8/10/22

Cases for Guarantee

Amrit Lal v. State Bank of Travancore

Facts:
1. On February 27, 1956, a partnership firm entered into an agreement with the then Travancore
Forward Bank Ltd. (now replaced by State Bank of Travancore) for a Cash Credit Account to
the extent of Rs. 1 lakh, secured by goods to be pledged with the Bank.
2. The Appellant executed the letter of guarantee in favor of the Bank guaranteeing the liability
of the borrowers in respect of the Cash Credit Account on March 07, 1956.
3. The respondent firm neglected to pay the amount due to the Bank in time and the goods
pledged with the Bank were consequently sold with notice to the partnership firm and the
proceeds applied to the line of credit.
4. As of May 21, 1958, the balance due to the Bank stood at Rs. 40,856. Consequently, the Bank
sues the Surety and the Borrowers in a civil suit. The Surety however, zealously takes up the
following arguments to defend the suit.

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Contd.
Now, the borrower firm had pledged some goods (as security) with the Bank with the following
conditions / disclaimers:
1. The borrowers were responsible for the quantity and quality of the goods pledged with the
Bank.
2. The borrowers were responsible for the correctness of Statements (dealing with market value
of the goods / balance due to the bank etc.) to be provided to the Bank.
3. At the time of pledging the goods, the borrowers declared that the goods had not been
weighed or valued and that the Bank could do so at any time. If the goods were lacking in any
manner whatsoever, the borrower promised to recoup them.

Contd.
Arguments by Surety:
1. There has been variation in the contract between the borrower firm and the Bank and therefore in line
with Section 133 he stands discharged. The variation pointed out by the Surety was the change in the
limit of Cash Credit Account from Rs. 1 lakh to Rs. 50 thousand and then back again to Rs.1 lakh. The
only evidence in support of this condition was entries in the accounts maintained by the Bank with the
title “limit”.
2. The Bank had given time to the partnership firm to make up for the shortage of goods pledged to the
value of Rs. 35,000 (approx.) and therefore the Surety stands discharged under Section 135.
3. Weekly statement on March 15, 1957 shows that the stock of pledged goods was valued at Rs. 1 lakh.
However, in the weekly statement on April 18, 1957 shows that the stock of pledged goods was approx.
Rs. 65,000.
Based on the above, the Surety argues that the Bank must be deemed to have lost the security under Section
141 and that the Surety should stand discharged of up to Rs. 35,000.

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What did the Court say?

1. Argument No. 1:
◦ The Court held (agreeing with the High Court) that this might be a private instruction to the cashier
that advances were not to be made beyond Rs. 50 thousand.
◦ The Court further held (in light of the exhaustive written agreements in place between the borrower
firm and the Bank) that it is unlikely that the Bank and the borrower firm changed the credit limit
under their contract, without another written arrangement.

2. Argument No. 2:
◦ The Court held that this extension of time was not the same as has been contemplated under Section
135.
◦ The Court stated, “What really constitutes giving of time is the extension of the period at which (by
contract between them) the principal debtor was originally obliged to pay the creditor, by substituting a
new and valid contract between the creditor and the principal debtor to which the surety does not
assent.”

What did the court say -

3. Argument No. 3:
◦ The agent / employee of the bank was unable to give an appropriate explanation of how exactly the
shortfall of the goods was created, the Court held that the shortage was possibly brought about either
by the negligence of the Bank or for some other reason, and to that extent there must be deemed to be a
loss by the Bank of the securities under Section 141.

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Bank of Bihar v. Damodar Prasad

FACTS:
1. The Plaintiff Bank lent money to Dr. Damodar Prasad (Defendant No. 1) on the guarantee of
Mr. Paras Sinha (Defendant No. 2).
2. In spite of repeated reminders, neither Defendant No. 1 nor Defendant No. 2 paid up their
dues of Rs. 14,500 (approx.).
3. Interestingly, the Surety (Defendant No. 2) had agreed to pay and satisfy the liabilities of the
principal debtor up to Rs. 12,000 and interest thereon, two days after demand.
ISSUE:
Whether or not the court was justified in issuing the following direction to the Plaintiff “plaintiff
bank shall be at liberty to enforce its dues in question against Defendant No. 2 only after having
exhausted its remedies against Defendant.

What did the court say?

The Court ruled in favor of the Plaintiff.
Rationale:
1. Solvency of the principal-debtor is not a sufficient ground for restraining execution of the decree
against the surety. It is the duty of the Surety to pay to the Creditor.
2. The very object of guarantee is defeated if the creditor is asked to postpone his remedies against
the surety. The liability of the surety is immediate!
3. The Creditor is not bound to exhaust his remedy against the principal, before suing the surety and a
suit may be maintained against the surety even though the principal has not been sued.
4. Ideally, the Creditor should have been allowed to go against the Surety. The Surety could have then
claimed the said amount from the principal-debtor.
5. Even though the Court had the inherent power to postpone the execution of the decree under
Section 151, the ends of justice did not require such postponement.

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Anirudhan v. The Thomco’s Bank Ltd.

Facts:
1. The Principal Debtor Mr. Sankaran approached the Bank for a loan of Rs. 20,000. The Bank
approved the loan in principle, however, insisted on having a Surety for the same.
2. Mr. Sankaran approached the Surety and sought a Rs. 25,000 guarantee. The Surety gave the
letter to Mr. Sankaran.
3. Mr. Sankaran then approached the Bank for a Rs. 25000 loan, which was rejected by the
Bank.
4. Mr. Sankaran then took back the letter of guarantee and made the following changes to the
letter:

Contd.
◦ The figure “5” in the amount of guarantee of Rs. 25,000 appeared to have been altered to “0” so that the
new guarantee amount is Rs. 20,000. (b) Also, the word “five” was struck out resulting in the sum being
“Rupees Twenty Thousand only”
◦ These changes were NOT approved or known to the Surety, however, it was accepted by the Bank.

5. After Sankaran defaulted on his dues, the Bank sued the Appellant and he took up a defense
that originally he had guaranteed Rs. 25000, whereas the deed was altered to now state his
liability to Rs. 20,000.
Issue: Whether or not the Surety stands discharged, where he himself hands over the possession
of the letter of guarantee to the sole custody of the principal debtor and some immaterial change
is made to the same, without taking the Surety on board?

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What did the court say?

Decision: The Court held that the Surety will not be discharged.
1. Under the circumstances, the Surety handed over the letter of guarantee solely to the Principal
Debtor, thereby giving birth to a relationship of agency between the two.
2. It is necessary that the variation made in a contract (without the consent of the Surety) under
Section 133 is such that it varies the rights, liabilities or legal position of the parties as
ascertained by the deed in its original state, or otherwise varies the legal effect of the
instrument as originally expressed.
3. Also, such an alteration was in no way detrimental to the surety as the reduced sum was
already included in the amount of guarantee originally furnished i.e. if the amount stood at Rs.
25,000, the Surety would have had to anyways cover the amount of Rs. 20,000 while paying
off the debt of Rs. 25,000. Thus, a reduction of an amount already consented to be paid would
not.

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… require a distinct consent and such consent can be taken as implied. Thus, the alteration made
by Mr. Sankaran in the letter of guarantee cannot be considered as a material one.
4. In such a case the principal debtor is deemed to be acting on behalf of the surety as it is at his
instance that the surety is furnishing the guarantee and also has entrusted his letter of guarantee
with him. This entrusting is important.
5. Entrusting means – Handing over the letter of guarantee to the Principal Debtor instead of
handing it themselves to the creditor.

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Subramania Chettiar v. MPN Gounder

Facts:
1. The Principal Debtor’s debt was scaled down by the Madras Agriculturists’ Relief Act.
2. The only question before the court was whether such scaling down of the Principal Debtor’s debt
will also ensure that the liability of the Surety is equally scaled down?
3. The Court after quoting Section 128 of ICA, held that this results from the definition of the surety's
engagement as being accessory to a principal obligation and that the extinction of the principal
obligation necessarily induces that of the surety, it being the nature of an accessory obligation that
it cannot exist without its principal.
4. "Ordinarily the liability of a surety is co-extensive with that of the principal debtor unless it is
otherwise provided for.”
5. It was observed that if an amount recoverable by a plaintiff, from a defendant debtor is diminished
in appeal, the surety's engagement, being one of indemnity, would diminish in like proportion. So,
if the sum recoverable became zero, owing to the decree being reversed, the surety's liability would
also be reduced to nothing."

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Contd.
6. The Court further added that if the release of the surety did not follow from that of the debtor,
the latter's release would be purely illusory because the consequence would be that the surety on
being compelled to pay would immediately turn round on the debtor.
Note: The liability of the Surety is always co-extensive with that of the Principal debtor!

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Hindustan Steel Works Construction Ltd.

v.
Tarapore and Co. and another
FACTS
1. The Hindustan Steel Works Construction Limited (HSCL) awarded a
contract to the contractor (Tarapore and co.) for construction of civil works
in its Visakhapatnam Steel Plant and the formal contract was signed on
25.10.1984.

2. It was a lumpsum contract for which a deadline was set but the contractor
could not finish work on time and extended the deadline.

3. On 28.8.1986 some disputes arose and the contractor initiated to solve it

through arbitration and now the dispute was pending before the arbitrators
appointed.

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FACTS

4. In August, 1988 by mutual agreement the contract work was reduced and the contract price was
fixed at Rs. 4.5 crores. Again, the deadline was extended due to unfinished work.
5. Finally, when for the 2nd time the reduced work could not be completed on the set date, HSCL
cancelled the contract on 17.10.1988.
6. In between 30.1.84 and 8.12.87, fourteen guarantees had been given by Bank of India in favour
of HSCL at the instance of the Contractor for various objects.

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FACTS

The bank guarantee held that:

1. HSCL would be indemnified against any loss or damage caused to or suffered by it
by reason of any breach by the contractor of any term and condition of the contract.
2. HSCL shall be the sole Judge on the question as to whether the contractor has
committed any breach of the contract and what is the extent of loss or damage.
3. the decision of HSCL in this behalf shall be treated as final and binding on the
bank.
4. bank has undertaken to pay HSCL on demand any amount payable by the contractor
without any demur and protest, without any reference to the contractor and such
demand by HSCL has to be regarded as conclusive and binding on the bank
notwithstanding any difference between the HSCL and the contractor.
On the day of cancellation of contract HSCL demanded its damages to be paid by the
bank.

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Arguments raised before the High Court

1. The contractor had approached principle subordinate judge at Vishakhapatnam
contending that since disputes were pending before the arbitrators HSCL should be
restrained from encashing the bank guarantees but the court on finding that the
guarantee was unconditional refused to grant injuction.
2. A revision petition was made before HC with the same prayer.
3. The principle observed by the HC was that unless there is fraud or special
circumstances or equities exist, the beneficiary cannot be restrained from encashing
the letter of credit, even if there are disputes between the beneficiary and the person at
whose instance the letter of credit was given by the Bank.
4. The same principle is extended in regard to the performance guarantees or
performance bonds executed by the banks in favour of the beneficiaries.

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Decision of the High Court

1. The HC searched for special equities or special circumstances.

2. It considered the position of law with respect to liquidated damages in our

country and relying upon the decision of Union of India v. Raman Iron
Factory "Hence there cannot be any agreement in regard to the amount that
has to be allowed except the upper limit that can be fixed, in case of
breach”, it held that any term in the agreement that one of the parties shall
be the sole judge to quantify the same has to be held as invalid.“

3. Therefore the liabilities were to be decided by the arbitrators and HSCL’s

contention of being the sole judge was rejected thus restraining it from
encashing the bank guarantee.

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Issue raised before the Supreme Court

The petitioner had filed SLP against the Andhra Pradesh high court’s order of injuction where the
issue to be decided was:

Whether High Court was right in restraining the appellant from enforcing the bank guarantees?

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Contentions raised:
1. The counsel for the appellant submitted that in the matter of encashment of
a bank guarantee the Court should not as a rule interfere unless it is a clear
case of fraud and is likely to result in irretrievable injustice.

2. The Counsel for the respondents, on the other hand, contended that though
fraud is an established exception to the general rule regarding interference
with the autonomy of irrevocable letter of credit or a bank guarantee, that is
not the only exception and the Court can and should interfere where special
circumstances or special equities exist and they are likely to result in
irretrievable injustice.

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Judgment
1. The court held bank guarantees were irrevocable obligations assumed by
banks and should be treated as confirmed letter of credits.
2. The correct position of law is that commitment of banks must be honoured
free from interference by the courts and it is only in exceptional cases, that
is to say, in case of fraud or in a case where irretrievable injustice would be
done if bank guarantee is allowed to be encashed, the court should interfere.
3. That a dispute was pending before the arbitrators to find out the defaulter
and fix the award was not sufficient to be a special circumstance or equity in
the case.
4. It was thus held that the HC of Andhra Pradesh was not right in restraining
HSCL from enforcing the bank guarantees till the arbitration as it failed to
observe the real object nature of bank guarantees and overlooked its
position as an independent and distinct contact.

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