04 December 1996
Supreme Court


Case number: C.A. No.-015357-015357 / 1996
Diary number: 76049 / 1996






DATE OF JUDGMENT:       04/12/1996




JUDGMENT:                THE 4TH DAY OF DECEMBER, 1996 Present:               Hon’ble Mr. Justice M.M. Punchhi               Hon’ble Mrs. Justice Sujata V. Manohar      Dushyant Dave,  Sr. Adv.,  and Pradeep Misra, Adv. with him for the appellant      V.C. Mahajan,  Sr. Adv., Anil Dr. Sangal, Adv. with him for the Respondent                       J U D G M E N T      The following Judgment of the Court was delivered:                       J U D G M E N T      Mrs. Sujata V. Manohar, J.      Leave granted.      The appellant,  U.P. State  Sugar  Corporation  entered into an  agreement  dated  2nd  of  August,  1989  with  the respondent, M/s  Sumac International  Pvt. Ltd.  under which the respondent  agreed to  design, to prepare an engineering lay-out and  to manufacture  or procure  and supply  to  the appellant the  machinery and  equipment for a complete sugar plant for  extension and  modernisation of  the  appellant’s existing   sugar    plant   at    Rohana   Kalan,   District Muzaffarnagar, U.P.  The respondent was required to set up a new plant  of 2500  TCD at  a new  site or an adjoining site close to  the existing  sugar plant  of the  appellant.  The total contract  price was  fixed under  Clause  2.1  of  the contract at Rs. 1780 lacs.      Under the  terms of  the agreement  the respondent  was required  to  set  up  the  plant  and  make  it  ready  for commercial  production   by  30th  of  November,  1990.  The agreement stated that in this regard time was of the essence of the  contract and  if the  respondent failed to do so the consequences were  also spelt  out in  the  contract.  Under clause 3  of the  contract a month-wise progressive delivery report was  to be submitted by the respondent and a PERT/CPM chart had  to be  submitted and  adhered to.  Clause 4 which dealt with  delivery required the respondent to complete all supplies by  15th of  November, 1990 so that the plant could be  commissioned   by  30.11.1990.  Under  Clause  11.1  the respondent-seller was  entitled to a reasonable extension of time as  decided by  the purchaser if the purchase order was



expressly suspended for no fault of the seller.      Under Clause  15 the  respondent-seller was required to furnish to  the appellant  five bank guarantees as specified therein. These were: 1.   A bank  guarantee for  timely  delivery  of  plant  and machinery as  provided  in  Clause  14.1  representing  five percent of  the contract  price referred  to in  Clause 2.1. This was required to be furnished within 3-1/2 months of the signing of the agreement. 2.   The seller  was required to furnish a bank guarantee in respect of guaranteed performance of the plant and machinery for an  amount representing  5% of  the contract price. This guarantee was  required to  be furnished eight months before the scheduled  date of commissioning mentioned in Clause 4.1 or within  six months  from the  date of  the signing of the agreement or after 2-1/2 months of the opening of the Letter of Credit whichever of these dates was earlier. 3.   Three bank guarantees in respect of advance payments to be made  by the  appellant to  the respondent  under  Clause 13.2(a) to  13.3(c) were  required to  be  for  Rs.89  lacs, Rs.178 lacs  and Rs.89  lacs respectively,  representing 5%, 10% and 5% of the contract price respectively.      Under Clause 13.2 on receipt of the first of these bank guarantees for  Rs.89 lacs  the first installment of advance would be  paid within a week from the date of signing of the agreement. Or  receipt of  the  second  bank  guarantee  for Rs.178  lacs  the  second  advance  would  be  paid  by  the appellant to  the respondent  within  2-1/2  months  of  the signing  of   the  agreement   subject  to   the  respondent furnishing various  statements, certificates etc. as set out in that  clause. The third bank guarantee for Rs.89 lacs was to be  furnished against  the advance  to  be  paid  by  the appellant to  the respondent  within 3-1/2  months from  the date of  the signing  of the  agreement.  These  three  bank guarantees are  thus in  respect  of  the  advance  payments required to be made by the appellant to the respondent.      Under Clause 15.5 all these bank guarantees are payable on demand.  It is  expressly provided  that it  shall not be open  to  the  guarantor  to  know  the  reasons  of  or  to investigate or  to go into the merits of the demand invoking the bank guarantee or to question or challenge the demand or to require  the proof  of the liability of the seller before paying the  amount demanded. It is further provided that the invocation of  the bank  guarantee shall  be binding  on the respondent and  that the  invocation of  the bank  guarantee would not  be affected  in any  manner by reason of the fact that  any  dispute  or  disputes  had  been  raised  by  the respondent with  regard to  its liability.  Nor would  it be affected by  the fact  that proceedings  were pending before any Tribunal, Arbitrator or Court with regard thereto.      Accordingly, the respondent furnished, inter alia, four bank guarantees,  one being a guarantee for due delivery and the other  three being  the bank  guarantees in  respect  of advance payment  of price.  The total  amount covered by the bank guarantees securing advance payments is Rs.3.56 crores, which amount  was paid by the appellant to the respondent as advance.      The contract  was  not  carried  out  within  the  time envisaged under  the contract. Thereafter, at a meeting held on 1.10.1991  between the  appellant and the respondent, the time for  completion of  this project was  extended upto May 1992 and a detailed chart was drawn up for the completion of the project  by that  date. No further extension of time has been given  by the  appellant to  the respondent thereafter. The respondent,  however, did  not complete the said project



within the extended period.      By their  letter dated 6th of September, 1995 the State of  U.P.  through  the  Special  Secretary,  Govt.  of  U.P. informed the  Managing Director of the appellant that it had been decided  to transfer  the Rohana  Kalan  (Muzaffarnagar unit) of the appellant to the joint sector. As a result, the expansion project  of this  unit  should  be  cancelled  and appropriate action  in accordance  with law should be taken. Thereupon the  appellant  cancelled  the  agreement  by  its letter  dated  7th  of  September,  1995  addressed  to  the respondent. The  appellant claimed  a refund  of the advance payment of  Rs. 3,14,78,093/-  as unutilised  and unadjusted amount of  advance  payment.  The  appellant,  by  its  four letters  all   dated  October  28,  1995  addressed  to  the respondent invoked  the three  bank guarantees in respect of advance payments  after giving  credit to the respondent for material worth Rs.42 lacs which had been supplied till then. The appellant  also invoked the delivery guarantee for Rs.89 lacs. The  bank guarantees  so invoked  are: Bank  guarantee no.9/47  dated  10.8.89  for  Rs.  89  lacs.  In  this  bank guarantee credit  for Rs.42  lacs has  been  given  and  the invocation of the bank guarantee is only for the balance sum of Rs.47  lacs. The  second bank  guarantee  so  invoked  is no.9/64 dated  20.11.89 for  Rs.178  lacs.  The  third  bank guarantee is  no.9/70 of  6.1.90  for  Rs.89  lacs  and  the fourth, delivery  guarantee is no.12/88 dated 13.11.1990 for Rs.89 lacs.      On 5.10.1995  the respondent  filed  a  petition  under Section 20  of the  Arbitration Act  for appointment  of  an arbitrator since  the agreement between the parties provides for arbitration.  The respondent also filed two applications for interim  relief under  Section 41(b)  of the Arbitration Act  seeking   interim  stay   against  encashment  of  bank guarantees. The Civil Judge, Senior Divisions, Muzaffarnagar before whom  these applications  were filed, dismissed these applications. In  revision, however, these applications have been allowed  by the  High Court  and an injunction has been granted restraining  the appellant from enforcing these bank guarantees. Hence,  the appellants  has come  by way  of the present appeal.      These bank  guarantees which are irrevocable in nature, in terms,  provide that they are payable by the guarantor to the appellant  on demand without demur. They further provide that the appellant shall be the sole judge of whether and to what extent  the amount  has  become  recoverable  from  the respondent or  whether  the  respondent  has  committed  any breach of  the terms  and conditions  of the  agreement. The bank guarantees  further  provide  that  the  right  of  the purchaser to recover from the guarantor any amount shall not be affected  or suspended by reason of any disputes that may have been  raised by  the  respondent  with  regard  to  its liability or  on the  ground that  proceedings  are  pending before any Tribunal, Arbitrator or Court with regard to such dispute. The  guarantor shall immediately pay the guaranteed amount to the appellant-purchasers on demand.      The law  relating to invocation of such bank guarantees is by  now well  settled. 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 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. The two grounds are not necessarily connected,  though both  may  co-exist  in  some cases. In  the case  of U.P.  Cooperative Federation Ltd. v. Singh Consultants  and Engineers (P) Ltd. (988 [1] SCC 174), which was  the case  of works contract where the performance guarantee given under the contract was sought to be invoked, this Court,  after  referring  extensively  to  English  and Indian cases on the subject, said that the guarantee must be honoured in  accordance with its terms. The bank which gives the guarantee  is  not  concerned  in  the  least  with  the relations between  the supplier  and the  customer; nor with the  question   whether  the   suppler  has   performed  his contractual obligation or not, nor with the question whether the supplier  is in  default  or  not.  The  bank  must  pay according to  the tenor  of its  guarantee on demand without proof or  condition. There  are only  two exceptions to this rule. The  first exception  is a  case when there is a clear fraud of  which the bank has notice. The fraud must be of an agregious nature  such as  to vitiate  the entire underlying transaction. Explaining the kind of fraud that may absolve a bank from  honouring its  guarantee, this Court in the above case quoted  with approval  the  observations  of  Sir  John Donaldson, M.R. in Bolivinter Oil SA v. Chase Manhattan Bank NA (1984  [1] AER  351 at 352): "The wholly exceptional case where an  injunction may  be granted  is where  it is proved that the bank knows that any demand for payment already made or which  may thereafter be made will clearly be fraudulent. But the  evidence must be clear both as to the fact of fraud and as  to the  bank’s knowledge.  It  would  certainly  not normally be sufficient that this rests on the uncorroborated statement of  the customer,  for irreparable  damage can  be done to  a bank’s  credit in the relatively brief time which must elapse  between the  granting of such an injunction and an application  by the  bank to have it charged". This Court set aside  an  injunction  granted  by  the  High  Court  to restrain the realisation of the bank guarantee.      The same question came up for consideration before this Court in Svenska Handelsbanken v. M/s Indian Charge Chrome & Ors. (1994  [1] SCC  502). The  Court once  again reiterated that a confirmed bank guarantee/irrevocable letter of credit cannot be  interfered with unless there is established fraud or   irretrievable   injustice   involved   in   the   case. Irretrievable injury  has to be of the nature noticed in the case of  Itek Corporation  v. The  First  National  Bank  of Boston etc.  (566 Fed  Supp. 1210). On the question of fraud this Court  confirmed the  observations made  in the case of U.P. Cooperative Federation Ltd. (supra) and stated that the fraud must  be that of the beneficiary, and not the fraud of anyone else.      On the  question of  irretrievable injury  which is the



second exception to the rule against granting of injunctions when unconditional bank guarantees are sought to be realised the court  said in  the above  case that  the  irretrievable injury must  be of  the kind which was the subject-matter of the decision  in the  Itek Corporation case (supra). In that case an  exporter in  the U.S.A.  entered into  an agreement with the  Imperial Government  of Iran  and sought  an order terminating its  liability on  stand by  letters  of  credit issued by  an American  bank in favour of an Iranian Bank as part of  the contract.  The relief  was sought on account of the situation  created after the Iranian revolution when the American  Government   cancelled  the   export  licences  in relation to  Iran and  the Iranian  Government had  forcibly taken 52  American citizens as hostages. The U.S. Government had blocked  all Iranian  assets under  the jurisdiction  of United States  and had  cancelled the  export contract.  The court upheld  the contention  of the exporter that any claim for damages against the purchaser if decreed by the American Courts  would   not  be   executable  in  Iran  under  these circumstances and  relisation of  the bank guarantee/Letters of credit  would cause  irreparable harm  to the  plaintiff. This contention  was upheld.  To avail  of  this  exception, therefore,   exceptional   circumstances   which   make   it impossible for  the guarantor  to reimburse  himself if  the ultimately succeeds, will have to be decisively established. Clearly, a  mere apprehension  that the other party will not be able  to pay,  is not  enough. In  the Itek  case (supra) there was  a certainty  on this  issue. Secondly,  there was good reason,  in that  case for  the court to be prima facie satisfied that the guarantors i.e. the bank and its customer would be found entitled to receive the amount paid under the guarantee.      Our attention  was invited  to a number of decisions on this issue  -- among  them,  to  Larsen  &  Turbro  Ltd.  v. Maharashtra State Electricity Board & Ors. (1995 [6] SCC 58) and Hindustan  Steel Workers Construction Ltd. v. G.S. Atwal & Co.  (Engineers) Pvt.  Ltd. (1995  [6] SCC  76) as also to National Thermal  Power Corporation  Ltd. v.  Flowmore  Pvt. Ltd. &  Anr. (1995  [4] SCC  515). The latest decision is in the case  of State  of Maharashtra  & Anr.  v. M/s  National Construction Company,  Bombay &  Anr. (JT  1996 [1]  SC 156) where this Court has summed up the position by stating, "The rule is  well established that a bank issuing a guarantee is not concerned  with  the  underlying  contract  between  the parties to  the contract.  The duty  of  the  bank  under  a performance guarantee  is created  by the  document  itself. Once  the  documents  are  in  order  the  bank  giving  the guarantee must  honour the  same and make payment ordinarily unless their  is an  allegation of  fraud or  the like.  The courts will not interfere directly or indirectly to withhold payment,  otherwise   trust   in   commerce   internal   and international would  be irreparably  damaged. But  that does not mean  that the parties to the underlying contract cannot settle the disputes with respect to allegations of breach by resorting to  litigation or arbitration as stipulated in the contract. The  remedy arising ex-contractu is not barred and the  cause   of  action  for  the  same  is  independent  of enforcement of  the guarantee." The other recent decision is in Hindustan  Steelworks Construction Ltd. v. Tarapore & Co. & Anr. (JT 1996 [6] SC 295).      Clearly,  therefore,   the  existence  of  any  dispute between the  parties to  the contract  is not  a ground  for issuing an  injunction to  restrain the  enforcement of bank guarantees. There  must be  a fraud  in connection  with the bank guarantee.  In the present case we fail to see any such



fraud. The  High Court  seems to have come to the conclusion that the  termination of  the contract  by the appellant and his claim  that the time was of the essence of the contract, are not  based on  the terms of the contract and, therefore, there is  a fraud  in the  invocation of the bank guarantee. This is  an erroneous view. The disputes between the parties relating to  the termination  of the  contract  cannot  make invocation of the bank guarantees fraudulent. The High Court has also  refereed  to  the  conduct  of  the  appellant  in invoking the  bank guarantees on an earlier occasion on 12th of April, 1992 and subsequently withdrawing such invocation. The court has used this circumstance in aid of its view that the time  was not of the essence of the contract. We fail to see how  an earlier  invocation of  the bank  guarantees and subsequent withdrawal  of  this  invocation  make  the  bank guarantees or  their invocation  tainted with  fraud in  any manner. Under  the terms  of the  contract it  is stipulated that the  respondent is  required to give unconditional bank guarantees against  advance payments  as also a similar bank guarantee for  due delivery  of the  contracted plant within the stipulated  period. In  the absence  of  any  fraud  the appellant is entitled to realise the bank guarantees.      Before us,  however, in the course of argument, learned advocate for the respondent urged for the first time that in this case  there would  be irretrievable  injustice  to  the respondent if the bank guarantees are allowed to be realised because the  appellant  is  a  sick  industrial  company  in respect of  which a  referee is pending before the Board for Industrial  and  Financial  Reconstruction  under  The  Sick Industrial Companies  (Special Provisions)  Act,  1985.  The respondent contends  that even  if it  succeeds  before  the Arbitrator it will not be able to realise its claim from the appellant. The  mere fact  that a  reference under  The Sick Industrial  Companies  (Special  Provisions)  Act,  1985  is pending before the Board, is, in our view, not sufficient to bring the case in the ambit of the "irretrievable injustice" exception. Under  the scheme  of the  said Act  the Board is required to  make such  inquiry  as  it  may  deem  fit  for determining whether any industrial company has become a sick industrial company.  Under Section  16(4)  where  the  Board deems it  fit to  make an inquiry or to cause and inquiry to be made  in this  connection, it  may appoint  one  or  more person  to   be  special   directors  for  safeguarding  the financial and  other interests  of the  company  or  in  the public interest.  Under Section  17 after making an inquiry, if the  Board is  satisfied that a company has become a sick industrial company,  the Board  may then decide, by an order in writing,  whether it  is practicable  for the  company to make its  net worth  exceed the  accumulated losses within a reasonable time.  If this  is practicable,  then  the  Board shall give  such company  the opportunity  to make  its  net worth exceed  the accumulated  losses. Under sub-section (3) of Section  17  if  the  Board  decides  that  this  is  not practicable within  a reasonable time, it may adopt measures specified in  Section  18  and  provide  for  a  scheme  for appropriate measures in relation to that company. There can, therefore, be  no presumption  that the  company will, in no circumstance, be able to discharge its obligations.      Under Section  22 on which the respondent relies, where in respect  of  an  industrial  company,  an  inquiry  under Section 16  is pending,  or any  scheme under  Section 17 is under  preparation   or  a   sanctioned  scheme   is   under implementation  or  when  an  appeal  under  Section  25  is pending, then  no proceedings  for the  winding  up  of  the industrial company  or for  execution, distress  or the like



against any  of the  properties of the industrial company or the appointment  of a  receiver in  respect thereof  can  be proceeded with; and no suit for the recovery of money or for the enforcement  of  any  security  against  the  industrial company shall  lie or  be proceeded  with  except  with  the consent of  the Board  or, as the case may be, the Appellate Authority. The respondent contends that its right to realise its claim,  if established,  would be  affected by reason of Section 22  of the  said Act. There is no material before us to show that the appellant-company cannot make its net worth positive. No  scheme has  been framed  under the said Act so far. Even  under Section 22 there is no absolute bar against any suit  for the  recovery of  money. The  suit  cannot  be proceeded with  except with  the consent of the Board or the Appellate Authority.  Therefore, in an appropriate case, the Board or  the Appellate  Authority is  entitled to  give its consent to  such a claim being proceeded with. This is not a situation  of  the  kind  envisaged  in  the  case  of  Itek Corporation  (supra)   where  there   was   no   possibility whatsoever of  recovery of any amount from the purchaser. In the present  case, there  is  a  good  possibility  of  such recovery. In  any case,  learned counsel  for the  appellant has, on instructions, very fairly stated that the appellant- company undertakes  to earmark the amounts realised from the bank guarantees  in question  for the purpose of recovery of claims, if any, which the respondent may ultimately be found to be  entitled to  recover from  the appellant.  Any scheme which the Board may frame under the said Act will be subject to this  undertaking given by the appellant to set apart the amounts realised  under the  bank guarantees in question for meeting any  validly adjudicated  claims of  the  respondent against  the  appellant  under  or  arising  from  the  said contract. If  any scheme is required to be framed, the Board shall take  into account this undertaking, while framing the scheme.      Both sides  are agreed  that for a speedy resolution of their disputes  they are willing to refer all their disputes under  or  arising  from  the  said  contract  to  the  sole arbitration of  Justice R.M.  Sahai (retd.), a retired Judge of this Court. We accordingly refer all disputes between the parties under  or arising  from the  contract  to  the  sole arbitration of  Justice R.M.  Sahai (retd.).  The arbitrator may fix  his remuneration  in consultation with the parties. The parties  shall obtain  appropriate directions  from  the learned arbitrator  in connection with the filing of claims, replies etc.  in accordance  with law. The petition filed by the respondent  before  the  court  of  the  Chief  Judicial Magistrate/Civil Judge,  Muzaffarnagar under  Section 20  of the Arbitration Act is disposed of accordingly.      The appeal  is allowed  and the  impugned judgment  and order of  the High  Court is  set aside  and the  injunction granted by  the High  Court is  vacated. Parties  will  bear their own costs.