INDIA BUSINESS WORLD - JULY - AUGUST - 2007
The Month that was ...

SUPREME COURT SETS GUIDELINES FOR ENCASHMENT OF BANK GUARANTEES

IN a significant ruling, the Supreme Court has laid down the guidelines pertaining to the encashment of a bank guarantee or letter of credit. A bench comprising Justice Tarun Chatterjee and Justice PK Balasubramanyan said: "We find that the following principles should be noted in the matter of injunction to restrain the encashment of a bank guarantee or a letter of credit".

First, the banks which give such guarantees are duty-bound to honour it as per the terms agreed upon between the parties concerned irrespective of any dispute raised by its customer. In the matter of invocation of a bank guarantee or a letter of credit, it is not open for the bank to rely upon the terms of the underlying contract entered into between the parties concerned, court said.

Second, the existence of any dispute between the parties to the contract is not a ground for issuing an order of injunction to restrain enforcement of the bank guarantee or letter of credit. The apex court said that the bank guarantee or letter of credit is an independent and a separate contract and absolute in nature.

Third, the beneficiaries are entitled to realise an unconditional bank guarantee or letter of credit 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 a letter of credit.

However, the bench said that courts can pass an order restraining encashment of the bank guarantee or letter of credit in two exceptional circumstances. These are: Fraud of an egregious nature which would vitiate the very foundation of such a bank guarantee or letter of credit and the beneficiaries seeks to take advantage of the situation.

Allowing encashment of an unconditional bank guarantee or a letter of credit would result in irretrievable harm or injustice to one of the parties concerned.

The guidelines pertaining to the issue came on an appeal of Himadri Chemicals Industries which entered into agreement with the Iranbased Coal Tar Refining Co which agreed to supply Extra Hard Pitch to the appellant. Accordingly, an irrevocable letter of credit was opened by the appellant in favour of the Iranian entity, Later, due to the disputes between parties with the appellant alleging supply of inferior quality of goods, moved the court with the plea not to release payment under the letter of credit. It said that its encashment will result in irreparable loss to it. It also alleged fraud committed by the foreign company.

The court while elaborating the guidelines dismissed the appeal as it failed to prove the allegations.