Bank guarantees are an integral part of a contract, but these have been encashed under dubious circumstances in a number of cases. Prachi Manekar examines the legal recourse available to aggrieved parties.
In May 2014, an Italian appellate court allowed the partial encashment of bank guarantees and performance bonds, worth about Rs 1,818 crore deposited by AgustaWestland in connection with the supply of 12 VVIP choppers to India. The Defence Ministry has scrapped the Rs 2700 crore deal in January this year after allegations of bribery were made against the company. The said bank guarantees were stayed since March 2014 when Agusta Westlandhad prayed for emergency interim relief.
Such instances of bank guarantee encashment are not new in the Indian infrastructure space. We have seen numerous instances of bank guarantee encashments. For instance, in 2013, within three days of taking over the operation of Delhi Airport Expressline Metro, the Delhi Metro Rail Corporation (DMRC) had encashed the bank guarantee deposited by Reliance Infra worth Rs. 55 crore. Similarly, leading infrastructure companies face the problem of bank guarantee encashments.
If we look at the instances of encashment, we find that in certain cases the encashment is justified like when infrastructure companies are unable to deliver on their promises eg., Kingfisher was not able to pay fuel charges to IOCL and it encashed its Rs 50 crore bank guarantee. However, nowadays bank guarantees are also used as a tool by beneficiaries. There are instances where companies/authorities have encashed bank guarantees on flimsy reasons just to tide over cash flow problems. At times encashment is used as a route to gain an edge in negotiations. On encashment, the beneficiary (party in whose favour bank guarantee is drawn) gets money upfront whereas it is the applicant (who has applied for bank guarantee) who must go to court. Thus, if there is a dispute, the beneficiary may simply encash the bank guarantee rather than going to court and proving its claim. The urban development ministry had sought to encash bank guarantees of Rs. 183 crore of the developer Emaar-MGF when defects and plan violations were noticed in the Games Village project. In instances where such encashment takes place, the applicant must then go to court/arbitration and establish its claim. Thus, such an applicant is at times doubly prejudiced - he does not get paid for performing his obligations under the contract and on encashment the bank recovers the amount of bank guarantee from the applicant.
Can encashment be stayed?
In the Italian Court, AgustaWestland was successful in staying the encashment by a few months. Many companies have tried a similar strategy in India wherein they have tried to stay encashment of bank guarantees by seeking an injunction from the Court. However, in India the law on injunction of bank guarantee is heavily skewed in favour of the beneficiary. The invocation of a bank guarantee by the beneficiary can be restrained by an injunction under the Civil Procedure Code, 1908, or the Specific Relief Act, 1963 or Arbitration & Conciliation Act, 1996. However, the normal considerations, which apply in granting an injunction, will not apply in case of a bank guarantee. The courts follow a very strict approach in granting any injunctions against encashment of bank guarantees.
The apex Court has laid down general principles in U.P. State Sugar Corporation that have been followed by Indian Courts while considering the question of encashment. According to the apex Court, when in the course of commercial dealings an unconditional bank guarantee is given or accepted, the beneficiary is entitled to realise such a bank guarantee in terms thereof irrespective of any pending disputes. The bank giving such a guarantee is bound to honour it as per its terms irrespective of any dispute raised by its customer. The very purpose of giving such a bank guarantee would otherwise be defeated. The courts should, therefore, be slow in granting an injunction to restrain the realisation of such a bank guarantee. If the language of the guarantee entitles the beneficiary to receive payment from the bank, the dispute between the applicant and beneficiary would not be a bar for the beneficiary to enforce the guarantee.
However, over time the Courts have evolved exceptions to this rule wherein the encashment can be stayed. Following are some specific grounds on which a Court has granted stay on encashment:
a. Fraud: In case of a fraud in connection with such a bank guarantee, the court may grant an injunction as fraud vitiates the very foundation of such a bank guarantee eg. forgery of bank guarantee, bank guarantee obtained in a fraudulent manner. For being successful a clear case has to be made out for fraud and the details of fraud ought to be provided. b. Irretrievable injustice: This arises if the party can show that the encashment of an unconditional bank guarantee would result in irretrievable harm or injustice to one of the parties concerned. Since in most cases payment of money under such a bank guarantee would adversely affect the bank and its customer at whose instance the guarantee is given, the harm or injustice contemplated under this head must be such an exceptional and irretrievable nature as would override the terms of the guarantee and the adverse effect of such an injunction on commercial dealings in the country. Courts have taken a very adverse stand by permitting encashment of bank guarantee. In case of Itek Corporation, this point was brought forth very distinctly and stay was granted on encashment. In this case the petitioner was able to show the Court that there was an element of fraud. He was able to establish irretrievable injustice. They show that if the bank guarantee was encashed they would never be able to recover the amount even if later they could establish their case. This was because a money decree could not be executable in the home country of the other party. c. Condition for encashment: In case the bank guarantee is conditional or prescribes certain mode of encashment, then injunction can be sought if the terms of the bank guarantee are not fulfilled. For instance, HCC obtained an injunction where bank guarantee was sought to be encashed by an engineer. In these cases, the bank guarantee was executed by the chief engineer and it was held that only he had the right to encash it. However, once the conditions in the bank guarantee are fulfilled, then the injunction will be lifted.
Companies often try to defend encashment of bank guarantee by taking recourse to the said exceptions. However, Courts have been slow in granting such injunctions. The reluctance of Courts is increasing the instances of beneficiaries encashing bank guarantee without justifiable cause. This brings us to the next question:
Are there any other remedies?
If the bank guarantee is wrongly encashed, remedies are available post-encashment. If bank guarantee is illegally encashed then the applicant can claim damages on account of illegal encashment. The additional margins and costs incurred can form part of the claim for damages. Further, the loss of reputation and additional costs of obtaining future bank guarantee can also be shown. The applicant can alternatively claim interest at the prevailing rate of interest on the amount wrongly encashed. At the interim stage, the aggrieved party can seek refund of amount wrongly encashed by granting another bank guarantee.
The law on bank guarantees is still evolving. Over time, the Courts are likely to take a strict view on bank guarantees illegally encashed and if they make the party pay heavy damages or interest for such encashments then it will curb the instances of illegal/wrongful encashments.