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PETITIONER: U.P. Co-OPERATIVE FEDERATION LTD.

       Vs.

RESPONDENT: SINGH CONSULTANTS & ENGINEERS (P) LTD.

DATE OF JUDGMENT19/11/1987

BENCH: OZA, G.L. (J) BENCH: OZA, G.L. (J) SHETTY, K.J. (J)

CITATION:  1988 AIR 2239            1988 SCR  Supl. (2) 859  1988 SCC  (4) 274        JT 1988 (3)   640  1988 SCALE  (2)571

ACT:      Performance  of   contract-guaranteed  performance   in accordance with  time schedule prescribed-Failure to perform obligation within  time stipulated-Effect  of-Bank guarantee Right to invoke-To injunction against.

HEADNOTE: %      The appellant,  a State  Government enterprise,  on  or about May  17,  1983,  entered  into  a  contract  with  the respondent, a  private limited  company, for  the supply and installation of  a vanaspati  manufacturing plant at a place in the  district of Nainital. The contract bond contemplated guaranteed performance  of the  work at  various  stages  in accordance with  the time  schedule prescribed  and provided for completion  and commissioning  of the  plant after trial run by  May 15,  1984. According  to the appellant, the time was  essentially   and  indisputably   the  essence  of  the contract.      As per  the terms  and conditions of the contract bond, according to  the appellant, the respondent was to furnish a performance bank guarantee for Rs.16.5 lakhs and yet another bank guarantee  for Rs.33  lakhs as  security for the monies advanced by  the appellant to the respondent for undertaking the work.  Both these  guarantees as  also the contract bond entitled the  appellant to  invoke them  and call  for their realisation and  encashment on the failure of the respondent to perform  the obligations for which the appellant was made the sole judge.      It was alleged that the respondent defaulted at various stages and  finally failed  to complete  the work within the stipulated time.  The appellant  invoked the  two guarantees one after  the other,  and thereafter  proceeded to have the plant completed,  etc. According to the appellant, the plant could actually  be commissioned for commercial production in July/August, 1985.      The respondent, on August 4, 1986, filed an application under section  41 of  the Arbitration Act, 1940 (The Act) in the court  of the  Civil Judge,  praying for  an  injunction restraining the appellant from realis- 1125

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ing and  encashing the  bank  guarantees.  The  Civil  Judge dismissed the  application. The  respondent filed a revision petition before  the High  Court, which  allowed  the  same, holding that  the invocation  of the  performance guarantees was illegal,  and the  contentions of the appellant that the performance guarantees  constituted independent and separate contracts between the guarantor bank and the beneficiary and created  independent  rights,  liabilities  and  obligations under the  guarantee bonds  themselves, as  being "technical pleas". The  High Court, however, directed the respondent to keep alive  the bank  guarantee during  the pendency  of the arbitration proceedings. The appellant then moved this Court for relief by special leave.      Allowing the appeal, The Court, ^      HELD: Per Sabyasachi Mukharji, J.      Under the terms agreed to between the parties, there is no scope  of injunction.  The High  Court proceeded  on  the basis that  this was  not an  injunction sought  against the bank but  against the  appellant. But  the net effect of the injunction is  to restrain the bank from performing the bank guarantee. That  cannot be  done. One  cannot do  indirectly what one  is not free to do directly. The respondent was not to  suffer   any  injustice  which  was  irretrievable.  The respondent can  sue the  appellant for damages. There cannot be any basis in the case for apprehension that irretrievable damage would  be caused,  if any.  His Lordship  was of  the opinion that  this was not a case in which injunction should be granted.  An irrevocable commitment either in the form of confirmed bank  guarantee or  irrevocable letter  of  credit cannot be  interfered with  except if  a case  of fraud or a case  of   a  question   of  apprehension  of  irretrievable injustice has  been  made  out.  This  is  the  well-settled principle of  the law  in England.  This is  also the  well- settled principle  of law in India. No fraud and no question of irretrievable injustice was involved in the case. [1138C- F]      In  order   to  restrain   the  operation   either   of irrevocable letter  of credit  or  of  confirmed  letter  of credit or  of bank  guarantee, there  should  be  a  serious dispute and  a good  prima facie  case of  fraud and special equities in  the form  of preventing irretrievable injustice between the  parties; otherwise,  the very  purpose of  bank guarantees would  be negatived  and the  fabric  of  trading operation would be jeopardised. The commitments of the banks must be  honoured free  from  interference  by  the  courts; otherwise, trust  in  commerce  internal  and  international would be  irreparably damaged.  It is  only  in  exceptional cases, that is, in 1126 cases of  fraud or  in cases of irretrievable injustice that the court  should  interfere.  This  is  not  a  case  where irretrievable injustice  would be done by enforcement of the bank guarantee. This is also not a case where a strong prima facie case  of-fraud in entering into a transaction was made out. The High Court should not have interfered with the bank guarantee. The  judgment and  order of  the High  Court  set aside. The  order  of  the  Civil  Judge  restored.[1141A-B; 1142D-H] Per K. Jagannatha Shetty, J. (concurring):      The crux  of  the  matter  relates  to  the  obligation assumed by the bank under a performance guarantee. [1143B]      Whether the  obligation is  similar to  the one arising under a  letter of credit? Whether the Court could interfere in  regard  to  such  obligation,  and  if  so,  under  what

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circumstances? These are the questions raised in the appeal. [1143B-C]      The primary  question for  consideration is whether the High Court  was justified  in restraining the appellant from invoking the  bank guarantees.  The basic nature of the case relates to  the obligations  assumed by  the bank  under the guarantees given  to the  appellant. If  under the  law, the bank cannot  be prevented  by the  respondent from honouring the  credit   guarantees,  the   appellant  also  cannot  be restrained from invoking the guarantees. What applies to the bank must  equally apply  to the  appellant. Therefore,  the frame of the suit by not impleading the bank cannot make any difference in  the position  of law.  Equally, it  would  be futile to  contend that  the court was justified in granting the injunction  since it  has found  a prima  facie case  in favour of  the respondent.  The question  of  examining  the prima facie case or balance of convenience does not arise if the court cannot interfere with the unconditional commitment made by  the bank  in the  guarantees in question. [1144C-D; 1145A-B]      The modern  documentary  credit  had  its  origin  from letters of  credit. The  letter of credit has developed over hundreds of years of international trade. It was intended to facilitate  the   transfer  of  goods  between  distant  and unfamiliar buyer  and seller.  It was  found difficult for a buyer to  pay for  goods prior to their delivery. The bank’s letter  of   credit  came   to  bridge  this  gap.  In  such transactions, the seller (beneficiary) receives payment from the issuing  bank when he presents a demand as per the terms of the  documents. The bank must pay if the documents are in order and the terms of credit are satisfied. The bank, 1127 however, was not allowed to determine whether the seller had actually shipped the goods or whether the goods conformed to the requirements  of the  contract. Any  dispute between the seller and the buyer must be settled between themselves. The Courts, however, in carving out an exception to this rule of absolute independence,  held that if there has been a "fraud in the  transaction", the bank could dishonour beneficiary’s demand for  payment. The  Courts  have  generally  permitted dishonour only  on the  fraud of  the beneficiary,  not  the fraud of somebody else. [1145C, E-H; 1146A]      In modern  commercial transactions, various devices are used to  ensure performance  by the contracting parties. The traditional letter of credit has taken a new meaning. Stand- by letters  of credit  are also  used in  business  circles. Performance  bond   and  guarantee  bond  are  also  devices increasingly  adopted   in  transactions.  The  Courts  have treated ch  documents as  analogous to  letter of  credit. l 1148E]      Whether it  is a  traditional letter of credit or a new device, like  performance bond or performance guarantee, the obligation of  the bank  appears to  be the  same. Since the bank pledges  its own  credit, involving  its reputation, it has no  defence except  in the  case of fraud. The nature of the fraud  that the  courts talk  about is  the fraud  of an ’egregious  nature  as  to  vitiate  the  entire  underlying transaction". It  is the fraud of the beneficiary, not fraud of somebody else. The bank cannot be compelled to honour the credit in  such cases. In such cases, it would be proper for the bank  to ask  the buyer  to approach  the court  for  an injunction. The court, however, should not lightly interfere with the  operation of  irrevocable documentary  credit.  In order to  restrain the  operation of  irrevocable letter  of credit, performance  bond or  guarantee, there  should be  a

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serious dispute to be tried and there should be a good prima Facie act of fraud . [1149E-H; 1150A]      The sound  banking system  may, however,  require  more caution in  the issuance  of irrevocable documentary credit. It would  be for  the banks to safeguard themselves by other means, and,  generally, not  for the courts to come to their rescue with  injunctions unless  there is established fraud. The appeal  must be  allowed, and  the order  of  the  civil judge, restored. [1150D-E]      Hamzeh Melas  & Sons  v. British  Imex Industries Ltd., [1958] 2  Q.B.D. 127;  Elian and Rabbath (Trading as Elian & Rabbath v.  Mastas and  Mastas & ors., [1966] 2 Lloyd’s List Law  Reports  495;  R.D.  Harbottle  (Mercantile)  Ltd.  and Another v. Nahonal Westminster 1128 Bank Ltd.  and Ors.,  [1977] 2  All England Law Reports 862; Edward owen  Engineering Ltd. v. Barclays Bank International Ltd, [1978]  1 All  England Law  Reports  976;  United  City Merchants (Investments)  Ltd. & Ors. v. Royal Bank of Canada JUDGMENT: v. State  Bank of  India &  Ors. AIR 1979 Calcutta 44; State Bank of India v; The Economic Trading Co. S.A.A. & ors., AIR 1975 Calcutta  145; B.S.  Auila Company Pvt. Ltd. v. Kaluram Mahadeo Prasad & Ors., AIR 1983 Calcutta 106; Union of India & ors.  v. Meena  Steels Ltd.  & Another, AIR 1985 Allahabad 282;  Arul   Murugan  Traders   v.  Rashtriya   Chemicals  & Fertilizers Ltd.  Bombay and  another, AIR  1986 Madras 161; Tarapore &  Co. Madras v. M/s. V/o Tractors Export, Moscow & Anr., [1969]  2 SCR  920; United  Commercial Bank v. Bank of India &  ors., [1981]  3 SCR  300; Centax  (India)  Ltd.  v. Vinmar Impex  Inc. and  others, [1986]  4  SCC  136;  United Commercial Bank  v. Bank  of India  & Ors., [1981] 3 SCR 300 and Bolivinter oil SA v. Chase Mannettan Bank & Ors., [1984] 1 All E.R. 351 at 352, referred to.

&      CIVIL APPELLATE  JURISDICTION: Civil Appeal No. 3054 of 1987.      From the  Judgment and  order dated  20.2. 1987  of the Allahabad High Court in Civil Revision No. 157 of 1986.      A.B. Diwan,  Sandeep Narain  and Shri  Narain  for  the Appellant.      V.M. Tarkunde, Shakeel Ahmed Syed for the Respondent.      The following Judgments were delivered by      SABYASACHI MUKHARJI, J. Special Leave granted.      In the Special Leave Petition notice was issued on 13th of July,  1987 and  it was directed that the matter would be disposed of  at the  notice stage.  After hearing  the rival contentions, we  grant leave  to appeal  and dispose  of the appeal by the order hereunder.      This is  an appeal  from the  judgment and order of the learned single  judge of  the Allahabad  High Court  Lucknow Bench) in Revision Petition No. 157 of 1986. It appears that the appellant,  a State  Government enterprise,  on or about 17th  of   May,  1983  entered  into  a  contract  with  the respondent-a private  limited company  for  the  supply  and installation  of   a  Vanaspati   manufacturing   plant   at Harducharu 1129 in the  District of Nainital, in the State of Uttar Pradesh. The contract  bond contemplated, according to the appellant, guaranteed  performance   of  work   at  various  stages  in accordance with  the time  schedule prescribed  therein  and

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provided for completion and commissioning of the plant after due trial  run by the 15th May, 1984. The appellant contends that time  was essentially  and indisputably  the essence of the contract.      The contention  of the  appellant was  that as  per the terms and  conditions of  the contract  bond, the respondent was to  furnish a  performance bank  guarantee for  Rs  16.5 lakhs and  yet another  bank guarantee  for Rs.33  lakhs  as security for  the monies  advanced by  the appellant  to the respondent  for   undertaking  the   work.  Both  these  two guarantees as  also the contract bond entitled the appellant to invoke them and call for their realisation and encashment on the  respondent’s failing  to perform the obligations for which the appellant was made the sole judge      The 15th of May, 1984 was the date fixed for completion and commissioning  of the plant after 15 days’ trial run for commercial production.  It was alleged that between the 26th of December,  1984 and  28th of January, 1985 the respondent defaulted at  various stages  and finally failed to complete the work  within the  stipulated time. The appellant invoked the two  guarantees  one  after  the  other.  The  appellant thereafter on  15th March,  1985 proceeded to have the plant completed  and  the  plant  was  formally  inaugurated.  The appellant  contends   that  the   plant  could  actually  be commissioned for commercial production in July/August, 1985. The respondent on 4th of August, 1986 filed a petition under section 41  of the  Arbitration Act 1940 (hereinafter called the Arbitration  Act), in  the Court  of  the  Civil  Judge, Lucknow praying  for an order restraining the appellant from realising and  encashing the  bank guarantees.  The  learned Civil Judge  for the  reasons indicated  in his  order dated 8.8.86 declined  to issue  any injunction  and dismissed the application      Being  aggrieved   by  the   aforesaid  decision,   the respondent went  up before  the Allahabad  High  Court.  The learned Single  Judge of  the Allahabad  High Court,  by the impugned  judgment  of  20th  February,  1987,  allowed  the revision petition  and  held  that  the  invocation  of  the performance guarantees  were illegal  and further  held  the contentions of the appellant that the performance guarantees constituted independent  and separate  contracts between the guarantor bank  and the  beneficiary and created independent rights, liabilities and obligations 1130 under the  guarantee bonds  themselves, as  being "technical pleas."      On  17th  May,  1983,  as  mentioned  hereinbefore,  an agreement had  been executed  between the  appellant and the respondent wherein it was decided as follows:           "WHEREAS  THE   PCF  (the  appellant  herein)  has           decided to  set up  a Vanaspati Plant of 62 5 M.T.           per day  Vanaspati Capacity, comprising of 70 M.T.           per day  hardening capacity  based on 95% usage of           soyabean oil  as raw  oil 62.5  M.T. per day, post           refining   capacity,   72   M.T.   deodoursisation           capacity and  72 M.T filling and packing capacity,           complete with  all  necessary  utilities  such  as           water  and   steam  Distribution   Equipments  oil           Storage Section  Electrification and  Distribution           Equipments   Automatic    Weighing   filling   and           packing/sealing   equipments   and   fire-fighting           equipments etc,  at Halducharu,  District Nainital           (UP) lying  at Bareilly-Haldwani  road  about  3.5           Kms.  from  Lalkuan  towards  Haldwani."  and  the           agreement further stated:-

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         "AND WHEREAS  the seller  (the respondent  herein)           has undertaken  to provide  technical know-how and           fabricate, design, engineer, manufacture, procure,           import, supply, erect, instal, give trial runs and           commission the  Vanaspati Complex  as referred  to           above  complete  in  all  respects  at  Halducharu           District-Nainital  (U.P.)  as  per  specifications           contained at  Annexures ’A’  to ’Q’  and signed by           both the  parties in  token of incorporation as an           integral part  of this  agreement with  guaranteed           performance   on    the   terms   and   conditions           hereinafter appearing and contained.           AND  WHEREAS   the  contract  price  here-in-after           mentioned is based on the ’Seller’s undertaking to           com  mission   and  make   ready  for   commercial           production the  said Vanaspati  Complex by May 15,           1984 and if the seller fails to do so the contract           price  shall   stand  reduced  to  the  extent  as           hereinafter provided.           AND  WHEREAS   the  contract   price   hereinafter           mentioned  is   also  based   on  the   guaranteed           performance of the said Vanaspati Complex as here-           in-after  provided  and  it  is  a  term  of  this           Agreement that if the said Vanaspati Complex fails           to give the guaranteed performance as hereinafter 1131           specified, the  contract price shall stand reduced           to the extent hereinafter provided."      Clause 1.6  stipulated that  the date  of commissioning and handing  over shall  be the  date on which the PCF takes over the  complete Plant  after successful commissioning and fulfilling  of   guaranteed  performance  specified  in  the agreement. This clause further stated:           "The seller  shall be deemed to have completed the           erection and-commissioning after giving successful           trial runs  for continuous  period of 15 days with           all the  Plants working  simultaneously.  However,           the  seller   should  fulfil   the  Warrantees  of           individual plants  separately also as given in the           specifications.            The            complete           Warrantees/Performance   guarantees    shall    be           demonstrated  by  the  seller  over  a  continuous           period of 15 days."      Thus the  mutual obligations  of the sellers as well as purchasers were  stated in the contract. It is not necessary to set  out in detail all the clauses, but clauses 5 2 and 5 3 are relevant and provide as follows:           "5.2 In  case the  seller fails  to fulfil and his           obligations as  referred to  in this agreement the           PCF shall  be at liberty to get the same completed           through and  other agency  or agencies without the           approval of  the seller  and  all  the  additional           expenses  so  incurred  by  the  P.C.F.  shall  be           recoverable from the seller.           5.3 The seller also agrees to exclude/include some           of the  machines equipments  components  from  the           plant as  may be  desired by  the PCF  during  the           course  of   this  agreement,  and  cost  of  such           machines  equipments   components  on   reasonable           actual basis  shall  deducted/added  to  from  the           contract  price  and  thus  the  reduced/increased           contract price  shall be  paid by the PCF However,           the PCF  should intimate  such exclusion/inclusion           within two  months from the date of signing of the           agreement. The  said price  of Rs.1,65,00,000 (Rs.

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         One crores  and sixty  five lakhs  only) shall  be           paid by  the PCF  to the  seller in  the following           manners:-      on or about 25th of June, 1983 two bank guarantees were executed by Bank of India, Ghaziabad and the bank guarantee 1132 numbered ]7/16 provided,inter alia, as follows:-           "NOW, THEREFORE,  the Bank  hereby  guarantees  to           make unconditional payment of Rs.16.5 lacs (Rupees           six  teen   lacs  fifty   thousand  only)  to  the           Federation on  demand at  its  office  at  Lucknow           without any  further question  or reference to the           seller on the seller’s failure to fulfil the terms           of the sale on the following terms and conditions           (emphasis supplied)           A) The  sole judge for deciding whether the seller           has failed  to fulfil the terms of the sale, shall           be the PCF.           B) This  guarantee  shall  be  valid  upto  twelve           months from the date of issue. i.e upto 24.6.84.           C) Claims. if any must reach to be Bank in writing           on or  before expiry  date of this guarantee after           which the  Bank will  no longer  be liable to make           payments to the pCF           D) Bank’s  liability under  this guarantee deed is           limited to Rs.16.5 lacs (Rupees sixteen lacs fifty           thousand only).           E) This guarantee shall not be revoked by the Bank           in any  case before the expiry of its date without           written permission of the Federation.      The Bank  guarantee No. 17/ 15 of the said date further went on to provide as follows:-           "AND WHEREAS  to  secure  the  said  advance,  the           seller  requested  the  Bank  to  furnish  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 Feder           ation.                Now,  therefore,   in  consideration  of  the           aforesaid advance  of the  said sum  of Rs 33 lacs           (Rupees thirty  three lacs only) 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 1133           at Lucknow  of the  sum  of  Rs.33  lacks  (Rupees           thirty three  lacs only)  or any  part thereof, as           the case may be, due to the 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 on the following terms           and conditions:-                                          (Emphasis supplied)           1) The  PCF shall  be sole judge to decide whether           the seller  has failed  to fulfil  any  terms  and           conditions of  the said  advance and on account of           the said failure what amount has become payable to           the PCF under this guarantee           2) This  Guarantee shall  be valid  upto  15  5.84           (Fifteenth  May  1984)  after  which  period  this           guarantee shall stand cancelled and revoked.           3) The  claims of  the PCF,  if  any,  under  this           guarantee, must  reach the  Bank on  or before the

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         date of  expiry of  this guarantee  and after  the           date of  expiry, no  claim will  be entertained by           the Bank.           4) The Bank shall not revoke this guarantee in any           case before  its expiry  date of  15.5 1984 except           with the writ- ten permission of the PCF."      I have  set out  in  extenso  the  terms  in  order  to highlight the  fact that  under the  terms agreed to between the parties, there is no scope of injunction .      The trial  Court in  its judgment  held that  the  Bank should be kept to fulfil its obligations and commitments and the Court  should not come in the way But that principle was distinguished by  the High  Court on  the  ground  that  the respondent was  seeking relief  against the U.P. Cooperative Federation Ltd. and the subject matter of the dispute itself being as  to whether the bank guarantee could be invoked and encashed The  High Court was of the view that even otherwise it cannot  be doubted that the appellant cannot be permitted to take  advantage of illegally invoking a bank guarantee on a technical  plea that  the guarantee was independent of the contract and  involving only the bank and the opposite party at pleasure. The High Court was of the view that prima facie it appeared that the plant was handed over 1134 after a  trial run  and that  the commercial  production had started and A this has not been assailed as a fact. The High Court was  of the  view, that  in these  circumstances  this cannot be  said that  the invocation  order  was  final  and irrevocable. The  High Court  was further  of the  view that having taken  over  the  possession  of  the  plant  it  was necessary to consider all the aspects and held that the bank guarantees could  not be  invoked. The High Court was of the view  that   it  was  not  a  question  of  restraining  the performance of any bank guarantee.      I am,  however, unable  to agree.  The principles  upon which the bank guarantees could be invoked or restrained are well-settled  our   attention  was  also  drawn  to  several decisions of  the High  Court as  well  as  of  this  Court. Reference  had  also  been  made  to  some  of  the  English decisions.  So  far  as  the  position  of  English  law  is concerned, the  principles by  now are  well-settled. I will refer to some of the decisions and explain the position.      The question  arose  before  the  Court  of  Appeal  in England in  Hamzeh Melas  & Sons  v. British Imex Industries Ltd., [1958] 2  Q.B  .D.  127.  There  the  plaintiffs,  a Jordanian firm,  contracted to purchase from the defendants, a British  firm, a  large quantity of reinforced steel rods, to be  delivered  in  two  instalments  Payment  was  to  be effected by  the opening  in favour of the defendants of two confirmed letters  of credit  with the Midland Bank Ltd., in London, one  in respect  of each  instalment. The letters of credit were  duly opened  and the  first was realized by the defendants on  the delivery  of the  first  instalment.  The plaintiffs complained  that  instalment  was  defective  and sought an  injunction to  bar the  defendants from realizing the second  letter of  credit. Justice  Donovan refused  the application. The  plaintiffs appealed to the Court of Appeal in England.  It was  held that  although the  Court had wide jurisdiction to  grant injunction,  this was  not a  case in which, in the exercise of its discretion, it ought to do so. The Court  of Appeal emphasised that an elaborate commercial system had  been built  up on  the footing  that a confirmed letter of  credit constituted  a bargain  between the banker and the  vendor of  the goods, which imposed upon the banker an absolute  obligations to pay, irrespective of any dispute

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there might  be between the parties whether or not the goods were up  to contract.  The  principle  was  that  commercial trading must go on the solemn guarantee either by the letter of credit  or by  bank  guarantee  or  irrespective  of  any dispute between contracting parties whether or not the goods were upto  contract. The  banks cannot  be absolved of their responsibility to  meet the  obligations. Lord  Jenkins L.J. Observed that a vendor of goods selling against a con 1135 firmed letter of credit was selling under the assurance that nothing would  prevent it from receiving the price. That was of no  mean advantage when goods manufactured in one country were sold  in another. Though, in this case no international trade was  involved, bank  guarantee was  uninvocable and on that  assurance   parties  have   bargained  This  principle enunciated by Lord Justice Jenkins has been invokved by this Court in some decisions in case of confirmed bank guarantee.      The Court  of Appeal in England had occasion once again to consider  this question  in Elian and Rabbath (Trading as Elian &  Rabbath). v.  Matsas and  Matsas &  ors., [1966]  2 Lloyd’s List  Law Reports  495. In  that case injunction was granted to  prevent irretrievable injustice. There the facts were peculiar In that case the first defendants’ Greek motor vessel Flora  M was  chartered by  Lebanese  charterers  for carriage of  plaintiffs’ cargo  (consigned to  Hungary) from Beirut to  Rijeka.  Discharge  was  delayed  at  Rijeka  and shipowners exercised  lien on  cargo in respect of demurrage Third defendant bank put up guarantee in London in favour of second  defendants  (first  defendants’  London  agents)  to secure release  of cargo.  There was a claim by Yugoslavians to distrain  on goods,  involving ship  in further delay and master of  Flora M,  on lifting  original lien,  immediately exercised another  lien in respect of extra delay (which was raised when Hungarian buyers put up  2000) Two years later, shipowners claimed  arbitration with  charterers  to  assess demurrage for  which first lien was exercised and claimed to enforce  guarantee.   Plaintiff  claimed   declaration  that guarantee  was   not  valid   and  injunction   to  restrain shipowners or  their agents  from enforcing  guarantee First and  second   defendants  appealed   against   granting   of injunction by  Blain, J.  It was held by the Court of Appeal that it  was a  special case in which the Court should grant an  injunction   to  prevent  what  might  be  irretrievable injustice. Lord  Denning, M  R., observed  that although the shippers  were   not  parties   to   the   bank   guarantee, nevertheless they had a most imporant interest in it. If the Midland Bank  Ltd., paid  under this  guarantee, they  would claim against  the Lebanese  bank, who  in turn  would claim against  the  shippers.  The  shippers  would  certainly  be debited with  the account.  On being  so debited, they would have to  sue the  shipowners for  breach  of  their  promise express or implied, to release the goods. Lord Denning, M R, further posed the question were the shippers to be forced to take that  course? or  can they short-circuit the dispute by suing the  shipowners at  once for an injunction? He further observed on  page 497  of the Report that this was a special case in  which injunction should be granted. Lord Denning, M R. went on to observe that 1136 there was a prima facie ground for saying that, on the telex messages A  which passed  (and indeed,  on the  first  three lines of the guarantee) the shipowners promised that, if the bank guarantee  was given,  they would release the goods. He further observed that the only lien they had in mind at that time was  the lien  for demurrage.  But would anyone suppose

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that the  goods would  be held for another lien? It can well be argued  that the guarantee was given on the understanding that the  lien was  raised and  no further lien imposed, and that when  the shipowners,  in breach  of that understanding imposed a  further lien,  they were  disabled from acting on the guarantee  But as  mentioned here-in-before,  this was a very special case and I shall notice that Lord Denning, M R. treated this as a very special case and in later decision he expressed his views on this matter.      This question was again considered by the Queen s Bench Division by  Mr. Justice Kerr in R.D. Harbottle (Mercantile) Ltd. and  Another v.  National Westminister  Bank  Ltd.  and others, [1977]  2 All  England Law Reports 862. In this case injunction  was  sought  on  a  question  in  respect  of  a performance bond. The learned Single Judge Kerr, J. gave the following views:-           "i) only  in exceptional  cases would  the  courts           interfere  with   the  machinery   of  irrevocable           obligations assumed  by banks.  In the  case of  a           confirmed performance  guarantee, just  as in  the           case of a confirmed letter of credit, the bank was           only concerned  to ensure  that the  terms of  its           mandate and  confirmation had  been complied  with           and was  in no  way concerned with any contractual           disputes  which  might  have  arisen  between  the           buyers and sellers. Accordingly, since demands for           payment had  been made  by the  buyers  under  the           guarantees and  the plaintiffs had not established           that the  demands were fraudulent or other special           circumstances,   there   were   no   grounds   for           continuing the injunctions.           "ii) It  was right  to discharge  the  injunctions           against the  bank,  the  fact  that  the  Egyptian           defendants had  taken no  part in  the proceedings           could not  be a  good ground for maintaining those           injunctions.     Further,      equally      strong           considerations applied  in favour of the discharge           of   the    injunctions   against   the   Egyptian           defendants, and  their failure  to participate  in           the proceedings  did not  preclude the  court from           discharging the injunctions against them." 1137      In my  opinion the  aforesaid  represents  the  correct state of  the A  law. The  Court dealt  with three different types of cases which need not be dilated here      In  Edward  Owen  Engineering  Ltd.  v.  Barclays  Bank International Ltd.,  [1978] 1 All England Law Reports 1976. English suppliers,  entered  into  a  contract  with  Libyan buyers to  supply goods  to them  in Libya  The contract was subject to  a condition  precedent that the plaintiffs would arrange for a performance bond or guarantee to be given, for ten per cent of the contract price, guaranteeing performance of their  obligations under  the contract.  Accordingly, the plaintiffs instructed  the defendants  their bankers to give on their behalf a performance guarantee for the sum of pound 50,203.  Acting   on  those   instructions  the   defendants requested a  bank in  Libya to issue performance bond to the buyers for  that sum, and promised the Libyan bank that they would pay  the amount  of the  guarantee  on  first  demand, without any  conditions or  proof. The  Libyan bank issued a letter of  guarantee for  pound 50,203  to  the  buyers  The contract between  the plaintiffs and the buyers provided for payment of  the price  of the  goods supplied by a confirmed letter of  credit. The letter of credit opened by the buyers was not  a confirmed letter of credit and did not therefore,

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comply with  the contract Because of that non-compliance the plaintiffs repudiated  the contract.  Although  it  was  the buyers who appeared to be in default and not the plaintiffs, the buyers  nevertheless claimed  on the  guarantee given by the Libyan  bank who  in turn claimed against the defendants on the guarantee they had given The plaintiffs issued a writ against the  defendants claiming  an injunction  to restrain them from  paying any  sum under the performance guarantee A judge granted  the plaintiffs  an interim  injunction in the terms of the injunction claimed by the writ but subsequently another  judge  discharged  the  injunction  The  plaintiffs appealed to the Court of Appeal in England. It was held by a Bench consisting  of Lord Denning M. R., Browne and Geoffrey Lane, LJ  that a  performance guarantee  was  similar  to  a confirmed letter  of credit.  Where therefore,  a  bank  had given a  performance guarantee it was required to honour the guarantee according  to its  terms  and  was  not  concerned whether either  party to  the contract  which  underlay  the guarantee was in default The only exception to that rule was where fraud by one of the parties to the underlying contract had been  established and  the bank had notice of the fraud. Accordingly,  as  the  defendants’  guarantee  provided  for payment on  demand without  proof or  conditions, and was in the nature  of a  promissory note  payable on demand and the plaintiffs had  not established  fraud on  the part  of  the buyers, the defendants were re- 1138 quired to  honour their  guarantee on the demand made by the Libyan Bank.  It followed  that the  judge had been right to discharge the  injunction  and  that  the  appeal  would  be dismissed.      Lord Denning,  M.R. held that Justice Kerr was right in discharging the injunction and reiterated that the bank must honour its  commitment. The principle must be that upon that basis trade  and commerce are conducted. Lord Denning, M.R., indicated at  page ’984  that seeing that the bank must pay, and will  probably come  down on  the English  suppliers  on their counter-guarantee, it followed that the only remedy of the English  suppliers was  to sue  the Libyan customers for damages. The  contract contained  a clause  giving exclusive jurisdiction to the courts of Libya.      In the instant case, the learned Judge has proceeded on the basis that this was not an injunction sought against the bank  but   this  was  the  injunction  sought  against  the appellant But  the  net  effect  of  the  injunction  is  to restrain the  bank from  performing the  bank guarantee That cannot be  done. One  cannot do  indirectly what  one is not free  to   do  directly.   But  a  maltreated  man  in  such circumstances is  not remedyless  The respondent  was not to suffer any injustice which was irretrievable. The respondent can sue the appellant for damages. In this case there cannot be any  basis for  apprehension that  irretrievable  damages would be caused if any. I am of the opinion that this is not a case  in which injunction should be granted An irrevocable commitment either in the form of confirmed bank guarantee or irrevocable letter  of  credit  cannot  be  interfered  with except  in   case  of  fraud  or  in  case  of  question  of apprehension of  irretrievable injustice  has been made out. This is  the well-settled  principle of  the law in England. This is  also a well-settled principle of law in India, as I shall presently  notice from  some of  the decisions  of the High Court and decisions of this Court.      In the  instant case there was no fraud involved and no question of irretrievable in justice was involved.      Before, however,  I deal  with the  decisions of  India

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reference may be made to a decision of the House of Lords in United City Merchants (Investments) Ltd. and others v. Royal Bank of  Canada and others, [1982] 2 All England Law Reports 720 where  it  was  reiterated  that  the  whole  commercial purpose  for  which  the  system  of  confirmed  irrevocable documentary credits  had  been  developed  in  international trade was to give the seller of goods an assured right to be paid before he 1139 parted with control of the goods without risk of the payment being refused  reduced or deferred because of a dispute with the buyer.  It followed that the contractual duty owed by an issuing or confirming bank to the buyer to honour the credit notified by  him on  presentation of  apparently  conforming documents by  the seller  was  matched  by  a  corresponding contractual liability  on the part of the bank to the seller to pay  him the  amount of the credit on presentation of the documents The bank’s duty to the seller was only vitiated if there was  fraud on  the part  of the  seller, and  the bank remained under a duty to pay the amount of the credit to the seller even  if the documents presented, although conforming on their  face with  the terms  of the  credit, nevertheless contained  a   statement  of  material  fact  that  was  not accurate. These  principles must in my opinion apply in case of bank guarantees in internal trade within a country.      I may  notice that in India, the trend of law is on the same line In the case of Texmaco Ltd. v. State Bank of India and others,  A.I.R. 1979  Calcutta 44, one of us (Sabyasachi Mukharji) held  that in  the  absence  of  special  equities arising from  a particular situation which might entitle the party on  whose behalf  guarantee is  given to an injunction restraining the bank in performance of bank guarantee and in the absence  of any  clear fraud,  the Bank  must pay to the party in  whose favour  guarantee is  given on demand, if so stipulated, and  whether the terms are such have to be found out from  the performance guarantee as such. There the Court held that  where though  the guarantee  was  given  for  the performance by  the party  on  whose  behalf  guarantee  was given, in  an orderly manner its contractual obligation, the obligation was undertaken by the bank to repay the amount on "first demand"  and ’without  contestation, demur or protest and without  reference to such party and without questioning the legal relationship subsisting between the party in whose favour guarantee  was given  and the  party on  whose behalf guarantee was given," and the guarantee also stipulated that the bank should forthwith pay the amount due notwithstanding any dispute between the parties," it must be deemed that the moment a  demand was  made without protest and contestation, the bank  had obliged  itself to  pay  irrespective  of  any dispute as  to whether  there had  been  performance  in  an orderly manner  of the  contractual obligation by the party. Consequently, in  such a  case, the  party on  whose  behalf guarantee was  given  was  not  entitled  to  an  injunction restraining the  bank in  performance of  its  guarantee  It appears that  special equities  mentioned therein  may be  a situation where  the injunction  was sought  for to  prevent injustice which  was irretrievable  in  the  words  of  Lord Justice Danckwerts in Elian and 1140 Rabbath (Trading  as Elian & Rabbath) v. Matsas and Matsas & Ors. (supra).      The same  view was  more or  less expressed by the High Court of  Calcutta in its decision in the case of State Bank of India  v. The  Economic Trading  Co. S.A.A.  and  others, A.I.R. 1975 Calcutta 145. See also a decision in the case of

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B.S. Aujla  Company Pvt.  Ltd. v. Kaluram Mahadeo Prosad and others, A.  I . R . 1983 Calcutta 106. In the instant case I have emphasised the terms of the Bank guarantee.      Our attention  was  drawn  to  Bench  decision  of  the Allahabad High  Court in  the case  of Union  of  India  and others v.  Meena Steels Ltd. and Another, AIR 1985 Allahabad 282. There  a  suit  by  a  company  was  filed  restraining Railways to  encash bank guarantee. In that suit application was made for temporary injunction. The Court was of the view that the  matter would  still be referred to arbitration and in those  circumstances if bank guarantees were permitted to be encashed,  if would  be improper. I am however, unable to sustain this  view, in view of the well-settled principle on which bank guarantees are operated.      Our attention  was also  drawn to  the judgment  of the learned single  Judge of  the  Madras  High  Court  in  Arul Murugan Traders  v. Rashtriya Chemicals and Fertilizers Ltd. Bombay and another, A.I.R. 1986 Madras 161 where the learned Single  Judge  expressed  the  opinion  that  there  was  no absolute  rule   prohibiting  grant  of  interim  injunction relating to  Bank guarantees  and in exceptional case courts would  interfere   with   the   machinery   of   irrevocable obligations assumed  by banks,  and that  the plaintiff must establish prima  facie case, meaning thereby that there is a bona fide contention between the parties or serious question to be  tried and further the balance of convenience was also a relevant  factor. If  the element  of fraud  exists,  then courts step in to prevent one of the parties to the contract from deriving  unjust enrichment by invoking bank guarantee. In that case the learned Single Judge came to the conclusion that the  suit involved  serious questions  to be  tried and particularly relating  to the  plea of  fraud, which  was  a significant factor  to be  taken into  account and claim for interdicting the  enforcement of  bank guarantee should have been allowed.      I am  however, of  the opinion  that these observations must be  strictly considered  in the  light of the principle enunciated. It  is not  the decision  that there should be a prima facie case. In order to restrain 1141 the operation  either of  irrevocable letter of credit or of confirmed letter  of credit  or  of  bank  guarantee,  there should be  serious dispute  and there  should be  good prima facie case  of fraud  and special  equities in  the form  of preventing  irretrievable  injustice  between  the  parties. Otherwise the  very purpose  of  bank  guarantees  would  be negatived and  the fabric  of  trading  operation  will  get jeopardised.      In Tarapore  & Co.  Madras v.  M/s V/o Tractors Export, Moscow and  Anr. [1969]  2 S  R 920 this Court observed that irrevocable letter  of credit had a definite implication. It was independent  of and  unqualified by the contract of sale or other  underlying transactions.  It was  a  machanism  of great importance in international trade and any interference with that  mechanism was bound to have serious repercussions on  the  international  trade  of  this  country  The  Court reiterated that  the autonomy  of an  irrevocable letter  of credit  was  entitled  to  protection  and  except  in  very exceptional circumstances  courts should  not interfere with that autonomy      These observations a fortiori apply to a bank guarantee because upon  bank guarantee  revolves many  of the internal trade and  transactions in  a country.  In United Commercial Bank v.  Bank of India and others, [1981] 3 S C.R. 300, this Court was  dealing with  injunction restraining  the bank in

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respect of  letter of  credit. This  Court observed that the High Court  was wrong  in granting  the temporary injunction restraining the  appellant bank  from recalling  the  amount paid to  the respondent  bank. This  Court  reiterated  that Courts usually  refrain from granting injunction to restrain the performance  of the  contractual obligations arising out of a  letter of credit, or a bank guarantee between one bank and another. If such temporary injunction were to be granted in a  transaction between a banker and a banker, restraining a bank  from recalling  the amount due when payment was made under reserve  to another  bank or in terms of the letter of guarantee or  credit executed by it the whole banking system in the country would fail      The Court  however, observed  that  the  opening  of  a confirmed letter of credit constituted a bargain between the banker and  the seller  of the  goods which  imposed on  the banker an  absolute obligation  to pay.  The banker  was not bound or  entitled to  honour the bills of exchange drawn by the seller  unless they  and such  accompanying documents as might be  required thereunder, were in exact compliance with the terms of the credit.      This principle  was again  reiterated by  this Court in Centax 1142 (India) Ltd.  v. Vinmar  Impex Inc.  and  others,  [1986]  4 S.C.C. 136  A where  the appellant  entered into  a contract with the  respondent company  of  Singapore  for  supply  of certain goods  to it.  The Contract,  inter alia  stipulated that the  bills of  lading  should  mention  ’shipping  mark 5202’. Pursuant  to the  contract, at  the  request  of  the appellant the  Allahabad Bank  opened a letter of credit, it favour  of   the  respondent.   The   respondent   thereupon despatched the goods covered by the bills of lading      This Court  was concerned  with the  bank guarantee and referred to  the previous  decision of  this Court in United Commercial Bank  v. Bank  of India and others, (supra). This Court found  that this  case was covered. The Court observed that the  Court should  not, in transaction between a banker and banker,  grant an  injunction at  the  instance  of  the beneficiary of  an irrevocable letter of credit, restraining the issuing  bank  from  recalling  the  amount  paid  under reserve from  the negotiating  bank, acting on behalf of the beneficiary against  a document  of guarantee,  indemnity at the instance of the beneficiary      On the  basis of  these  principles  I  reiterate  that commitments of banks must be honoured free from interference by the  courts. Otherwise,  trust in  commerce internal  and international would  be irreparably  damaged. It  is only in exceptional cases that is to say in case of fraud or in case of  irretrievable   injustice  be  done,  the  Court  should interfere.      Mr. Tarkunde  submitted before us that in this case the grievance of  the appellant  was that  there  was  delay  in performance and  defective machinery  had been  supplied. He submitted that  if at  this stage  appellant was  allowed to enforce  the  bank  guarantee,  damage  would  be  done.  He submitted before us that appellant could not be permitted to take advantage of illegality by invoking the bank guarantee. But in  my opinion these contentions cannot deter us in view of the  principle well-settled  that  there  should  not  be interference  in   trade.  This   is  not   a   case   where irretrievable injustice would be done by enforcement of bank guarantee. This  is also  not a  case where  a strong  prima facie case  of fraud in entering into a transaction was made out. If that is the position, then the High Court should not

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have interfered with the bank guarantee.      In the  aforesaid view  of the matter, this appeal must be allowed  The Judgment  and order  or the  Allahabad  High Court dated  20 2.87  must be set aside and the order of the learned civil Judge Lucknow dated 8.8 86 restored. 1143      In the facts and circumstances of the case parties will bear their own costs of this appeal.      JAGANNATHA SHETTY,  J. l  agree respectfully  with  the judgment of  my learned  brother Sabyasachi  Mukherji, J.  I wish, however,  to draw  attention to some of the aspects of the matter  to which  I attach  importance. The  crux of the matter relates to the obligation assumed by the bank under a performance guarantee.  Whether the obligation is similar to the one  arising under a letter of credit? Whether the Court could interfere  in regard  to such  obligation, and  if so, under what  circumstances? These are the questions raised in this appeal.      The facts which are relevant for my purpose are these:      On May  17, 1983,  M/s. Singh  Consultants &  Engineers      (Pvt.) Ltd.  ("SCE (P)  Ltd.") entered  into a contract      with U.P.  Cooperative Federation  Ltd. ("UPCOF  Ltd.")      for constructing  a Vanaspati  manufacturing  plant  at      Haldpur, District  Nainital, U.P. The contract required      that UPCOF Ltd. should be given two bank guarantees for      proper construction and successful commissioning of the      plant. In accordance with the terms of the contract,the      Bank of  India gave  two guarantees  in favour of UPCOF      Ltd.,   one    for   Rs.16,50,000   and   another   for      Rs.33,00,000.   These   contain   similar   terms   and      conditions. Thereunder,  the bank has undertaken not to      revoke the  guarantee in any event before the expiry of      the due  date. The  Bank has  also undertaken  to  make      unconditional payments  on demand. without reference to      SCE (P) Ltd. The guarantee also provides that the UPCOF      Ltd. was  the sole  judge for  deciding whether  SCE(P)      Ltd. has  fulfilled the  terms of  the contract or not.      The guarantee  was thus  undisputedly irrevocable  with      absolute discretion for UPCOF Ltd. to invoke the same.      The  dispute  arose  between  the  parties  as  to  the erection and  performance of  the  plant.  The  SCE(P)  Ltd. apprehending that  the bank  guarantees would  be invoked by the UPCOF  Ltd, approached  the Court  of the  Civil  Judge, Lucknow for a restraint order against the latter. The action was brought  under Sec.  41 of the Arbitration Act read with order 39  r.  1  and  2  of  the  Code  of  Civil  Procedure contending inter-alia,  that there  was no  default  in  the construction or delivery of possession of the plant. But the UPCOF Ltd.  had a  different version.  It contended that the construction  was   not  within   the  time   schedule   and performance of the plant was not up to the mark. It also 1144 contended that  the Court should not grant injunction in the matter.      The trial  court refused  to interdict  UPCOF Ltd.  the SCE(P) Ltd.  took up  the matter  in revision before Lucknow Bench of  the Allahabad High Court. The learned Judge before whom the  matter came  up for  disposal was of the view that SCE(P) Ltd.  has made  out a prima facie case . It has prima facie proved  that the plant was delivered after a trial run and commercial  production had  started. So stating, learned Judge allowed  the revision  and granted  the relief  sought for. The  UPCOF Ltd.  was restrained  from invoking the bank guarantees. The  learned Judge,  however, issued a direction to SCE(P)  Ltd. to keep alive the bank guarantees during the

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pendency of the arbitration proceedings.      The UPCOF Ltd. by special leave has come up before this Court challenging  the validity  of the  order of  the  High Court. The Primary question for consideration is whether the High Court  was justified  in restraining the appellant from invoking the  Bank guarantees?  The submission  of Mr.  A.B. Diwan learned  counsel for  the appellant  rested on the law governing the irrevocable letter of credit where courts keep themselves away  from the liability assumed by the banks. In support of  the submission, the counsel strongly relied upon the two  decisions of this Court: (i) United Commercial Bank v.. Bank  of India  & Ors., [1981] 3 SCR 300 and (ii) Centax (India) Ltd.  v. Vinmar  Impex Inc. & Ors. [1986] 4 SCC 136. Mr. V.M. Tarkunde, learned counsel for the respondent or the other hand,  urged that  both the  said  decisions  are  not relevant since  the present  case concerns  with rights  and obligations of  parties under  a construction  contract. The rights under the contract in question are justiciable in the Court of  law. The  performance guarantee  given by the Bank flows from  the terms  of the construction contract. But the issues to  be determined  in the  suit do  not relate to the obligations of  the bank  under the guarantees given and the bank is  also not  a party  to the suit. The counsel further urged that the respondent has established a prima facie case to justify the grant of injunction and this Court should not interfere with the discretionary relief granted.      The argument  for the  respondent is  attractive but it seems to  overlook the  basic nature  of the case. The basic nature of the case relates to the obligations assumed by the bank under  the guarantees given to UPCOF Ltd. If under law, the bank  cannot be  prevented by  SCE(P) Ltd from honouring the  credit  guarantees,  the  UPCOF  Ltd.  also  cannot  be restrained from invoking the guarantees. What applies 1145 to the  bank must equally apply to UPCOF Ltd. Therefore, the frame of the suit by not impleading the bank cannot make any difference in  the position  of law.  Equally, it  would  he futile to  contend that  the court was justified in granting the injunction  since it  has found  a prima  facie case  in favour of  the SCE(P)  Ltd. The  question of  examining  the prima facie case or balance of convenience does not arise if the court cannot interfere with the unconditional commitment made by the bank in the guarantees in question.      The modern  documentary  credit  had  its  origin  from letters of  credit. We  may, therefore, begin the discussion with the traditional letter of credit. Paul R. Verkuil in an article [Bank  Solvency  and  Guaranty  Letters  of  Credit, Standford Law Review V. 25 (1972-73 at p. 719)] explains the salient features of a letter of credit in these terms: C           "The letter  of credit  is a contract. The issuing           party-usually   a   bank-promises   to   pay   the           ’beneficiary’-traditionally a  seller of  goods-on           demand  if   the  beneficiary   presents  whatever           documents may  be required by the letter. They are           normally the  only two  parties  involved  in  the           contract. The bank which issues a letter of credit           acts  as   a  principal,  not  as  agent  for  its           customer, and  engages its  own credit. The letter           of credit  thus ’evidences-irrevocable  obligation           to honour  the draft  presented by the beneficiary           upon compliance with the terms of the credit."      The letter  of credit  has been developed over hundreds of years  of international  trade. It was most commonly used in conjunction with the sale of goods between geographically distant parties.  It was intended to facilitate the transfer

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of goods between distant and unfamiliar buyer and seller. It was found  difficult for  the seller to rely upon the credit of an  unknown customer.  It was  also found difficult for a buyer to  pay for  goods prior to their delivery. The bank’s letter of  credit came into existence to bridge this gap. In such transactions, the seller (beneficiary) receives payment from issuing  bank when he presents a demand as per terms of the documents.  The bank  must pay  if the  documents are in order and  the terms  of credit  are  satisfied.  The  bank, however, was not allowed to determine whether the seller had actually shipped the goods or whether the goods conformed to the requirements  of the  contract. Any  dispute between the buyer and the seller must be settled between themselves. The Courts, however,  carved out  an exception  to this  rule of absolute independence.  The Courts  held that  if there  has been "fraud in the transaction 1146 the bank  could dishonour  beneficiary’s demand for payment. The A  Courts have generally permitted dishonour only on the fraud of the beneficiary, not the fraud of somebody else.      It was perhaps for the first time the said exception of fraud to  the rule of absolute independence of the letter of credit has been applied by Shientag, J. in the American case of Sztejn  v. J.  Henry Schroder  Banking  Corporation,  (31 N.Y.S. 2d  631). Mr. Sztejn wanted to buy some bristles from India and so he entered into a deal with an Indian seller to sell him  a quantity.  The issuing  bank issued  a letter of credit to the Indian seller that provided that, upon receipt of  appropriate  documents,  the  bank  would  pay  for  the shipment. Somehow  Mr. Sztejn  discovered that  the shipment made was  not crates  of bristles,  but crates  of worthless material and  rubbish. He  went to  his bank  which probably informed him  that the  letter of  credit was an independent undertaking of the bank and it must pay.      Mr. Sztejn  did not  take that sitting down. He went to court and  he sought  an injunction. Now in 1941 people just did not  get injunctions  against payment  under letters  of credit. The  defendant bank, against its customer, filed the equivalent of  a motion  to dismiss  for failure  to state a claim. In  that posture all the allegations of the complaint were taken  as true,  and those allegations were gross fraud that the  holders in  due course  were  involved.  On  those facts, the court issued an injunction against payment.      The exception  of fraud  created in  the above case has been codified  in sec. 5-114 of the Uniform Commercial Code. It has  been accepted  by Courts in England. See: (i) Hamzeb Milas and  Sons v. British Lmex Industries Ltd. [1958] 2 QBD 127], (ii)  R.D. Harbottle  (Mercantile) Ltd. and another v. National West-Minister  Bank Ltd.  [1977] 2  All  E.R.  862; (iii)  Edward   Owen  Engineering   Ltd.  v.  Barclays  Bank International Ltd.,  [1978]  l All  E.R. 976  and (iv)  UCM (Investment) v. Royal Bank of India, [1982] 2 All E.R. 720. The last case is of the House of Lords where Lord Diplock in his speech said (at p. 725):                "The whole  commercial purpose  for which the           system  of   confirmed   irrevocable   documentary           credits has  been developed in international trade           is to  give to  the seller  an assured right to be           paid before he parts with control of the goods and           that does  not permit  of the any dispute with the           buyer as  to the  performance of  the contract  of           sale being  used as  a ground  for non-payment  or           reduction or deferment of payment. 1147                "To this general statement of principle as to

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         the contractual obligations of the confirming bank           to the seller, there is one established exception:           that is,  where the  seller, for  the  purpose  of           drawing on the credit, fradulently presents to the           confirming bank  documents that contain, expressly           or by  implication,  material  representations  of           fact that  to his  knowledge are  untrue. Although           there  does   not   appear   among   the   English           authorities any  case in  which this exception has           been  applied,  it  is  well  established  in  the           American cases, of which the leading or ’landmark’           case is  Sztejn v. Henry Schroder Banking Corp., [           1941] 3  1 NYS  2d 63  1. This judgment of the New           York  Court   of  Appeals  was  referred  to  with           approval by  the English Court of Appeal in Edward           Owen   Engineering    Ltd.   v.    Barclays   Bank           International Ltd.  [1978]  1 All E.R. 979 (1978)           QB 159  though this  was actually  a case  about a           performance  bond   under  which  a  bank  assumes           obligation to  a buyer  analogous to those assumed           by  a  confirming  bank  to  the  seller  under  a           documentary credit. The exception for fraud on the           part of  the beneficiary  seeking to avail himself           of the  credit is a clear application to the maxim           ex trupi  cause  non  oritur  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 a fraud."      This was  also the  view taken  by this Court in United Commercial Bank  case [1981]  3 SCR  300. There A.P. Sen, J. speaking for the Court, said (pages 323 and 324):                "The rule  is well  established that  a  bank           issuing or  confirming a  letter of  credit is not           concerned with the underlying contract between the           buyer and  seller. Duties of a bank under a letter           of credit  are created by the document itself, but           in any case it has the power and is subject to the           limitations which  are given  or imposed by it, in           the absence  of the  appropriate provisions in the           letter of credit.                "It is  somewhat unfortunate  that  the  High           Court should  have granted a temporary injunction,           as it  has been done in this case, to restrain the           appellant from  making a  recall of  the amount of           Rs.85,84,456 from  the Bank  of India  in terms of           the letter  of guarantee  or indemnity executed by           it.  The  courts  usually  refrain  from  granting           injunction to 1148           restrain  the   performance  of   the  contractual           obligations arising out of a letter of credit or a           bank guarantee  between one  bank and  another. If           such temporary injunctions were to be granted in a           transaction  between   a  banker   and  a  banker,           restraining a  bank from  recalling the amount due           when payment is made under reserve to another bank           or in  terms of  the letter of guarantee or credit           executed by  it, the  whole banking  system in the           country would fail.                "In view  of the banker’s obligation under an           irrevocable letter  of credit  to pay,  his buyer-           customer cannot instruct him not to pay."      In Centax  (India) Ltd.,  [1986] 4 SCC 136, this Court again speaking  through A.P.  Sen, J. following the decision in the  United Commercial Bank case said: "We do not see why

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the same principles should not apply to a banker’s letter of indemnity."      It is  true that both the decisions of this Court dealt with  a   contract  to   sell  specific   commodities  or  a transaction of  sale of  goods with an irrevocable letter of credit.  But  in  modern  commercial  transactions,  various devices are  used to  ensure performance  by the contracting parties. The  traditional letter  of credit  has taken a new meaning. In  business circles, standby letters of credit are also used.  Performance bond and guarantee bond are also the devices increasingly  adopted in  transactions.  The  Courts have treated such documents as analogous to letter of cedit.      A case  involving the  obligations under  a performance guarantee was  considered by  the Court  of Appeal in Edward Owen Engineering  Ltd. v. Barclay’s Bank International Ltd., [1978]  1 All  E.R. 976.  The facts in that case are these: English sellers  entered into a contract to supply and erect glass-houses in  Libya. The  Libyan buyers  were to  open an irrevocable letter  of credit  in favour of the sellers. The sellers told  their  English  bank  to  give  a  performance guarantee. The  English bank  instructed a  Libyan  bank  to issue a  performance bond  in favour  of the  buyers  for  a certain sum  and gave  their  guarantee  payable  on  demand without proof  or conditions  to cover  that sum. The Libyan bank issued  a bond  accordingly. The  sellers  received  no confirmed letter  of credit  and refused to proceed with the contract. The  sellers obtained  in  interim  injunction  to prevent the  English bank  from paying  on the guarantee. On appeal Lord Denning M.R. said: 1149                "So as on takes instance after instance these           performance guarantees  are  virtually  promissory           notes payable  on demand.  So long  as the  Libyan           customers make  an honest  demand, the  banks  are           bound to  pay and  the banks will rarely, if ever,           be in  a position  to know  whether the  demand is           honest or  not. At  any rate they will not be able           to prove it to be dishonest. So these will have to           pay. " And said:                "All this  leads to  the conclusion  that the           performance guarantee  stands on a similar footing           to a  letter of  credit.  A  bank  which  gives  a           performance guarantee  must honour  that guarantee           according to its terms. It is not concerned in the           least with  the relations between the supplier and           the  customer:   nor  with  question  whether  the           supplier has  performed his contractual obligation           or not;  nor with the question whether supplier is           in default  or not. The bank must pay according to           its  guarantees,   on  demand  if  so  stipulated,           without proof or conditions. The only exception is           when there  is a clear fraud of which the bank has           noticed. "      Whether it  is a  traditional letter of credit or a new device like  performance bond  or performance guarantee, the obligation  of   banks  appears  to  be  the  same.  If  the documentary credits  are irrevocable  and  independent,  the banks must  pay when  demand is made. Since the bank pledges its own  credit involving  its reputation, it has no defence except in  the case  of fraud.  The  bank’s  obligations  of course should  not be  extended to  protect the unscrupulous seller, that is the seller who is responsible for the fraud. But, the  banker must be sure of his ground before declining to pay.  The nature  of the fraud that the Courts talk about

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is fraud  of an  "egregious nature  as to vitiate the entire underlying transaction". It is fraud of the beneficiary, not the fraud  of somebody  else. If  the bank  detects  with  a minimal investigation  the fraudulent  action of the seller, the payment  could be  refused. The bank cannot be compelled to honour  the credit  in such  cases. But  it may  be  very difficult for  the bank  to take  a decision  on the alleged fraudulent action. In such cases, it would be proper for the bank  to  ask  the  buyer  to  approach  the  Court  for  an injunction.      The Court,  however, should  not lightly interfere with the operation  of irrevocable  documentary credit.  I  agree with my learned 1150 brother  that   in  order   to  restrain  the  operation  of irrevocable letter of credit, performance bond or guarantee, there should be serious dispute to be tried and there should be a  good prima  facie acts of fraud. As Sir John Donaldson M.R. said  in Bolivinter  oil SA  v. Chase  Mannattan Bank & ors. [1984] 1 All E.R. 35 1 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 discharged."      From the  above discussion, what appears to me is this: The sound  banking system may, however, require more caution in the issuance of irrevocable documentary credits. It would be for  the banks to safeguard themselves by other means and generally not  for the  court to  come to  their rescue with injunctions  unless  there  is  established  fraud.  In  the result, this  appeal must be allowed. The judgment and order of the  Allahabad High Court dated February 20, 1987 must be set aside  and the  order of  learned Civil  Judge,  Lucknow dated August 8, 1986 restored. S.L.                                         Appeal allowed. 1