INTRODUCTION

With the increment in trade or business within the country or across the
globe, there develops a must need of some credible or reliable source for
protecting and reducing the risks in the trade or business transaction. As in
present business environment the transaction related to business happens to
be done globally where parties being at a distance from one another, so an
institution is required to fulfill the very purpose of guarantee which is
ensuring security to payments and ensuring security to the claims, so for
this very purpose the idea of bank guarantee was presented. Bank
guarantee is considered as the “life-blood” for the purpose of trade both
domestic as well as international. 1

CONTRACT OF GUARANTEE

Contract of guarantee is well explained under Section 126 of The Indian

Contract Act, 1872 which defines it as “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’. A guarantee may be either oral or written."

BANK GUARANTEE

Contract of bank guarantee is a contract between three parties that is the

banker,“the beneficiary or the debtor and the creditor in this type of contract
the bank becomes the surety for the exchanges between the debtor and the
creditor. Bank guarantee is a contract which is in the written form given by a
bank on behalf of a client which undertakes to pay or discharge the liability
of the debtor if there be an occurrence of any default. Essentially, the
principle of bank guarantee is implemented for the free flow of trade as a
guarantee offered by the bank protects the borrower from failure and also
helps the creditor to claim the debt in the event of any default without
preferring the litigation method.”

For”Example: Mrs. 'X' leases her home to Mrs. 'Z' for a sum of Rs. 2,00,000
per month. Mrs. 'X' insists on a bank guarantee from Mrs. 'Z' 's bankers,
suppose the Bank of Baroda for Rs.2,50,00,000 to compensate her in case
Mrs. 'Z' refuse to hand over the possession at end of the lease period. Here,
Mrs. 'Z' is the principal debtor, The Bank of Baroda is the surety and Mrs. 'X'

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Avtar Singh, Contract and Specific Relief
is the creditor. For any default of Mrs. 'Z' Mrs. 'X' can indemnified directly by
the bank of Baroda.”

In order to reduce transaction risks, the concept of bank guarantee is

essentially introduced. Bank guarantee has enabled different new firms to
set“up efficiently, now firms can also start up with small sum of money. The
Entrepreneurs who start their business don't have a large amount for
investment are greatly benefited as now they can raise their money in credit
with the help bank as a Surety and the creditor also in the name bank can
give loans without risk as if the debtor couldn't pay then the bank could
reimburse them. Bank guarantee is one of the reliable source of exchange
and reduces the risk of purchases in business. Not only does the Bank
promise protect the lender, but it also secures the buyer's advances or
reward.”

According to the importance and requirements, different types of Bank

guarantee are used in different circumstances such as:
 Advance Payment Guarantee.
 The Payment Guarantee.

Advance Payment Guarantee-

In general, this type of guarantee is used in business transactions, including

exports and imports, but is also extended to domestic trade. The purchasers
of goods exert this guarantee to secure the advances made by them. For
example suppose Mrs. 'X' orders television for her home from Mr. 'Z' the
seller, Further Mr. 'Z' wants some advances before the delivery of television,
advances were paid by Mrs. 'X' but latter on the television was not delivered
and Mr. 'Z' declared the agreement to be void, so in such kind of cases Mrs.
'X' can recover her advanced money from the guaranteeing bank. As in the
case of Meritz Fire & Marine Insurance Co Ltd v Jan De Nul NV,(137 Con LR
41) the opinion of the Court of Appeal affirmed that, in this situation, the
advance payment assurances received can be restored, since it is the
primary duty of the guaranteeing bank to pay when the appropriate
documentation are provided.2

The Payment Guarantee-

In general, this type of guarantee is a kind of debtor or buyer's pledge or

promise that renders the debtor or buyer responsible for the loan. The
additional benefit of "cash assurance" is that it provides additional protection

2
Available at : www.nordea.ru
as the guarantee is applied to some co-lateral assets and properties as well.
Most often this kind of insurance is used as an Indemnity by the lending
agency or bank. If the bank paid the debtor's default to the creditor, the
bank may recover the sum from the debtor's collateral security. This is an
additional, non-conditional guarantee to exporters that enhances transaction
security.3

Other bank guarantees such as the Bank Guarantee for Warranty

Obligations, and Guarantee Attributes as Security are also available. 4

INVOCATION OF BANK GUARANTEE

A”bank guarantee may be invoked by the beneficiary at any time when the
terms of the guarantee have been met, all that the bank has to verify that
all the terms of the guarantee contract have been fulfilled and that the bank
should have reasonable time to verify the documents. 5 Invocation of a bank
guarantee relies on the contract terms. The creditor has to know that the
bank guarantee is of unconditional assurance regardless of the fact that a
lawsuit is ongoing. If it is well within the parameters of invocation of the
bank guarantee, it is not even important for the recipient to determine the
amount of loss and to note the number or”figure.6

EXCEPTION

While the”bank guarantee is intended for the creditor's security, there are
some exceptions where the creditor can not exercise his encashment right.
The variations to that”are:

 Fraud- An injunction against bank guarantee enclosure may be issued

in the event of clear fraud on the part of the beneficiary notified by the
bank. The fraud must be to vitiate the transaction as a whole. This
principal has been emphasized in the Sztejn v J case. (1941) 3 HYS
2d631) Henry Schroder Banking Corpn. In the event of fraud the basic
reason for the injunction is to protect the misuse of this credit system.
This concept is the clear application of the maxim "ex turpi causa non
3
Available at: www.universalwealthcreation.com

4
Available at: http://law-projects.blogspot.in/2013/04/contractual-obligation-in-bank-
guarantee.html

5
Pollock & Mulla, The Indian Contract Act, 1872.

6
Hindustan Constn. Co. Ltd. v. State of Bihar, AIR 1997 SC 3710
 obiter actio," meaning the "truth unravels everything". In the case of
Rigoss Exports International (P) Ltd. v Tartan Infomark Ltd (AIR 2001
Delhi 285), it was held that as a result of the fraud, the bank
guarantee was obtained and the beneficiary is not entitled to claim the
amount. However, it was also held that the court could interfere in
such cases, and prohibit bank guarantee encashment.

 Irretrievable harm or injustice- Another exception to bank

guarantee encashment is irretrievable harm or injustice to one of the
parties concerned, as in most situations history shows that the bank as
well as the client on whose behalf the guarantee is issued is adversely
affected by the encashment of money under bank guarantee, the harm
or injustice considered under this heading must be of such an
extraordinary and irretrievable type that it could adversely affect
commercial transactions that is both domestic transactions as well as
international transactions.7

Judicial Interpretation of Bank Guarantee and recent

developments

In”the case of Maharashtra SEB v official liquidator, Ernakulam (AIR 1982 SC

1497) the Supreme Court perfectly expressed that the board is entitled to
implement the guarantee payments as money is payable on demand and not
on violation. Bank guarantee is also referred to as the "On Demand
Guarantees" or Unconditional Guarantee Performance which means that in
any case of dispute the bank is liable to pay without the need of the creditor
to prove any infringement or loss occurred as a result of that infringement.
The creditor can ask for the performance in case of any default by the debtor
and the bank is bound to indemnify the creditor without any proof of default
means that the bank guarantee is "Absolute" and "Unconditional." Very
recently in the case of M / S Adani Agri Fresh Ltd V Mahaboob Sharif & Ors
[Civil Appeal No.14015 of 2015 arising out of SLP (C) No.9506 of 2014]
Supreme Court said the Bank guarantee is an unconditional one. The
respondent can not, therefore, raise any dispute and prevent the appellant
from encashing the bank guarantee. Also in the case of Ansal Engineering
Projects Ltd v Tehri Hydro Development Corporation Ltd (1996) 5 SCC 450),
the bank guarantee is a separate and distinct arrangement between the
Bank and the recipient and is not covered by the underlying transaction. As
the bank promised to pay on demand unconditionally and unambiguously,
the Court therefore held that the bank's liability was absolute and
unconditional, and could not be circumvented in any way. Furthermore, in
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Avtar Singh, Contract and Specific Relief
the case of Rawala Construction Co. v Union of India (ILR 1982 Delhi 44),
the Supreme Court ruled that the bank guarantee constitutes an agreement
between the bank and the government under which the bank has an
absolute obligation to pay to the government merely on the government's
request and under the guarantee, the Bank is prohibited from raising any
objection.8”

Article Review.

Bank Guarantee and Judicial Intervention.

By Akshay Anurag.
Published in Manupatra.

In this Article it is well expressed that the bank guarantees secures the third
party in the event of the debtor's default and all the debtor's obligations will
be then discharged by the respective bank. But the bank's responsibility is
secondary, ensuring that, the bank can only be held liable in the event of the
debtor's default. And about the judicial intervention in the case of bank
guarantees under this article it is expressed that in the case of Tarapore and
Co. v VO Tractors Export (AIR 1970 SC 891), the Supreme Court held that
the contract between the creditor and the bank is separate from the original
contract between the buyer and the seller because of the creditor's
commitment to the bank is absolute and unconditional, therefore there is no
as such need of courts to interfere, because court proceedings can
undermine the very existence of the Bank's guarantee. Bank guarantee
allows individuals to recover their debts by avoiding the long lines of legal
proceedings, and if there will always be judicial interferences, then it will
defeat the purpose of bank guarantee itself. Furthermore under this article it
is expressed that, in the case of United Commercial Bank v Bank of India
(AIR 1981 SC 1426), the Supreme Court ruled that courts should not
interfere in the Bank Guarantee since more interference could contribute to
delays and could impact the transaction process but there are also certain
situations where the action by courts becomes a must like in the case of
fraud or Irretrievable harm or injustice interference by courts is needed
otherwise confidence in international and domestic trade would be vitiated.

8
Available at: http://www.indianlawcases.com/ILC-2015-SC-CIVIL-Dec-8
Article Review.

Bank Guarantee.
By Arpit Lahoti.
Published in Legal Service India.

In this article it is well expressed that the amount of liabilities borne in a

loan guarantee without any demur or conflict under the provisions of the
guarantee is total and unambiguous and In a standard guarantee, the
responsibility of the protection pursuant to Section 128 of the Indian
Contract Act 1872 coexists with that of the principal debtor, i.e. the liability
of the guarantee is to the same degree as that of the key debtor. 9 And the
bank has to pay regardless of any issue posed by the individual in whose
case the promise was granted10 and can not make a question about the
principal debtor's violation.11 A difference in a contract signed by one of the
parties also does not change the obligation under the guarantee. 12 Moreover
the bank may reject the bank guarantee if the beneficiary is unable to
demonstrate that the bank guarantee fulfills all the conditions required, in
the event that all the conditions are met, the bank must make the payment.
In this article it is also expressed that, in order to reduce the threats or risk
that banks are subject to while offering loan assurances on behalf of their
consumers, banks generally use the some measures to secure their profit
such as Limits, Margins, Counter Guarantee and Limitation Period.

CONCLUSION

With the respective study and research that I have done on the topic of Bank
Guarantees: Recent development and Judicial Interpretation I analyse that
the bank guarantee eliminates the financial risk that the deal involves and
allows sellers / beneficiaries to expand their business on a credit-based
basis, due to low risk and as banks assess and approve the business '
financial stability, its reputation improves, which in turn increases business
opportunities though sometimes the banks are sometimes so rigid in
assessing the firm's financial position and this complicates and time-
consuming the process moreover with the strict evaluation of banks, the
obtaining of a bank guarantee by loss-making entities is very difficult, but in
the trades or businesses inside or around the world the bank guarantee
plays a very important role.
9
Ansal Engineering projects Ltd v. Tehri Hydro Development Corporation Ltd, (1996)
5 SCC 450.
10
Dwarikesh Sugar Inds. Ltd. v. Prem Heavy Engg. Works, AIR 1997 SC 2477.
11
Dena Bank v. Fertilizer Corpn., AIR 1990 Pat 221.
12
Loyds Steel Inds. Ltd. v. Indian Oil Corpn. Ltd., AIR 1999 DEL 248.