Exceptions :
Cases of fraud:
The Supreme Court in United Commercial Bank v. Bank of India, AIR 1981 SC 1426 observed as follows:
“Except possibly in clear case of fraud of which the banks have notice, the courts will leave the merchants to settle their disputes under the contracts by utilisation or arbitration as available to them or as stipulates in the contracts.”
Fraud has been held to be one of the exceptions to the general rule regarding the contracts of guarantee. A banker who has knowledge of fraud can therefore refuse payment of the amount guaranteed. The question, however, would arise as to whether a banker can decide if a fraud has been committed or not. In such cases, it is advisable that the banks inform their customers about the invocation of the guarantees by the creditors and the bank’s intention to pay within a given time if the customer does not obtain an injunction order. This would relieve the bank of the task of judging as to whether a fraud has been committed or not. On this point the observations of Supreme Court in UP Co-operative Federation vs. Singh Consultants 1988(1) Section 174 is worth-noting. Whether it is traditional letter of a credit or a new device like performance bond or performance guarantee, the obligation of bank 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 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. M/s. Escorts Ltd. vs.M/s. Modern Insulators and another AIR 1988 Delhi 345 also illustrates the point that banks in case of doubt should seek appropriate direction from the court. In this case, the Escorts supplied generating sets to Modern the performance of which was guaranteed by the bank. Modern invoked the guarantees whereupon Escorts moved the court to restrain Modern from recovering the amount and the bank from making payment of the guaranteed sum. The court granted injunction since the guarantee was not invoked properly. Thereafter Modern invoked the guarantee once again but the bank did not pay. The matter came before the High Court and Escorts pleaded that Modern had played a fraud and hence were not entitled to the guaranteed amount. The High Court held that averments of fraud have to be pleaded and proved, which was not done by Escorts of importance of this judgment is the Court’s remark as regards the conduct of the bank. The court remarked that the bank should have approached the court for appropriate directions if it had any doubts. Merely because an application for injunction was made would not be as ground for the bank not to honour its commitment under the bank guarantee. It is therefore important to ensure that a clear-cut case of fraud is established before a bank can refuse payment.
If there is any possibility of an irretrievable harm or injustice to one of the parties concerned, the courts would injunct from making payment. As an illustration to the exception, the Supreme Court cited and approved the decision of the US Court in Itek Corp. v. First National Banks of Boston (566 Fed. Supp 1210). In this case an exporter in USA entered into an agreement with the Imperial Government of Iran and Sought on order 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 revolutions when the American Government cancelled the export licenses in relation to Iran and the Iranian Government had forcibly taken 52 American citizens as hostages.The US Government had blocked all Iranian assets under the jurisdiction of Unites 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 Court would not be executable in Iran under these circumstances and realization of the bank guarantee letters of credit would cause irreparable harm to the plaintiff. This contention was upheld. To avail this exception, therefore, exceptional circumstances which make it impossible for the guarantor to reimburse himself if he ultimately succeeds will have to be decisively established. Clearly, as mere apprehension that the other party will not be able to pay, is not enough.