Banker’s Duty to Honour Guarantee :

Bank guarantees from the foundation of trade and commerce. Even though they are an off shoot of a primary contract between the debtor and creditor, these guarantees are independent commitments taken by bank on behalf of their customer. In most bank guarantees, bank undertakes to make payment merely on demand by the beneficiary. It, therefore, is absolutely necessary that irrespective of the underlying contract and dispute between the parties to the contract, the bank makes payment if the guarantee has been invoked properly.

The obligation of a banker to honour his commitment on a guarantee given by him being primary casts a duty on the bank to honour it irrespective of the disputes between the beneficiary and the debtor (customer).

Bank, having issued a bank guarantee owes a duty to pay the amount undertaken in the guarantee as soon as it is invoked by the beneficiary. Under no pretext can the banker either deny or defer the payment. Once the liability crystallises, bank is obliged first to pay. Its right of recovery arises upon payment of the guaranteed amount.

In an important English case R.D Harbottle Ltd vs. National Westminster Bank Ltd (1978) justice kerr ruled about the bank’s commitment to honour its guarantee as under:

“Such guarantees, even though having their genesis in the primary contract between the parties, are nevertheless autonomous and independent contracts and a blank which has given a performance guarantee must honour that guarantee according to its terms. It is not concerned in the least with the question whether the supplier is in default or not and the only exception is when there is a clear fraud, of which the bank has notice.”

The above principle has been accepted by courts in India and they have refused to grant injunctions against banks from making payment under the guarantee except in cases of fraud or special equities in favour of the person on whose behalf the guarantee has been issued. The decision of the Calcutta High Court in Texmaco Ltd v. State Bank of India (1979) Cal 44, the first among the Indian cases illustrates the duty imposed on a bank to honour its guarantee. In this case the bank had issued a guarantee to STC on behalf of M/s Texmaco Ltd. Wherein the bank irrevocably and unconditionally guarantee the due performance of the contractual obligations of M/s Texmaco and in case of default by Texmaco the bank on first demand by STC guaranteed payment of the amount without any contestation, demur or protest and /or without reference Texmaco and /or without questioning the legal relationship subsisting between Texmaco and STC. The guarantee was invoked by STC upon which Texmaco filed a suit for injunction to restrain the bank from making any payment. In this landmark case the High Court held that:

“In the absence of such special equities and in the absence of any clear fraud, the bank must pay on demand, if so stipulated, and whether the terms are such must have to be found out from the performance guarantees as such ….. Here though the guarantee was given for the performance by Texmaco in an orderly manner their contractual obligation, the obligation was taken by the bank to repay the amount on “first demand” and “without contention, demour or protest and without reference to Texmaco and without questioning the legal relationship subsisting between STC and Texmaco”.

It further stipulated, as I have mentioned before, that the decision of STC as to the liability of the bank under the guarantee and the amounts payable thereunder shall be final and binding on the bank. It has further stipulated that the bank should forthwith pay the amount due “notwithstanding any dispute between STC and Texmaco.” In that context, in my opinion, the moment a demand is made without protest and contestation the bank has obliged itself to pay irrespective of any dispute as to whether there has been –performance in any orderly manner of the contractual obligation by the party.”

The Supreme Court has also considered the liability of a banker on a guarantee and after referring to various English decisions and the decisions of various High Courts held in UP Co-operative Federation v. Singh Consultant [1988 (1) Sec 174] that the 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 are to say in cases of fraud or in case of irretrievable injustice be done, the Court should interfere.