Performance of unconditional Bank Guarantee

A "contract of guarantee " is a contract to perform the promise, or discharge the liability, of a third person in case of his default. The person who gives the guarantee is called the "surety";

the person in respect of whose default the guarantee is given is called the " principal debtor ", and the person to whom the guarantee is given is called the "creditor". Guarantee may be either oral or written.

A performance of Bank Guarantee (also called performance bond) states that in the event of failure to perform an agreed task the beneficiary can raise a claim on the bank.

An unconditional bank guarantee is normally to be paid to the holder as and when a demand arises, court's are pretty reluctant in granting stays on bank guarantees. The Courts believe that if in all mercantile matters when a person proceeds on the guarantee of an unconditional bank guarantee - staying would make the business work come to a standstill.

Whether in exceptional cases of fraud/ special equities/ irretrievable injustice do the courts stay the en-cashing of bank guarantees.

When in the course of commercial dealings an unconditional bank guarantee is given or accepted, the beneficiary is entitled to realize 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 realization of such a bank guarantee. The courts have carved out only two exceptions.

A fraud in connection with such a bank guarantee would vitiate the very foundation of such a bank guarantee. Hence if there is such a fraud of which the beneficiary seeks to take the advantage, he can be restrained from doing so. The second exception relates to cases where allowing 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 of 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.

Dealing with the question of fraud it has been held that fraud has to be an established fraud i .e. an injunction may be granted where it is proved that the bank knows that any fraudulent demand for payment is made or which may be made and despite that Bank had not taken any reasonable step to avoid such fraud. Evidence must be clear, both as to the fact of fraud and as to the bank's knowledge.

The second exception to the rule of granting injunction, i.e., the resulting of irretrievable injury, has to be such a circumstance which would make it impossible for the guarantor to reimburse himself, if he ultimately succeeds. This will have to be decisively established and it must be proved to the satisfaction of the court that there would be no possibility whatsoever of the recovery of the amount from the beneficiary, by way of restitution.

Bhawani Mahapatra

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Bhawani Mahapatra 
on 01 September 2012
Published in Corporate Law
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