Liability of Bank under a Bank Guarantee Given on behalf of a Company Ordered to be wound up :

Liability of a bank on a guarantee issued by it on behalf of a company that was being wound up is well – established now thanks to Supreme Court’s landmark judgment in the case Maharashtra Electricity Board, Bombay v. Official Liquidator, High Court of Ernakulum and another (AIR 1982, SC 1497). The facts of the case are as under:

The Cochin Malleable private Ltd. (Company) entered into a contact with Maharashtra State Electricity Board, Bombay (Board) for supply of goods from time to time. As per the terms of the contract the company furnished a bank guarantee for Rs. 50,000/- as Earnest Money Deposit. As per the guarantee given by Canara Bank, the bank agreed unequivocally and unconditionally to pay within 48 hours on demand in writing from the board a sum not exceeding Rs.50,000/- on 30 July 1973, a petition for winding up of the company was presented and the High Court, Kerala, on 16 September 1974, ordered the company to be wound up. On 27 August 1973 the board called upon the bank to pay the guarantee amount of Rs. 50000/- followed by several reminders and final demand was made on 23 July 1974.

On 4 November 1974 the Bank wrote to the official Liquidator stating that the company was liable to the bank for payment of Rs. 164353=12 which included the guaranteed amount. Thereupon, the Official Liquidator filed an application before the Company Judge, praying for an order restraining the Board from realizing the amount covered by the bank guarantee on the ground that since the company was ordered to be wound up, the board could not claim payment under the bank guarantee.

The learned Company Judge upheld the plea of the official liquidator and issued on order restraining the Board from realizing the amount from the bank. The Board filed on appeal to the Division bench of the High Court, Which was also dismissed. The Board thereupon approached to the Supreme Court. Supreme Court held that: ‘Where under a letter of guarantee the bank has undertaken to pay any amount not exceeding Rs.50000/- to the Board, within 48 hours of the demand and the payment of the amount guaranteed by the bank was not made dependent on the proof of any default on the part of the company in liquidation, the bank was bound to make payment to the Board. The Board was not concerned with what the bank did in order to reimburse itself after making the payment under the bank guarantee. It was the responsibility of the bank to deal with the securities held by it in accordance with law. The Supreme Court observed that under Section 128 of the Contract Act, the liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided in the contract. Further, a surety is discharged under section 134 by any contract. Further, a surety is discharged under section 134 by any contract between the creditor and the principal debtor by which the principal debtor is released or by any act or omission of the creditor, the legal consequences of which is the discharge of the principal debtor. But a discharge which a principal debtor may secure by operation of law in bankruptcy (or in liquidation proceedings in the case of a company) would not absolve the bank from its liability under the bank guarantee.”

The Question whether the bank is absolved of its liability under a guarantee issued by it when the main contract is suspended by a statue was considered by the Bombay High Court in SCIL (India) Ltd v. India Bank and another (AIR 1992 Bom. 121). The facts of the case are as under;

For carrying out erection, testing and commissioning LP Pipe Works, the company engaged the service of a contractor. On the request of the contractor, the bank furnished a performing guarantee where under the Bank undertook to pay to the company on demand “any and all moneys payable by the contractor to the extent of Rs.10,72,806 at any time up to 30 June 1989 without demur, reservation, contest, recourse of protest and/or without reference to the contractor.”

The Government of West Bangal has issued a notification under which the contractor was declared as an unemployment relief undertaking under West Bangal Act, 1972, and had suspended all contracts and others and all the rights, obligations and liabilities arising thereof.

On invocation of the guarantee the contractor, therefore, submitted that the contract of erection, etc. entered into by the contractor with the company stood suspended.

On behalf of the company, it was submitted that the bank guarantee was independent contract between the bank and the company and was not affected or suspended by operation of the above referred to Act or the notification.

The High Court observed that the company had not invoked the guarantee fraudulently or malafide. The High Court pointed out that according to the decision of The Bombay High Court and Supreme Court, the contract of bank guarantee is an independent and separate contract. The High Court noted that in several Supreme Court decisions, particularly in M.S.E.B Bombay vs. Official Liquidator, AIR 1982, S.C. 1497 and in State Bank of India vs. M/s Saksaria Sugar Mills Ltd, AIR 1986, SC 868, it was held that the liability of the guarantor to pay was not affected by suspension of liability of the principal debtor under some statutory provision. In the result the High Court refused to grant any injunction restraining the bank from making payment under the bank guarantee more so when there was no special equity in favour of the contractor.

From the above decisions, it can be seen that the liability of the bank is not dependent on the underlying contract but is an independent contract, which the courts would enforce except in case of fraud.