the expiration date of the loan plus a few days for instance 15 days.19
A bank guarantee, for all purposes, should be taken to be a credit not issued by the bank in
favour of the person in whose favour the bank guarantee has been issued, and it should be
encashable just like a credit note ordinarily, unless the intention of the parties is otherwise20

19 Jessy Ramchandran, Types

<http://www.americancharomical.com>

of

Bank

Guarantee,

March

06,

2015.

Available

20 Handerson Wade, Bank Guarantee Explained, March 06, 2015. Available at - < http://ezinerticles.com/>

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at

BANK GUARANTEE & LETTER OF CREDIT COMPARED

Bank Guarantees and Letter of Credits are financial instruments often used in inland or
international trade when suppliers or vendors do not have established business relationship with
their counterparts. The difference between the two instruments is the position of the bank relative
to the buyer or seller of goods or services.
A Letter of Credit is a banks direct undertaking to the supplier to pay. When a letter of credit is
in use, the issuing bank does not wait for the buyer to default, and for the seller to invoke the
undertaking.21 In contrast, a guarantee is a written contract stating that in the event the primary
party is unable or unwilling to pay its dues to the supplier, the bank as a guarantor to the
transaction and an issuer of the bank guarantee, would pay the debt to the supplier. In other
words, a bank guarantee is an undertaking of a bank on behalf of its customer . But this comes
into play only when the principal party has failed to pay its supplier.
Essentially, the bank becomes a co-signer for its customers purchases. Hence in a Bank
Guarantee the initial claim is still settled primarily against the banks client, and not the bank
itself. Should the client default, only then would the bank agree to pay for its clients debts on
behalf of its client. This is a type of contingent guarantee.22

21 Herman N. Finkelstein, Performance of Conditions under a Letter of Credit, 25 Colum. L.

Rev. 724 (1925). Available at - <http://home.heinonline.org/>

22 Rupnarayan Bose, Bank Guarantee and Letter of Credit, 12, Economic Law Journal, University of Chicago Press
76 (1995).

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A bank guarantee, therefore, is more risky for the client and less risky for the bank. But this is
not the case with a letter of credit. With a bank guarantee, if a client defaults the bank assumes
liability. (With a letter of credit, liability rests solely with the issuing bank, this being the key
difference and main advantage in a letter of credit) which then must collect the money from its
client . Therefore, the principal character of a letter of credit is that it is a potential claim against
the bank, rather than the banks client. A Letter of Credit the banks credit for its clients. The
sellers risk is mitigated from the risk that the buyer will not pay to the risk that the bank will be
unable to pay, which is unlikely. Also, a letter of credit is less risky for the merchant but more
risky for the bank, though banks accept full liability in both cases.
1. A letter of credit is a direct responsibility of the issuing bank. The buyer does not at all
2.

come into the picture. The letter of credit is a primary instrument in the transaction.
In contrast, a bank guarantee comes into operation only when the buyer has failed to
perform his bit Therefore the bank issuing the bank guarantee is the second line of
defence , it is not a primary party.

CONTRACTUAL OBLIGATION IN BANK GUARANTEE

JUDICIAL INTREPRETATION
The Supreme Court and various High Courts over the years have passed numerous judgements
which have dealt with various circumstances and disputes which can take place when dealing
with bank guarantees. The following are some of the cases that deal with the same:-

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Name of the Case: United Commercial Bank V. Bank of India and Ors.23
HELD: The Supreme Court was of the opinion that a bank guarantee is very much like a letter of
credit. The courts will do their utmost to enforce it according to its terms. They will not, in the
ordinary course of things, interfere by way of injunction to prevent its due implementation.It was
also said in this case that if the seller has complied with terms of letter of credit, however, there
is an absolute obligation upon a banker to pay irrespective of any dispute there may be between
the buyer and the seller as to whether the goods are upto contract or not.

Name of the Case: Rawala Construction co. V. Union of India24

Held: The Supreme Court laid down that the bank guarantee constitutes an agreement between
bank and the government under which there is an absolute obligation of the bank to make
payment to the government merely on the demand of the government. The bank is prohibited
under the guarantee from raising any objection.

Name of the Case: Hindustan Steel Workers Constn. Ltd. V. G.S. Atwal & Co.25
Held: Supreme Court laid down that there are two types of Performance Guarantees. The first
one is absolute and is encashable on the very demand of the beneficiary and the demand
according to the terms of the Guarantee is conclusive.
23 AIR 1981 SC 1426

24 AIR 1997 Del 205

25 (1995) 6 SCC 76.

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In such types of Guarantees the

Beneficiary is the Sole Judge or Arbiter as to whether there is any breach of underlying or
primary contract on the part of the other party and as to how much amount is due to the former.
The other type is where the Guarantee is not encashable without proof of breach of underlying
contract. However, in both types of Guarantees, the Bank issuing the performance Guarantee is
not concerned with the underlying contract. The duties in such Guarantees are created by the
document itself which in other words is independent and autonomous and is not concerned with
the underlying contract unless the Guarantee itself says that it will be enforceable on the proof of
breach of the primary underlying contract.

Name of the Case: Hugglunds Drives AB V National Heavy Engineering Co-op. Ltd. 26
Held: The issuing bank is bound to observe and honour the terms of the guarantee. The
beneficiary of a bank guarantee cannot be restrained from invoking the bank guarantee, and the
issuing bank cannot be injuncted from paying over the proceeds of Bank Guarantee save and
except in the case of fraud which vitiates the entire underlying transaction or in case where
irretrievable injustice would be caused by the invocation or encashment of the Bank Guarantee.

Name of the Case: Rigoss Exports International (P) Ltd. V. Tartan Infomark Ltd27
Held: Bank Guarantee obtained by beneficiary through fraud, held that Court could intervene in
such cases.

26 AIR 2002 Bom 305.

27 AIR 2001 Del 285.

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Name of the Case: National Telecom of India Ltd. V Union of India28

Held: There was a bank guarantee in favour of the government in respect of supplies to be made
by the contractor as per the purchase order. As per the guarantee agreement, the amount was
payable without any demur and on demand.
To invoke the bank guarantee it has to be shown that there was existence of one of the two
conditions:a) That there failure on the part of the contractor to perform the contract, and
b) That the amount claimed was by way of loss or damage to the government due to the
breach of contract.
If the contractor fails to supply the goods against purchase order, in spite of extension of time,
and the government writes to the Bank to claim compensation stating that the same has arisen
due to non-performance of the contract by the contractor, the guarantee, in such a case, has been
properly invoked in accordance with the terms of the contract.
It was further held in the case that if there is a breach of contract in the judgment of the
beneficiary of the contract, the bank has a obligation to pay the amount covered under the bank
guarantee on demand by the beneficiary without raising any objection. The bank is not to judge
that whether there is breach of contract or not.

Name of the Case: Daewoo Motors India Ltd. V. Union of India29

28 AIR 2001 Delhi 236.

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Held: The Appellant Company agreeing to fulfill export obligations had obtained various import
licenses from the government after furnishing bank guarantee in that regard. There was a term in
the bank guarantee that made the President under guarantee would be conclusive. Such guarantee
was held to be absolute and equivocal, hence invocation of guarantee on failure to fulfill export
obligation was held not arbitrary and its encashment could not be resisted by the bank.
Name of the Case: Bank of Baroda V Ruby Sales Corporation Agency30
Held: One of the parties demanded for discharging Bank guarantee by producing proper
documents. No proceedings had been initiated by party for alleged breach of agreement against
other party. Bank was not concerned with dispute between parties. Unless it was a case of fraud,
bank was bound to discharge bank guarantee. Plea that there was negligence on the part of bank
in discharging bank guarantee though it was informed not to make payment was rejected by the
Gujarat High Court. Action of Bank in discharging Bank Guarantee was not improper.

Name of the Case: Mula Sahakari Karkhana V State Bank of India31

Held: Document was supplied between the plaintiff and the bank and the supplier of the goods
was not a party to it. The document and the intention of the parties was clear covering
comprehensive claim of plaintiff to the extent of Rs. 3,40,000/- . The guarantor was invoked
within the prescribed time. Since there was no dispute between the plaintiff and the supplier as
29 AIR 2003 SC 1786.

30 AIR 2001 Del 285

31 AIR 2005 Bom. 385

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also there being no fraud or misrepresentation involved, the Bank was held bound to honour the
guarantee.
Name of the Case: Prabhu Mktg. V. N.S.C 32
Held: The Calcutta High Court was of the opinion that where the is a very strong prima facie
case of element of fraud in connection with the invocation of bank guarantee, the party giving
the bank guarantee can lawfully seek injunction against the invocation of bank guarantee. But
there was no finding of fraudulent injunction against encashment of bank guarantee cannot be
granted.

Name of the case: Man Industries India Ltd., Indore V N.V. Kharote Engineers and
Contractors, Pune33
Held: The Bombay High Court was of the opinion that there was a contract for supply of goods
by the company to the contractor. Dispute arose between parties regarding outstanding amount.
Bank guarantee executed at the instance of contractor in favour of company was unconditional. It
was not dependent on extent of goods supplied. Condition was stipulated in bank guarantee that
it could become en-cashable in the event of default of payment. No prima facie case for
injunction was made out by contractor. No irretrievable injustice would be caused to him.
Balance of convenience was also not in his favour. Injunction against encashment of bank
guarantee was refused as there was no finding of fraud recorded.

32 A.I.R. 2006 Cal. 301

33 AIR 2005 Bom 311

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Name of the Case: Hindustan Steelworks Corp. Ltd. V. Tarapore and Co.34
Held: The Supreme Court laid down the law in terms of following propositions:
1.

A bank guarantee is an independent and distinct contract between the bank and the

beneficiary and is not qualified by the underlying transaction and the primary contract between
the person at whose instance the bank guarantee is given and the beneficiary.
2. In the case of an unconditional bank guarantee the nature of the obligation of the bank is
absolute and not dependent upon any dispute or proceeding between the party at whose instance
the bank guarantee is given and the beneficiary.
3. The commitment by banks must be honoured free from interference by the court 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, that the court would interfere.

Name of the case: A.C. Roy & Co.V. Union of India35

Held: The Calcutta High Court held that the person claiming the guarantee must establish that
conditions for invoking the guarantee do exist. In another case of Natioanal Telecom of India
Ltd. V. Union of India36 the government was required to show at least one or two conditions for
34 (1996) 5 SCC 34

35 AIR 1995 Cal 246.

36 AIR 2001 Delhi 236.

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invoking guarantee, ie. either that the amount had become due because of loss caused by breach
or that the amount was being forfeited by reason of the contractors failure to perform his
commitment.
Name of the case: U.P. Co-op Federation Ltd V. Singh Consultants and Engineering Ltd37
Held: The Supreme Court held that the operation of a bank guarantee should be stayed only in
cases of serious dispute, fraud or special equities.
Name of the Case: General Electric Technical Co Inc V Punj Sons(P) Ltd38
Held: The Supreme Court dealt with a case of bank guarantee given for securing mobilization
advance, it was held that the right of a contractor to recover certain amounts under running bills
would have no relevance to the liability of the bank under the guarantee given by it.
A bank guarantee is a sort of an absolute undertaking to pay the amount whenever demanded by
the guarantee-holder. It has nothing to do with the state of relations between the guarantee-holder
and the person on whose behalf the guarantee was given. While ordinary guarantees are linked to
and dependent on the underlying transaction, a bank guarantee is an arrangement where the
guarantee is independent of the underlying transaction.

37

AIR 1988 SC 2239.

38 AIR 1991 SC 1994.

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NO INJUNCTION TO RESTRAIN PAYMENT UNDER

A BANK GUARANTEE
Where a bank gives a guarantee to pay on first demand and without contestation and without
reference to such party or notwithstanding any disputes between the parties .., the guarantee
bank is obliged to pay according to the contractual obligation, and the court will not give an
injunction restraining the bank for payment. The fact that the guarantee issued by the bank is
wider in terms, than that agreed between the bank and the debtor is also no reason to grant
injunction restraining payment. Where however, there is no unconditional or irrevocable promise
to pay in the guarantee in which it was only undertaken to indemnify the company from any loss
or damage that was caused to it or was suffered by it by the act of the contractor, that temporary
injunction could be granted, restraining the company from realizing the bank guarantee, since the
guarantee sought to be enforced amounted to a contract of indemnity and the beneficiary has to
show the loss or damage caused to it. It is settled law that a contract of guarantee is a complete
and separate contract by itself. The law regarding enforcement of an on demand bank guarantee
is very clear. If the enforcement is in terms of the guarantee, then courts must not interfere with
the enforcement of bank guarantee. The court can only interfere if the innovation of on demand
guarantee in accordance with its terms by looking at terms of the underlying contract.39
EXCEPTIONS - Payment under a bank guarantee may be refused or restrained:

39 M.L. Tannan, Tannans Banking Law and Practice in India, Vol I (Wadhwa and Company,
Nagpur, 2nd edn., 2005).
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1. Where the bank knows that the documents presented by the beneficiary for seeking
enforcement are forged or fraudulent.
2. Where a fraud by one of the parties to the underlying contract has been established and
the bank has notice of the fraud.
3. Where a case of apprehension of Irretrievable Injustice is made out.
4. Where the guarantee is conditional and the condition has not been complied with.
5. Where the conditions necessary for invoking a conditional bank guarantee have not
arisen.
6. Where the purpose for which a conditional guarantee was given has been accomplished.
7. Where the period stipulated for innovation of the guarantee has expired.
Therefore, as a general rule, bank guarantee must be honoured in accordance with its terms,
there are, however, two exceptions: The first is when there is clear fraud of which the bank
has notice and a fraud of the beneficiary from which it seeks the benefit. The fraud must be
of an egregious nature as to vitiate the entire underlying transaction. The second exception to
the general rule of non-intervention is when there are special equities in favour of injunction,
such as when irretrievable injury or irretrievable injustice would occur if such an injunction
were not granted.

SAFEGUARDS TAKEN BY BANKS

To reduce the risks to which the banks are exposed while furnishing bank guarantees on behalf of
their clients, banks resort to the following to safeguard their interest.
(a) Limits :- Banks lay down maximum monetary limits upto which they would furnish
guarantees and open letters of credit at any point of time. The limits are fixed on the
basis of the financial standing, extent to which the account has been maintained by
customers satisfactorily, the volume of transactions, past track record of the client in23 | P a g e

respect of such guarantees etc.40 The limits are reviewed are re-fixed periodically along
with monetary limits for overdrafts, cash credits etc.
(b) Margins :- Banks lay down maximum monetary limits upto which they would furnish
guarantees and open letters of credit at any point of time. The limits are expired on the
basis of the financial standing, extent of which the account has been maintained by the
customers satisfactorily, the volume of transactions, past track record of the client in
respect of such guarantee etc. The limits are reviewed and refixed periodically along with
monetary limits for overdrafts, cash credits etc.
The percentage of margin money could range from ten to fifty percent of the value of the
guarantees. The margin money will be released once the bank guarantee has expired and is
returned to the bank duly discharged.41
(c) Counter Guarantee :- In addition to fixing limits and taking margin money as
security, banks invariably obtain counter guarantees from the clients for equal value
before furnishing bank guarantees on their behalf. This document provides the basis for
the bank to debit the clients accounts when it has to honour a bank guarantee invoked by
the beneficiary, and to proceed legally against the client, if it is unable to fully reimburse
itself of the amount from the client.42
Bank Guarantee And Arbitration Clause in the Contract

40 Supra.note 3, p.156.

41 R.K. Gupta, Banking Law and Practice. (Modern Law Publications, 2nd edn., 2005).

42 Supra.note 15, p. 163-164.

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The enforcement of a bank guarantee cannot be made the subject-matter of arbitration

proceeding but where a bank found that there was a pending arbitration under which the liability
of all the parties had to be ascertained, the bank can rightfully decide to withhold the payment
under the guarantee.43

MAJOR FINDINGS & CONCLUSIONS

Guarantee is an undertaking to be collaterally responsible for the debt, default or miscarriage of
another. In banking context it is an undertaking given by the guarantor to the banker accepting
responsibility for the debt of the principal debtor if he defaults. Undoubtedly, Bank guarantees
are simple, flexible and effective guarantee and play a major role in the promotion of national
and international trade. So far, it can be safely concluded that a bank guarantee is an independent
and distinct contract between bank and the beneficiary, and is not qualified by the underline
transaction and the primary contract between the people at whose instance the bank guarantee is
given. When bank gives absolute and unconditional guarantee then the courts cannot issue an
injunction restraining the bank for the payment.
The Apex Court in its significant ruling in the landmark case of Himadri Chemicals Industries
Ltd. V. Coal Tar Refining Co.44 has culled out the principles that should be noted in the matter of
injunction to restrain the encashment of a bank guarantee.
43M.A. Mir, The Law Relating to Bank Guarantees in India. (Universal Book Traders, 1 st edn.,
1992).

44 AIR 2007 SC 2798.

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First, banks that give such guarantees are duty-bound to honour them as per terms agreed upon
between the parties concerned, irrespective of any dispute raised by its customer. In the matter of
invocation of a bank guarantee, it is not open for the bank to rely upon the terms of the
underlying contract entered into between parties concerned, court said.
Second, the existence of any dispute between parties to the contract is not a ground for issuing an
order of injunction to restrain enforcement of bank guarantee. The apex court said that the bank
guarantee or LoC is an independent and a separate contract and absolute in nature.45
Third, the beneficiaries are entitled to realise an unconditional bank guarantee in terms of the
agreement, irrespective of any pending disputes relating to the term of the contract.
Fourth, the courts should be slow in granting an order of injunction to restrain the realisation of a
bank guarantee or.46
However, there is a grave need for improvisation in Bank guarantee regime in India. There is no
written law for Bank Guarantee, therefore there is an immediate need for codified law as
situations are becoming more technical. Moreover court cannot issue injunction in bank
guarantee except in exceptional cases which are decided by the courts so there should be written
laws. As we have progressed now bank guarantees are transmitted electronically on a bank-tobank basis. So one must be very concerned if presented with a hard copy of a bank guarantee; it
45 Sanjay K Singh, Bank Guarantees LOCs are absolute, The Economic Times, August 09, 2007.
<http://articles.economictimes.indiatimes.com/2007-08-09/news/28484612_1_bank-guaranteeloc-encashment>

46 Supra.note 28, 15.

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may likely to be fraudulent instrument. This is not to preclude pro forma writings of bank
guarantees where the parties agree on the terms, and the applicant takes these terms to the bank
and has the bank incorporate them into the electronic bank guarantee.
Bank should not interfere with the dispute related to the encashment of bank guarantee. As far as
possible the dispute should be solved by Arbitrators. Commitment of banks must be honoured
free from interference by the courts. It is only an in exceptional case that is to say in case of
fraud or in case of irretrievable injustice, that the court should interfere. Thus in commercial
transactions bank guarantees achieve relevance. Beneficiaries or the creditors may charge a rate
of penal interest in the event of delayed payment of the due amount. Hence, it is imperative that
banks remain cautious, when signing a contract of guarantee with the beneficiary, which may
contain provisions pertaining to the payment of penal interest in the event of delay in payment on
default of the principal debtor.

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BIBLIOGRAPHY
Cases
Bank of Baroda V Ruby Sales Corporation Agency ,AIR 2001 Del 285.13
A.C. Roy & Co.V. Union of India, AIR 1995 Cal 246...................................................................16
Daewoo Motors India Ltd. V. Union of India ,AIR 2003 SC 1786...............................................13
General Electric Technical Co Inc V Punj Sons(P) Ltd ,AIR 1991 SC 1994...............................16
Himadri Chemicals Industries Ltd. V. Coal Tar Refining Co ,AIR 2007 SC 2798.......................21
Hindustan Steel Workers Constn. Ltd. V. G.S. Atwal & Co ,(1995) 6 SCC 76..............................11
Hindustan Steelworks Corp. Ltd. V. Tarapore and Co ,(1996) 5 SCC 34.....................................15
Hugglunds Drives AB V National Heavy Engineering Co-op. Ltd ,AIR 2002 Bom 305..............12
Man Industries India Ltd., Indore V N.V. Kharote Engineers and Contractors, Pune,
AIR 2005 Bom 311........................................................................................................................15
Mula Sahakari Karkhana V State Bank of India ,AIR 2005 Bom. 385........................................14
National Telecom of India Ltd. V Union of India ,AIR 2001 Delhi 236.......................................12
National Telecom of India Ltd. V. Union of India ,AIR 2001 Delhi 236.......................................16
Prabhu Mktg. V. N.S.C ,A.I.R. 2006 Cal. 301...............................................................................14
Rawala Construction co. V. Union of India ,AIR 1997 Del 205...................................................11
Rigoss Exports International (P) Ltd. V. Tartan Infomark ,Ltd AIR 2001 Del 285.....................12
U.P. Co-op Federation Ltd V. Singh Consultants and Engineering Ltd ,AIR 1988 SC 2239.......16
United Commercial Bank V. Bank of India and Ors, AIR 1981 SC 1426.....................................10

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Statutes
The Indian Contract Act, 1872.........................................................................................................1
Treatises
1. A.C. Moitra, Law of Contract and specific relief Act (Universal Law publishing Co. Pvt.
Ltd., 7th edn., 2006 Reprint).................................................................................................6
2. Avtar Singh, Law of Contract and Specific Relief, (Eastern Book Company 11th ed. 2006)
2
3. Halsburys Laws of England, Guarantee and Indemnity, 4th edn., Reissue, Vol.20, para
101. .4
4. M.A. Mir, The Law Relating to Bank Guarantees in India. (Universal Book Traders, 1 st
edn., 1992). 19
5. M.A.Sujan, Law Relating to Building Contracts 5 (Universal Law Publishing Co., Delhi,
1999). .1
6. R.K. Gupta, Banking Law and Practice. (Modern Law Publications, 2 nd edn., 2005)
..
18
7. The Indian Contract Act, 1872, Pollock & Mulla 721 (Lexis Nexis Butterwoths Wadhwa,
14th Ed. 2012)..1
Web Links
Bank Guarantee, Investopedia, (March 06, 2015)...........................................................................6
Guarantee or Guaranty Legal Definition, Duhaime.org (February 28, 2015).................................2

Articles
Amrita Ganguli, Bank Guarantee : An Analysis, Manupatra Article, March 01, 2015...................5
Handerson Wade, Bank Guarantee Explained, March 06, 2015.....................................................7
29 | P a g e

Herman N. Finkelstein, Performance of Conditions under a Letter of Credit, 25 Colum. L. Rev.

724 (1925)....................................................................................................................................8
Jessy Ramchandran, Types of Bank Guarantee, March 06, 2015....................................................7
Sanjay K Singh, Bank Guarantees LOCs are absolute, The Economic Times, August 09, 2007.. 20
Sankalp Jain, Commercial Instruments : Bank Guarantee & Letter of Credit, March 05, 2015.....5
Journals
1. Mohd Yasin Wani & Rais Ahmad Qazi, A Legal Perspective of Bank Guarantee System
in India, 3, International Journal of Research in Commerce & Management, 161, 163
(2009)...................................................................................................................................5
2. Rupnarayan Bose, Bank Guarantee and Letter of Credit, 12, Economic Law Journal,
University of Chicago Press 76 (1995)....8

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