1. The document discusses bank guarantees and injunctions related to letters of credit. It focuses on situations where injunctions may be granted to prevent payment under a letter of credit, specifically in cases of fraud.
2. The general rule is that a bank's obligation under a letter of credit is independent of any disputes between the buyer and seller. However, courts will make an exception and grant an injunction in cases where the seller is proven to be acting fraudulently, such as shipping worthless goods instead of what was agreed upon.
3. One case example discussed is Sztejn v. Henry Schroder Banking Corporation, where the plaintiff alleged the seller shipped cow hair and rubbish instead of the agreed upon
1. The document discusses bank guarantees and injunctions related to letters of credit. It focuses on situations where injunctions may be granted to prevent payment under a letter of credit, specifically in cases of fraud.
2. The general rule is that a bank's obligation under a letter of credit is independent of any disputes between the buyer and seller. However, courts will make an exception and grant an injunction in cases where the seller is proven to be acting fraudulently, such as shipping worthless goods instead of what was agreed upon.
3. One case example discussed is Sztejn v. Henry Schroder Banking Corporation, where the plaintiff alleged the seller shipped cow hair and rubbish instead of the agreed upon
1. The document discusses bank guarantees and injunctions related to letters of credit. It focuses on situations where injunctions may be granted to prevent payment under a letter of credit, specifically in cases of fraud.
2. The general rule is that a bank's obligation under a letter of credit is independent of any disputes between the buyer and seller. However, courts will make an exception and grant an injunction in cases where the seller is proven to be acting fraudulently, such as shipping worthless goods instead of what was agreed upon.
3. One case example discussed is Sztejn v. Henry Schroder Banking Corporation, where the plaintiff alleged the seller shipped cow hair and rubbish instead of the agreed upon
1. The document discusses bank guarantees and injunctions related to letters of credit. It focuses on situations where injunctions may be granted to prevent payment under a letter of credit, specifically in cases of fraud.
2. The general rule is that a bank's obligation under a letter of credit is independent of any disputes between the buyer and seller. However, courts will make an exception and grant an injunction in cases where the seller is proven to be acting fraudulently, such as shipping worthless goods instead of what was agreed upon.
3. One case example discussed is Sztejn v. Henry Schroder Banking Corporation, where the plaintiff alleged the seller shipped cow hair and rubbish instead of the agreed upon
to lay down or define the rights of the parties but to provide for and grant relief when a person is prevented from realizing or enjoying his rights or when the right has been infringed or in other words, when the corresponding duty is not being fulfilled or has been violated. The highest form of protection which may be expected from or should be aimed by the state is to see that no one encroaches upon or inter- cepts the rights of another. Palling that, the aim of the Law should be to give a suitor the very thing or nearly equivalent or similar to it as possible which is being or has been deprived.
An injunction is a discretionary r^nedy, and
for the grant of an injunction we have to refer to the provisions of the specific Belief Act and the Code of Civil Procedxire, This means that the Courts in India have to deal with Injunction not only as an equitable relief but as a relief founded on the basis of law which embodies the principles of injunction. 294
Lretters of credit are now coming Into wide
spread use as an effective commercial device. More small manufactures and business are engaging in international trade« necessitating their use. Letters of credit are also becoming more common in domestic trade. Most important* however* is the dramatic development of performance guarantee/ bank guarantee used in both domestic and international transactions to guarantee the performance of such contractual promises as construction of roads, sewers* or buildings* malntainaDce of Sophisticated communication* manufacturing* or other facilities in foreign countries. The spread of credit into nonsale areas* moreover* has just begun. The only limits on their use are the creative abilities of those who use them. In short* performance guarantees are being used in more ways* in more business tran- sactions* than ever before. The telling proof of the broadenced Interest in letter of credit law is dramatic Increase in the number of reported cases. In the great bulk of these cases the critical Issue has been under what circiunstances may an Injunction issue restraining a bank from making payment on its letter of credit. In other words two questions are important in this regard. Firstly* is there any 29J
situation in which the bank is under a duty to
refuse payment when requested to do so by the customer? Secondly, if so, when will an injunction lie that orders the seller not to draw under the credit or the issuing banker not to accept or pay?
Corresponding to cases in which buyers try
to take advantage of minor deviations known in banking parlance as technicalities, beneficiaries occassionally engage in fraudulent practices such as falsification of bills of lading or other docu-> ments of title. When this comes to the attention of the customer or the issuing bank, a thorney legal problem is in the making.
The Courts will only interfere to grant an
injunction against the beneficiary of the credit pre- venting him from receiving payment under the credit Af a sufficiently grave reason could be shown, namely forgery or fraud by the beneficiary or by some one for whom he is responsible.
Fraud will be inferred In circumstances when
the goods shipped by the beneficiary are of a totally different nature from thos contracted for and the contract of sale ^s specified in the contract of 29J
credit, or the godds shipped contain rubbish. In
cases of fraud the court will not c^npel the Issuing or confirming banH to honour the credit because the beneficiary deliberately acts wrongfully in seeking to avail himself of the credit when the Icnows that he ( or a person for whOTi his respcMMliale) has shipped goods which are not those called for by the terms of the credit*
In accordance with customary law, the bank's
duty to verify and subsequently to accept or pay is Independent of failure of consideration in the underlying agreement. The issuing banker is, there- fore, in an unconfortable position, he knows that the acceptance or the payment he is going to make, although warranted by the law because the documents appear on their face to be genuine, will possibly cause a loss to his custcxner, especially if the transaction is an international one. If a seller is willing to risk the consecjuences of a criminal action on fraud, it is quite likely that his assets are either virtually non exlstant or so well hidden that an action in restitution by the distant purchasers would result in nothing but an expensive academic 29;
victory for the pucchaser. The banker could became
'technical* himself and pick some deviation, however, slight, in order to avoid payment, but, if there is compliance on the face of the documents the bank would be hard put to make such a claim, especially if the drafts and documents were presented by an intermediary negotiating bank.
Since the development of Modern letters of
credit law in the nineteenth century, courts have uniformly held, as a general rule, the issu^ obli- gation under the letter of credit is independent of any defence the customer may have against payment on the underlying contract. To this rule there is a recognised exception. This exception provides that the Courts will give relief if it is established that the seller is acting fraudulently in the transaction. In Edward Owen Engineering Ltd. v, Barclays Bank International Ltd, Brown L,J, stated the exception as follows I
"The exception is that where the
docviments under the credit are presented by the beneficiary himself and the bank knows when the documents are presented that they are forged or fraudulent, the bank is entitled to refuse payment". 290
Under the Anglo-American Law, the customer
should be entitled to the Injunctive relief only when he could show irreparable damage, for example, if he had deposited cash with the issuing bank and the bank was in danger of insolvency, but that. where the credit was issued merely against the promise of the buyer to indemnify the bank, the former can in no way control the discretion of the bank in paying out its funds under the credit. In sztejn v« 2 Henry Schsoder Banking Corporation, the plaintiff in New York contracted to purchase a quantity of bristles from a supplier in India* Payment under the contract was to be effected by an irrevocable letter of credit. The letter of credit provides that the drafts by the beneficiary for a specified portion of the siile price would be paid by the defendant bank upon shipment of the merchandise and presenta- tion of an invoice and bill of lading made out to the order of the bank. The letter of credit was delivered to the beneficiary by a correspondent of the issuing bank in India. Both the bills of lading and the invoices described the material shipped exactly as required in the credit as bristles. 29^
The plaintiff alleged that the beneficiary
had filled the fifty crates with cow hair and other worthless material and rubbish, with the intend of simulating the merchandise and defrauding the plain- tiff then alleged that the beneficiary had drawn a draft under the letter of credit to the order of the correspondent bank in olndia for collection. The correspondent bank presented the draft and dociiments to the issuing bank for payment. The plaintiff there- upon brought an action seeldng that the letter of credit be declared void, and asking for an injunction to prevent of the drafts. Justice Shientag observed!
" I t would be a most unfortunate inter-
ference with business transactions if a bank before honouring drafts drawn upon it was obliged or even allowed to go behind the doctiments, at the request of the buyer, and enter into controversies between buyers and the seller regarding the quality of the merchandise shipped. If the buyer and the seller intended the bank to do this they could have so provided in the letter of credit itself, and in the absence of such a provision the court will not demand or even pennit the bank to delay drafts which are proper in form". But he further said} "this is not a controversy between the buyer and seller concerning a mere breach of warranty regarding the quality of the merchandise. OJ
On the present motion, it must
be assumed that the seller has Intentionally failed to ship any goods ordered by the buyer. In such a situation,where the seller*s £raud has been called to the bank's attention before the drafts and documents have been presented for payments» the principle of independence of the banks' obligation under the letter of credit should not be extended to protect the unsczupulous seller It is true that even though the documents ojr forged or fraudulent, if the issueing bank has already paid the draft before receiving notice of the seller's fraud, i£ will be piayteeded if it exercised reasonable diligence before making such payment.
The restraint which was granted, in
SJZTezn's case is subject to two impori:ant qualifi-
cations. First^ that the bank which was collecting the draft was s^erely acting as the agent of the seller. This point is significant because if the drafts had been negotiated to a third party, the court would have not restrained payrant. Secondly, the case proceeded on the basis that fraud has been established. The difficulty which most buyers face in practice is establishing that fraud had taken place, Vfhen the buyer is merely alleging that the seller has been fraudulent* as opposed to actually establishing fraud. 30
the courts are normally cjulte reluctant to interfere.
Equally, if the drafts drawn under the credit had been negotiated to the holder in due course, the courts again will not interfere with the payment Both these facts were taken into account by Megarry 3 J, in Discount Redards v» Barclays Bank, when he dismissed the buyer's application to stop the issuing and confirming bank from making payment under the letter of credit. In this case, the plaintiff, an English company, ordered from a French Canpany, 8,625 gramophone records and 825 oassetters. A confirmed irrevocable letter of credit was opened by the buyers through the defendant bank. When the goods were delivered, the plaintiffs found that only 275 records were as oi!"dered and that 75% of the cassetters delivered vfere not as ordered. The Inspection of the goods was done in the presence of a representative of the bank. The plaintiffs instructed the Bank not to pay on the ground that the seller had acted fraude- lently. Counsel referred to Sztejn's case for the proposition that where the seller's fraud has been called to the bank's attention before the drafts and documents have been presented for payment, the 3o:
principle of the Independence of the bank's obliga-
tion under the letter of credit aught not to be extended to protect the unscrupulous seller* In dismissing the application, Megarray J, distinguished Szte^n's case on two grounds. First, that Satejn's case was dealing with established fraud and secondly in that there was an absence of any possible holder 4 in due course. He saidt
" In the present case, there is,
of course, no established fraud, but merely an allegation of fraud, I do not say that the doctrine of that case is wrong or that it is incapable of exten- sion to cases in which fraud is alleged but has not been established, provided a sufficient cause is made out".
Adding the usual caution against undue inter-
ference with the bank's payment obligations, 5 Megarry J, saidg
" 1 wouflid be slow to interfere
with bank*s irrevocable cre- dits, and Hot least in the spare of international banking, unless a sufficiently grave cause is shown, for intejrventions by the Court that are too ready or too frequent might gravely impair the relliance which, quite properly, is placed on such credits". 30.
The difficulty of establishing actual fraud
has been one of the causes which has prevented the plaintiff from getting an injunction. In United city Merchants ( investments) Ltd, v* Boyal Bank of Canada, the House of Lords further decided that a plea of fraud will only apply If the person applying for payment is a pazrty to the fraud. The plaintiff in this case agreed to sell to peruvian buyers equipment for a glass fibre making plant, Paj^ent was to be by way of a letter of credit. The contract of sale provided that shipment was to be made on or before December 15, 1976, The goods were loaded on boardship at Flen±4towe on Deceotiber 15, but the loading agents issued a set of bills of lading on December 15, stating that the goods were"received for payment". The defen- dant bank objected to the bills of lading on the ground that they were not on board bills of lading. The carriers freight brokers then issued a fresh set of bills of lading stating that the goods were loaded on board ship at London on December 15, The bank again refused to pay, this time on the ground that they had information which suggests that shipment had not been made on the date stated in the bills of lading. In an action by the plaintiffs against the bank, the bank 304
conteiided they were under no obligation to pay i£
the documenta presented although conforming on their face with the credit, nevertheless contain seme statements of material facts which were not accurate. This contention was rejected by the House of Lords on the ground that to accede to it would undermine the whole system of financing international trade by means of documentary credits. Lord Diplock saidt •• The exception for fraud on the part of the beneficiary seeking to avail himself of the credit is a clear application of the maxim exturpi causa non orifxxr actio or, if plain English is to be preferred, fraud unravels all". The Courts will not allow their process to be used by a dishonest person to carry out the fraud. The instant case ,however, does npt fall within the fraud exception".
In spite of the fact that the Courts have
expressly acknowledged the existence of the fraud exception, they have, however, shown extreme reluc- tance to apply the rule lest any damage be done to the confidence in this system of payment. As in the case of Bolivinter Oil S,A, V . Chase Manhattan 7 Bank, the court granted an injunction against the 30o
beneficiary of the credit of/performance bond but
left the bank free to honour their obligations if they chose to do so* The plaintiff's in this case were freight contractors who entered into an agre«nent with Homs, an Iranian Company to carry 238 million tons of Iranian cnide Oil to Syria, The plaintiffs' gave Hone a performance bond for US fi million payable at your first request without any other producers whatever from your side". There was some delay in the performance of this contract and Homes made a claim on the plaintiff. The parties entered into second freight agreement and it was agreed that the performance guarantee would be released upon the arrival ofthe cost vessel carrying oil to Syria, The plaintiffs agreed to provide Homes with a letter of credit for US^ 4,3 million to cover their disputes. In spite of the argument Homes made a claim under the performance guarantee. The plaintiffs obtained injunctions against Homes# the issuing bank and the confirming bank« the commercial bank of Syria from paying out on the performance guarantee, Staughton j. diacharged the injunctions against the issuing and confirming bank in a subsequent hearing and the 30 J
plaintiff*a appealed againat this deciaion. The
plaintiffs contended that the injunction was sought to prevent the beneficiary from profiting from his own fraud. The court of Appeal decided that this was not a case of established fraud*
It is clear from the above decisions that
courts maintain a great and fundamentally important separation between the rights of the peurties under the underlying contract and the rights of one of them under the independent banking contract.
Whether fraud has been established in any
given case is a question of fact and closely related to this is the question of the burden of proof that lies on the plaintiff before a case of fraud is made out. The issue was considered by the court of Appeal g
in United Trading Corporation v. Allied Arab Bank.
The plaintiffs in this case contracted to supply Agromark, a state enterprise in Iraq* with eggs, chicken* lamb and beef, A total of 19 contracts* worth some US ^ 950 million were involved. The plain- tiffs provided the buyers with a performance guarantee of 10% of the total value of the contract. The 3o;
guarantee payable unconditionally against any claim
for damages was given hy Rafidian BanX in Iraq on behalf of the plaintiffs. The buyers made a claim under the performance bond and the plaintiffs sought an injunction against the issuing and the confirming bank to restrain th«m from paying under the guarantee. The plaintiffs contended that the buyers were acting fraudulently in that the claims related to contracts which had been satisfactorily perfoinmed many years before. The court of Appeal was of the view that the plaintiffs have established a seriously arguable case that fraud Y^ad occiired but on the balance of convenience, they would not grant the injunction, 9 Ackner L.J. said. The evidence of fraud must be clear, both as to the fact of fraud and as to banlcs knowledge. The mere assertion or allegation of fraud would not be sufficient. The Courts require strong corroborative evidence of the allegation, usually in the form of contemporary documents, particularly those emanating from the buyer. In general, for evidence of fraud to be clear, courts would also expect the buyer to have been given an apportunity to answer the allegation and to have failed to provide any, or 30J
any adequate euiswer in circumstanoes where one could
properly be esqpected* where the Courts consider on the material before it the only realistic inference is that of a fraud* Then the seller would have made out a sufficient case of fraud.
Commenting on the reluctance of the courts to
10 apply the exception in practice, AcJcner L,J« observed!
"Moreover we would find it an unsatis-
factory position if, having established an important exception to what had previously been thought an absolute rule, the courts in practice were to adopt so restrictive approach to the evidence reguired as to prevent them- selves fran intervening were this to be the case, in pressive and high sounding phrases such as fraud unravels all".
It is well recognised that letter of credit lore
their economic viability if they are constantly subject to delay or uncertainty. Letters of credit work well only if payment under theOR . is pranpt and inevitable when the beneficiary's documents are in order. C«nmer- cial law has always recognised the high cost of fraud, however, and some courts are justifeably concerned that the credit not become a device for perpetrating fraud. In cases of fraud, courts have been willing to resort to their ecjuity powers to delay payment of the 30o
credit unfortunately, courts are not in a position
to know whether an account party's claim of fraud is valid« and sometimes are properly reluctant to entertain the fraud defence of an issuer or of an account party seeking to enjoin honour of the credit. The fraud inquiry entails considerable investigation and time, if courts delay honour of credit until the parties have litigated the fraud issue, the credit will not survive as an efficient cannmercial device and will not achieve some of its significant commercial functions. Although there is a split of authority on the scope of ffaud question, even those courts that given the fraud defence broad scope acknowledge that the costs of doing so are high.
Section 5-111(1) of the Uniform Commercial
Code imposes on the beneficiary of a letter of credit a warranty obligation. The statute provides that the beneficiary transfer or presentation of a docu- mentary drafts or demand for payment warrants to all interested parties that the necessary conditions of the credit have been complied with.
First, the existence of warranty often gives
the complaining account party an adequate remedy at 310
law and should deprive him or her of the Equitable
relief so Often sought at great expense to the letter of credit transaction. Second, the warranty gives independent significance to the beneficiary's certi* ficate common in perforraance guarantee transactions and thereby over-comes the impliaation that the purpose of the certificate is to give the account party/beneficiary a fraud defence to a claim for payment under the credit. Third, the warranty relieves the account party from sometimes burden some proof problems in his or her action for damages against beneficiary that has obtained payment under the credit with documents that contain latent defects.
In performance guarantees, the credit commonly
requires the beneficiary to certify - - ^i_ that the account party has failed to perform his or her executary permission. This is also known as a certificate of inspection. A certificate of inspection is a document which is issued by some one designated euMl by both parties, or by a third party that is asked to inspect the goods prior to shipment or at the moment of shipment, or whatever is the nature of credit. It may be a construction of something,it may be, now-a-days drilling equipment or whatever, a certificate of inspection is a documents then which 31
says, " I have inspected that which is to be
inspected under the credit. I hereby render an opinion that this is in accordance with that was 12 stipulated to be the goods or service to be performed" , The requirement of other documents, and particularly certificates of analysis, quality, weight and the like, is a reasonable precaution for a prudent buyer to take, since he may in this way obtain some measure of assurance that the merchandise is as ordered. Courts unaware of the beneficiary's warranty may be inclined to see these certificates as a protection against the beneficiary's fraud, under this view the account party has insisted on the certificate in order to have a fraud defence should the beneficiary present a false certificate. This view beccmies all the more compelling when the certificate referes to the underlying contract by reciting for example, that a sum is due under a contract or a lease. In these cases, the courts are wont to say that the certificate incorporates the under- lying contract and opens the letter of credit litiga- tion to the resolution of underlying contract disputes, that is, whether the sxun is in fact due. It is impor- tant to recognise that the certificate plays an important role in the transaction without serving as a vehicle for 312
entering the underlying dispute in the credit
transaction. It is true that the warranty forces the court to look beneath the face of documents but the warranty inquiry occures after the credit is paid and does not interfere with the proper functioning of the credit,
Cotirts can achieve two desirable results by
giving full rein to warranty provisions. First, they can enhance the remedies for a defrauded account party. Second, they can reduce the number of orders restraining issuing bank from paying credits. This first result puts fraud costs on beneficiaries withoat damaging the credit. The second protects the credit device from the impredictable costs and delays that equitable interference inevitably imposes on credits in general By reducing these costs and delays, courts will enhance 13 •to the benefit of all industries that use them,
A ccMiunercial letter of credit is independent
of the underlying sales contract between the customer and the beneficiary. The issuers responsibility:K >to honour a draft drawn under the credit is not affected by the sellers* breach of warranty concerning the quality or the conditions of goods involved. Thus in the usual course the issuer must honour the draft for 313
payment that complies with the terms of the relevant
credit, regardless of whether the goods or dociiments conform to the underlying contract. However, where the documents or the underlying transaction are tainted with the beneficiary's intentional fraud the issuer need not honour the draft even though the documents comply on their face, A proper definition of fraud will necessarily encompass and be limited by the recjuirement of scienter, that there be an affir- mative, knowing misrepresentation of fact or that the beneficiary state a fact not having any idea about its truth or falsity, and in reckless disregard of truth.
The stand-by letter of credit is useful in
such transactions precisely because it allows the parties to shift the risk of unjustified demand from the beneficiary to the custaner. This legitimate purpose can best be served by a narrow definition of fraud in the transaction. A strict definition of fraud in the transaction would ultimately made the standby letters of credit more valuable v/here it is appropriate and thus preserve its usefulness in commer- cial transactions.14 J14
Such a Btand«rd would not destroy the
coinmercial utility of letters of credit because it serves no commercial purpose to provide certainty of payment to one who has intentionally deceived other parties to a transaction. Nor would such a standard make injunctions readily available. Not merely fraud be pleaded with particularity, but also the four traditional factors Justifying a preliminary injunction must be considered, First the probability that the plaintiff will eventually succeed on the merits; second, the presence of irreparable injury to the plaintiff; third, the injury to the defendant if the injxinction is granted; and, finally, the interest of the public or third parties.
It is clear that the fraud exception is now
firmly recognised by the English Courts, in spite of this recognition one seases an extreme reluctance by the courts to apply it in practice for fear that irre- porable damage would be done to the system of payment that has grown up with the letter of credit. The Courts have strived to maintain confidence in this system of payment at the expense of a few individuals who have entered into inexpedient contracts and this is by no means a bad thing. 31J
The letter ot credit to-day Is an extremely
useful and viable financing device« both In the sale of goods transaction traditional/and In the more recent performance guarantee. In the future the letter of credit will become Increasingly Important In both International and domestic earamercial and business transactions. As the letter of credit grows in popularity the principles of law applied to th«n- must be more fully elaborated if their efficacy is to be maintained, in case of letter of credit of international trade requires presen- tation of documents prepared independently of the beneficiary. In the case of performance guarantee the documents called for is usually the beneficiary's own certificate that the other party to the underlying transaction is in default there under an open initiation to abuse by the unscrupulous beneficiary. In any events instances of fraud involving performance guarantee appears ^ to be much ra«er than theoretical fears could indicate. Loss of reputation in the interna- tional community is a severe and immediate sanction awaiting a dishonest beneficiary. Indian poaltlon
Vfhether a bank guarantee has become enfor-
ceable or not wiil depend on its terms and the language of the letter of demand. In other words. In case of bank guarantee or a letter of credit the enforceability of such an instrument against the bank depends on the terms and conditions of the same. In practice, the questions that most frequently arise relate to the guarantor's liability. The guaranteeing bank is liable for non-performance of the underlying contract. This much is elementary and flows from the very nature of the contract. But in practice there arises questions of enforcement. Is the guaranteeing bank entitled to defnahd proof of non-performance, or is it bound to comply with the guarantee as soon as it is called upon to do so 7 If the former is the case, then there can possibily arise disputes as to non-performance. This is likely to drag in the conflict between the Principal and the beneficiary in the correspondence between the guarantor and the beneficiary. On the other hand, if the beneficiary and the bankioat to avAid such three dimensional controversy, the guarantee can either be made absolute and unconditional or at least JIV
some acceptable mechanism for concrete proof of non-
performance may be laid down in the contract of guarantee.
The same principles of Law which have been
adhered to and accepted by the courts in England and the United States have been adopted and adhered to by the courts in India as well. In Ten Maco Ltd, v, 16 State Bank of India and others^ it was held that the bank must pay according to its guarantee, on demand, if so stipulated, without proof or conditions. The only exception is when there is a clear fraud of which the *tbank has notice. The facts of the case wh«=»re that at the request of the Pet|:tdkoner company the respondent bank had given an irrevocable and unconditional performance guarantee in favour of the State Trading Corporation of India Ltd, ( S,T,C, ) which provided interalia that in the event of the company's failure to fulfil their contractual obligations the bank shall pay to S,T,C, on its first demand the guarantee amount without any contestation, demur or pro-test and/or without amy reference to the ccmipany and /or without questioning the legal relationship subsisting between S,T,C, and Texrmaco, The guarantee was later invoked by the S,T,C, and asked the bank for full payment. 313
the petitioner company there upon filed a suit.
A question, therefore« arose whether the Textnaco was entitled to the Injunction as asked for, res- training the bank from making any payment to the S,T»C, In pursuance of the performance guarantee.
The Court said that In the absence of any
special equities and the absence of any clear fraud, the bank must pay on demand, if so stipulated and whether the terms are such must have to be found out from the performance guarantee as such* Though the guarantee was given for the performance by Te^^aco In an orderly manner their contractual obligation was taken by the bank to repay the amount on first demand and without contestation, demur or protest as without reference to Te^^aco and without question the legal relationship subsisting between S.T.c. and Termaco. The performance guarantee fxorther provided that the decision of S.T.C. as to the liability of the bank under the guarantee shall be final and binding on the bank. It has further stipulated that the bank should forthwith pay the amount due " notwithstanding any dispute between S.T.C. and Texmaco." In that context the moment a demand is without protest and contestation the bank is obliged to payirrespectlve of any dlsjmte as to whether there has been performance In an 31J
orderly maaner of the contractual obligation by
the party. There was no question here of any fraud or
equity entitling Tcamaco to an injunction.
Another case on the subject is National Oils
and Chemical Industrie3« Delhi v, Punjab and Said Bank n Ltd.J Delhi. In this case it was contended that a confijnmed letter of credit constitutes a bargain between the banker and the vendor of the Qoods^ which imposes on the bank an absolute obligation to pay irrespective of any dispute which there may be between the parties and it would be wrong for the courts to interfere with that established practice by granting and in confirming the injunction, because an eleborate coramercial system has been built upon on the footing that the bankerts confirmed credit raises an rassurance that nothing will prevent the vendor from receiving the price, that the character-istlc feature of the irrevocable credit own is its/independence of the contract for sale and of contract between the banker and the buyer and that ano- ^^®^ important feature is the duty of strict compliance being a mechanism of great* importance in international trade, interference with which is bound to have serious 32
repercussions on the international trade in the
country and that the letter of credit being the life blood of international commerce and except possibly in clear cases of fraud of which the banks have notice, the courts ought to leave the merchants to settle their disputes under the Contract by litigation and arbitration available them as stipulated in the contracts, the courts being not concerned with the difficulties of the merchants to enforce their claims because these are the risks which the merchants take*
In case there are serious allegations of fraud
on prima facie examination of the said allegations in the light of the averments of the parties, the matter cannot be allowed to rest at that and deserves to be fully probed and determined. In such a case the principle of Independence of bank's obligation under the letter of credit is not to be extended to protect the unscrupulous seller.
Pesticides India v, S«C^ and p. Corporation
of India, raised the question of performance guarantees by banks, particularly in the light of the absolute nature of liability: of the principal debtor on whose behalf the guarantee was given. In the instant case J2'^
the £act8 were*
W« the Statui Bank o£ Bikaner and Jaipur,
Udalpur bind ourselves xincondltlonally and Irrevocably guarantee and undertake that in the event of any default/ failure on the part of the Actual user/ Allottee to observe all or any of the conditions prescribed/ to be prescribed by you. We shall on your first demand without protest or demur and without reference to the Actual user/Allottee and notwithstanding any contestation by actual user/Allottee or existence of any dispute whatsoever between you and the Actual user/ Allottee pay forth with to you that you may deanand.
It was held that the bank was bound to pay on
the first demand without any contestation by the Pesticides India, the principal debtor. Thus according to the Court the unqualified terms of the guaranttee could not be interfered with by the courts, irrespec- tive of the existence of the dispute.
The above has been supported bv the Supreme
Court in Centeen (India) Ltd. v. Vlnmor/lnc. The point before the Suprane Couri; was whether in view of its earlier decision in United Cooanercial Bank v. Bank of 20 India* it could interfere to grant Injunction for th Enforcement of the bank gueurantee. The sellers, a 322
Singapore oonoern, agreed to sell high density
polythene to the buyer^ em Indian Company^ Canteix (India) Ltd. on the basis of an irrevocable letter of credit in favour of the former. The buyer complied with the condition. The seller failed to forward, through bank, the original bills of lading, marine insurance policy, signed invoices etc, to enable the buyer to take the delivery of goods. The buyer secured bank guarantees In favour of the shipping Company, where-after the latter released the goods to the buyer without furnishing to it the above documents. The buyer receive the goods, sold them and realised the sale proceeds* But no amount was paid to the seller. The buyer brought a suit for res- training the bank from paying the money on the alleged ground of inferiols quality of goods. The Supreme Court held that the balance of convenience was that the injunction should not be granted. Affirming the deci- sion of the High Court the Supreme Court held that commitments of banks must be allowed to be honoured free from interference by the courts, otherwise, trust in international ccxnmerce would be irreparably damaged.
The courts usually r«frain from granting
injunction to restrain the performance of the contractual liZ.
obligations arising out o£ a letter o£ cjredlt or
bank guarantee between ane bank and another. If temporary Injunctloas were to be granted In a tran- saction between a bank and a banker, restraining a bank fvon recalling the amoiint due when payment Ip made under reserve to another bank or In terms of the letter of credit executed by lt« the whole banking system In the country would fall. In view of the Banker's obligation under an Irrevocable letter of credit his buyer customer cannot Instruct him not to
In the following cases the enforcement of bank
guarantee as a qpilck mode of recovery of sums due under the printed terms of the contract has been considered and the law Is almost settled.
In National Project Constinictlon Corporation
22 Ltd. V. M/s G. Ranjan^ the bank guaranteed the recovery of the sumof te, 3,50«000 by the petitioner,corporation. The bank guarantee provided If the said contractor faljs to utilise the said advance for the purpose of contract we the Bank of Baroda, hereby unconditionally and Irre- vocably undertake to pay the corporation on demand and without demur and any claim made by the corporation on :i2
us for the loss or damage caused to or suffered by
reason of the corporation not being able to recover In full the said sunt*
The trial court Issued an Injunction res-
training the corporation from enforcement of the bank guarantee. The Calcutta High Court allowed the revision application and set aside the order of injunction. The Court cited with approval the deci- sion of the Supreme Court in MSEB Bombay v» Official 23 Liquidator^ The Cotxrt held thusi
** The petitioner is entitled to fall
back upon the bank guarantee when the balance sum had not been paid petitioner's right to realize that balance is not dependent upon adjudica- tion of the dispute to arbitration* To this extent^ the bank guarantee can very well be enforced on its own terms,"
The law is thus settled that extraneous claims
and counter claims do not injunct the enforcement of the bank guarantee. The enforcement depends upon its terms and conditions.
In a recent case D»T»H, Construction (P) Ltd,, v,
24 Steel Authority of India,,# the Calcutta High Court refused to issue an injunction restraining the :idJ
enforcement of bank guarantee. The contract In the
Inatant case was for dredging and deepening a reservlor and the plaintiff received from the defendant No«l Rs, 30 lakhs for bringing machinery for the work, A survey revealed that the reservoir could neither be dredged nor deepened because of the brlck« railway tracks and rocks under neath. The judge did not accept the Contention of the bank that under section 56 the guarantee was rendered void an account of Impossibility of performance. The Judge observed:
Even If the main contract between
the plaintiff and defendant No.l was entered Into by the plaintiff on account of lackof knowledge of certain facts by the defendant No,l or even because of misrepresentation made by defendant No, 1, the bank co\ild have no say In the matter. This Is now %rell established by several decisions of this ootirt as well as the Supreme Coxirt and of the English Courts, 25
The decision correctly follows the judicial
preeedctata and Is grounded on the theory that the contract between bank and defendant No,l was Independent 26 of the Contract between the plaintiff an6 defendant No,l
Again, In United CCTtimerclal Bank v, Hanuman~
27 Synthetlces Ltd,, the latter agreed to buy from a 323
Singapore concern specified quantity of vis core
staple fibre. The purchasers opened an irrevocable letter of aredit at the Central Bank of India in favour of the seller. The United Commercial Bank Singapore, paid the amount ag2Li.n8t the documents for the goods shipped and forwarded them to Central Bank of India, Bombay* The united Commercial Bank refunded the amount on arrival, the customs authorities declared that the imported stuff was not vis core but polyester fibre. The purchasers asked its bank to repudiate its liability and sought a perpetual injunction against it from making any payment or giving credit to the seller an^er the irrevocable letter of credit. The Court held that except possibly in clear caMe of fraud of which the banks have notice, the courts will leave the merchants to settle their disputes under the contracts by liti- gation or arbitration as available to them or stipulated in the contract.
If the bank guarantees are unconditional the
bank has no defence when its guarantee is sought to be enforced. It iai :th« document of guarantee that has to be scanned to ascertain whether the guarantee is conditional or otherwise and whether it is an autonomous contract by itself. Only in case of a clear fraud of which the 327
bank haa notice and where the special equity was
in favour of the beneficiary - the courts may grant an injunction restraining enforcement of bank 28 guarantee*
Recently Sabyasachi Mukharji and Jagannatha
Shetty, JJ, of Supreme Court have considered the various Supreme Court and High Courts cases in U»P. Co«>operative Federation Ltd, v» Singh Consultants and 29 Bngineers (P) Ltd, The Court heldi
The principles upon which bank guarantees
could be invoked or restrained are well settled, only in exceptional circumstances would the courts interfere with the machinery of irrevocable obligations assured by the banks. In the case of a confined performance guarantee^ Just as in the case of a confined letter of credit, the bank is only concerned to ensure that the terms of its mandate and confizitnation had been complied with and is in no way concerned with any contractual disputes which might have arisen between the parties. Therefore the commitments of banks must be honoured free from interference by the courts, otherwise trust in commerce* internal and international, would be irre- porably damaged. It is only in exceptional cases of 32J
fraud or in cases of irretrievable injustice to be
done* the courts should interfere.
The facts of the instant case were that the
appellant, a State Government enterprise, on May 17, 1983 entarttd into a contract, a private limited company for the supply and installation of a vanaspati manufacturing plant at Hardeecharu in the District of Nainital. The contract bond contemplated guaranteed performance of work at various stages in accordance with schedule prescribed therein and provided for completion and commissioning of the plant after due trial run by the May 15, 1984,
Two bank guarantees were executed by the
Bank of India, Ghaziabad, and the bank guarantee provided, inter alia as followsi
Now, therefore, the Bank hereby guarantees
to make unconditional payments of Rs, 16,5 lacs to the Federation on demand at its office at Lucknow without any further question or reference to the on the seller's failure to fulfil the terms of the sale on the following terms and conditionsi (A) The sole judge for deciding whether the seller has failed to fulfil the terms of the sale, shall be the PCB. a2j
(B) This guarantee ahull be valid upto twelve
months from the date of is8ue«i,e« upto June 24,1984« (C) Claims, if any, must reach the bank in writing on or before expiry date of this guarantee after which the bank will no longer be liable to make payment to PCF.
(D) Bank's liability under this guarantee
deed is limited to 16,5 lacs ( Rupees sixteen lacs fifty thousand only )«
(£} This guarantee shall not be revoked by the
bank in any case before the expiry of its date without written permission of the Federation,
And whereas to secure the said advance, the
seller requested the bank to fxirnish a Bank guarantee of the said amount of Rs. 33 lacs ( Rupees thirty three lacs) in favour of the PCF and the bank accepted the said request and agreed to issue the required bank guarantee in favour of the Federation,
Now, therefore, in consideration of the
aforesaid advance of the said sum of Rs, 33 lacs (Rupees thirty three iacs) to be paid by the PCF to the seller as aforesaid the bank hereby agrees and guarantees to make unconditionally immediate payment to the Federation at its office at Lucknow of the sum or any part thereof. 33d
as the case may be, due to PCF from the seller
at any time on receipt of the notice of demand without any question or reference to the PCF or to the seller on the seller's failure to fulfil the terms of the said advance.
In the instant case, injunction was sought
against the bank and not against the respondents, it was held by the Supreme Court that the net effect of injunction was to restrain the Bank from performing bank guarantee. That could not be done.one cannot indirectly do what one is not free to do directly. But a mal ~ treated man in such circumstances is not remedyless. The respondent was not to suffer any injustice which was irretrievable» The respondent could sue the appellant for damages. This is not a case where an injunction can be granted. Irrevocable ccxnmitment either in the form of confirmed bank guarantee or irrevocable letter of credit cannot be interfered with except in the case of question of apprehension of irjretrievable injustice , This is a well settled principle of law in England, This is also a well settled principle of law in India, 33x
Each case has to be examined In the light
of the followingI
(1) Whether demands for enforcing the bank
guarantees has been made strictly In accordance with the terms of the document concerned; or
(2) Whether there is any allegation of fraud
against the beneficiary of which the bank has notice; or (3) Whether there is any special equity arising out of the peurticular situation of the case giving rise to a strong prima facie arguable case against enforcement of the bank guarantee or not. This test was applied in f^/s Banerjee and Banerjee v, Hindustan Steel Works Construction Ltd, in the instant case the bank guarantees were g]bren pursuant to the express terms of the contract entered into between the peti- tioner, a principal debtor and the respondent No.l, a beneficiary, a company for constjruction of works in the Super power Thermal project. Out of the seven bank guarantees, two were in lieu of security deposit and five were for securing mobilisation advance by the respondent No.l to the petitioner under the terms of guarantees^ for enforcement of the guarantees the respondent No,l had to make a written demand stating 33^
that the petitioner has coramitteed breach of any
terms of the contract and the extent and the quantum of JLOSS or damage suffered or to be suffered by the respondent No.l as a result thereof. The decision of the respondent No«l regarding the quantum of damage was not to be questioned or challanged by the banks or fulfilment of these tvro conditions, the bank was bound to release the guaranteed amount. However the respondent No.l while seeking the enforce- ment of the bank guarantees failed to discharge its duty as the sole Judge to quantify the damages and to mention the extent of recoveries made by it although it was within its special knowledge. Although a large amount was recovered by the respondent No.l there was no whisper about the same in the demand letters.
It was held that by suppressing the material
fact from the bank the respondent No, 1 attempted to recover the entire sum under the seven guarantees and the suppression of such material fact in the demand letters have given rise to a special equity in favour of the petitioner to stop payment by the bank on the basis of these demand letters. Although in the 33o
petition, there was no allegation of fraud, the
said wilful flase representation by the beneficiary that the entire guaranteed amount has become due and payable by suppressing the facts of recoveries already made, was a factor, which must be treated on the same footing as fraud giving rise to a special equity and must be treated as an exception to the general rule that the court should not Inter- fere In these matters.
Similarly in Jute .^^ corporation of India v#
-31 M/s Konark Jute Ltd,, the principal had given two bank guarantees to the purchasing agent. The principal sought to restrain the purchasing agent of Jute from enforcing the bank guarantee and restrain the banks from making payment thereof. The Court found that the balance of convenience was in favour of the principal. It was held that in the peculiar circum- stances of the case, the receipt of the money on bank guarantee would ruin of the principal which cannot be repaired. The balance of convenience in such a situa- tion would be in favour of the principal. The Court also wanted to protect the business of the agent so that the ends of Justice were not defeated. It, therefore, held that this could be best ,} d -i
done in case the principal securiBd the commercial
rate of interest on the amount on both the bank guarantees £or six months to the satisfaction of the trial court.
In M,S,J,R» Enterprises v« M/s State Trading
32 Corpn, of India Ltd,, the bank guarantee provided that the bank hereby unconditionally and irrevocably guarantee that if the Agents fall to perform any of th^i^obligatlons contained in the contract dated 10,9.1982 including any amendments or modifications to the aforesaid contract dated 10,9,1982 made between the Agents and STC, The bank shall pay forthwith to the STC such amount or amounts as the bank may be called upon to pay subject to the mauclmum of Rs, 10 lakhs pro- vided -that the guarantee herein furnished shall be released and discharged after the expiry of 30 days from the day of the shipment of the I'ost lot of goods, in respect of the export contracts between the STC and the foreign buyers.
It has been held that since prima facie the
guarantee stood discharged and although no element of fraud existed yet the guarantee having been Invoked after it had prima facie esqpired. It was a fit case d:i
that during the pendency of the suit the injunc^on
was granted restraining the corporation frcxn realising the amount o£ the bank guarantee.
Although the courts are not concerned with
the underlying contract on the basis of which the bank guarantee have been given. Yet the situation may arise where the underlying contract was not concluded one. In such a case the cjuestion is v Can there be enforcement of the bank guarantee or not? The Bombay High Court in Kirtoskar Pneumatic Co,Ltd»v, N,T»P, Corpn. Ltd, it was held that there was no contract between the parties to keep to bid alive that the bid could be revoked before the acceptance or the appellant have done, that the respondents did not act to their detriment relying on the bid of the appellants, the bid guarantee c o u M only be invoked if the contract were to be awarded to the appellant•s and they had failed to pay the amount or to perform their part which stage never arose. The respondents could not invoke the bid guarantee in terms of the contract and hence a clear prima facie case exists, where in an injunction can be issued whereby the bank is restrained by making the payment. The court ri * J3
further held that the balance of convenience also
Is clearly in favour of the appellants because even are if the above findings/ found to be wrong all that would happen is that at the end of the litigation Appea- lants would be able to recover the amount of the bid guarantee or such other sum as may be determined by the Court, It is nobody's case that the appellant's are not solvent to the extent of bid guarantee and hence all the conditions of Issuance of temporary injunction are satisfied.
In M/s Synthetic Foams Ltd. v, aimplex C»P«
34 (India) Pvt, Ltd», the facts were that the completion of the contract by the plaintiff has been withheld not due to any default of the plaintiff but due to the intervening fire which has taken place at the site. There is nothing to suggest that the plaintiff has committed any default in the performance of the contract or any breach of the terms of the order, where as the peirusal of letter filed by the plaintiffs shows that the guarantee was sought to be invoked by the defendant No, 1 on the ground that the plaintiff have not fulfilled the obligation contained in the terms and the conditions of the order, which is misrepresentation of facts. secondly, the contract has been cancelled by the defendant No, 1 due to technical reasons and also due to Increase in prices rather than due to any fault of the plaintiff.
The bank guarantee was as follows:
••we, Indian overseas Bank hereby
agree and undertake that if in your opinion any default is made by M/s Synthetic Foams Ltd, in performing any of the terms and/or conditions of the order or if in your opinion they commit any breach of the order or there is any demand by you against ^^/s Synthetic Foams Ltd, then on notice to us by you, we shall on demand and without demur and without reference to M/s Synthetic Foams Ltd, immediately pay to you, in any manner in which you may direct, the said amount of Rs, 1,00,000/- (Rupeea one lakh only ) or such portion thereof as may be demanded by you not exceeding the said seen and as you may from time to time require . ••
The courts ?Iown where there are allegations of
misrepresentation or suppression of material facts or violation of the terms of guarantee, the courts would not hesitate in granting an injunction. In this content, misrepresentation or suppression of material facts or violation of the terms of the guarantee can be treated as a species of the same genus as fraud. What is necessary that there exists special equity in favour of li'S
the pl«dntlff to grant of injunction. No doubt an
obligation of a bank under the bank guarantee is' absolute^ but such an absolute obligation arises only if the conditions of the bond are satisfied and if the demand made on the bank is in strict accord with its terms and there is no element of fraud, misrepresentation or suppression of material facts involved but where there are allegations of fraud, misrepresentation or suppression of facts made by the party against the beneficieiry and there is prima facie evidence to suggest that there is some truth in these allegations then there would possibly be no absolute bar against the courts from granting an injunction restraining the bank fran making payment on the basis of the bank guarantee* Similetr would be the position where the dememd made by the beneficiary is in violation of the conditions of the bond or is not in strict accord with its terms keeping in view the nature of obligation of the bank the terms of the bank guarantee would have to be strictly construed in such cases. Accordingly in the instant case an injunction was granted restraining the defendants from enforcing the bank guarantee. 33-
By enunciating the general principle of non-
interference by the courts in respectof the bank guarantee and letter of credit^ the courts only Intended that the International trade and commerce should function smoothly without interference from court. At the same time, the courts expected that the merchants and traders in international trade and ccwnmerce will honour their respective ccxnmitments and the business honesty would be maintained. By the theory of non-interference in cases of letters of cxredit and bank guarantees, certainly the courts did not intend that international trade and commerce should flourish by adopting dishonest unscmpulous practice. These trade practices and the commitments by the banks are treated on a different level by the courts and are allowed to function without interference frcxn courts only with the view that the trust in inter- national com/nerce is not damaged in any way and not for encouraging malafide activities of unscrupulous traders. If so, fraud or the special equity arising out of the peculiar situation of the case could not have been made exceptions to the general principles of non-interference by courts. REFERENCES
1. (1978) 1 Q,B. 159
2. (1941) 31 N.Y.S. 2d. 631 3. (1975) ILloyds Rep« 444 4« Ibid*« at p, 447 5, Ibid,,at p. 448 6, (1982) 2 Llyod»s Rep, 1 7, (1984) 1 Llyod's Rep, 251 8, (1985) 2 Llyod's Rep, 854 9, Ibid, at p, 561 10, Id, at p. 56 11, John F, Dolan,letters of credit. Article 5 Warranties, Fraud and the BeneiElclary's certi- ficate. The Business Lawyer, Vol, 41 No,2 P, 347 1986, 12, Boriskozolchyk. The letter sif credit In courtj An Export Testifies, Banking Law Journal, 340 13, Supra note 11 14, Mlchhale Stern, The Independence Rule In standby Letters of Credit, The University of ChlcagoLR vol, 52, 1985, 15, Nussbei,um« Temporary Restraining Orders and Preliminary Injunctions, The Federal Practice, 26 S.W,L.J. 265, 273 ( 1972) cited by Edward L, Symons,JR,, Letters of credit. Fraud, Good-faith and the Basis for Injunctive Relief, TULANE LAW R, Vol, 54, 1979, p, 380 (1980) 34
16. A.I.R, 1979 Cal, 44; Indian Cable Co, Ltd, v*
M/s Plastic Products Engineering Co,,A,I,R. 1979 Cal. 370, 17, A,I,R, 1979 Del, 9 18, A,I,R. 1982 Del, 76| A same view has been taken In M/s B,L,R« Mohan y., P,S, Co-op, S.& M, Federation,Ltd, A,I,R, 1982 Del, 357| B.S.Aujla Company Pvt, Ltd, v« Kaluram Mohan Deo Prasad, A.I.R, 1983 Cal, 106; Banwarl Lai v, Punjab State Co->op, and s,& M, Federation Ltd,(Dell^l} A,I,R, 1983 Del, 86 19, A,I,R. 1986 S,C. 1924 20, A«I.R, 1981 S,C« 1426 21, Supra note 19 at 1927 22, A.I.R. 1985 Cal.23 23. A.I.R. 1982 S.C. 1947 24. A.I.R, 1986 Cal, 31 25. Id.« at 38 26. I.e. Saxena, Law of Contract, ASIL Vol. XXII, P. 98 (1986). 27. A.I.R. 1985 Cal, 96; The Calcutta High Court noted and approved the decision of the Supreme Court In Tarapore & Co., Madras v. V.D, Tracta Export MOSCOW, A.I.R. 1970 S.C. 891, the Court shduld not freese the amount of the Irrevocable letter of credit. 34-:
28. A.I.R, 1985 Mad. 213; State v, M/s M.K, Patel
& Co., A.I.R. 1985 Guj. 179 29. (1987) 8 Reports (S.C.) 567; In M/s G,S. Atwal & Co, (Engineers) Pvt.Ltd, V. N.P, C. Ltd.. A.I.R, 1988 Del. 243, it kaa been held that where there is a mere allegation without any prima facie proof of fraudulent act- the courts cannot and should not interfere without bank guarantee by issuing an injunction; M/s Escorts Limited v. Modern Insulators Ltd., A.I.R. 1988 Del. 345. 30. A.I.R. 1986 Cal. 374; Allied Resins & Chemicals Ltd., V. M&M. Trading Corporation, A.I.R. 1986. Cal. 346. 31. A.I.R. 1986 Ori. 238| M/s Brul Mxumgan Traders v. R.C. & F. Ltd., Bombay, A.I.R. 1986 Mad. 161. 32. A.I.R. 1987 Delhi 188 33. A.I.R. 1987 Bom. 308 34. A.I.R. 1988 Del. 207
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