Payments Under Bank Guarantee –Precautions to be taken :
Before making payment, a banker has to ensure that the invocation of the guarantee has been properly done failing which he may not have any recourse against the debtor. The banker should also see that no order of injunction has been passed by any court of law prohibiting the bank from making payment.
In case a banker makes a payment, in spite of there being an order by a competent court in which the bank is a party, then the bank will be answerable for contempt of court.
The bank while making payment on its guarantee has to be careful and has to ensure that the invocation has been properly made. There are divergent views as regards the proper manner in which a bank guarantee should be invoked.
It is incumbent upon the bank to ensure that invocation of bank guarantee has been in order; it will do well to see that following requirements are duly complied with:
– The invocation is well within the claim period.
– The amount claimed by way of invocation is not in excess of what is guaranteed.
– The authority invoking the guarantee has the powers to do so. In the case of Government Departments, the authority to invoke bank guarantee is usually is entrusted to a post by way of allocation of authority. It is the duty of the banker is make himself doubly sure about the authority invoking the bank guarantee.
Instances of courts granting injunctions restraining the banks from making payment under a guarantee are there in many cases. In one such case that came up before Calcutta High Court, injunction was granted. The facts of the case in M/s G.S. Atwal Co. Engineers (P.) Ltd. v. Hindustan Works Construction Ltd. Are under;
Under the terms of contract entered into between the petitioner and the respondent, the petitioner was to furnish a bank guarantee for mobilization advance made by the respondents to the petitioner for Rs. 32.50 lakh. The contract did not require the petitioner to gives any bank guarantee for the dues performance of the contract. The petitioner requested the bank to issue a guarantee for Rs. 32.50 lakh to cover the mobilization advance received by the petitioner from the respondent. The bank made use of its standard format of guarantee and did not delete certain clauses therein as a result of which the guarantee IIssued by it became a mobilization advance – cum – performance guarantee. The respondent took advantage of the mistake and although the mobilization advance was recovered in full, it invoked the bank guarantee for recovery of its claim for damages for loss suffered as a result of nonperformance of the contract by the petitioner and demanded payment of the amount guaranteed by it, petitioner approached the High Court for an order restraining the bank for making payment
The High Court in this case held that:
The respondent was aware of the mistake on the part of the bank and with ulterior motive took advantage of the mistake by demanding payment of its claim for damages for non-performance and not in respect of any amount due for mobilization advance given to the petitioner.
The bank has no right to saddle its customers with any additional liability under the guarantee by issuing the same contrary to the instructions by its customer.
The respondent has invoked the guarantees foe recovery of loss and damages alleged to have been suffered due to alleged breach of contract by the petitioner.
Though the general principles of non-interference by the court in cases of bank guarantee and letter of credit is for the smooth function of international trades and commences, this principle would not apply where bank has acted negligently and issued bank guarantee contrary to the customers’ instructions.
Whether the invocations of the bank guarantee was in terms of the guarantee or not will depend upon the terms of the guarantee and the letter of invocation. The bank cannot act arbitrarily or whimsically in deciding whether the invocation was in terms of the guarantee when in fact it was not.
In the instant case, the bank guarantee was for mobilization advance and not for performance of the contract and the invocation of bank guarantee was admittedly for recovery of damages for the alleged non-performance was special equity in favour of the petitioner and he can prevent the beneficiary from enforcing the bank guarantee. It is therefore absolutely necessary for the bank to confirm that no injunction order has been issued restraining the bank from making payment.
Banks grant loans and advances (fund based) and provide other credit facilities (non fund based) such as, bank guarantee and letters of credit. Non fund based limits are granted by banks to facilitate the customers to carry on with the trading and business activities more comfortably. Bankers can earn front end fees and these non fund based items become contingent liabilities for banks.
A contract of guarantee is covered under the Indian Contract Act,1872. Sec 126 defines a guarantee as contract to perform the promise or discharge a liability of a third person in case of his default. The contract of guarantee may be oral or in writing. Banks, however insist on written guarantees.
There are 3 parties to the contract of guarantee. They are called Surety, Principal Debtor and the Creditor. These parties are also called as the guarantor, borrower and the beneficiary.
Banks deal with two types of guarantees: (i) Accepted by the bank, and (ii) Issued by the bank
(1) Guarantees accepted by the Bank:
At the time of lending money, banks accept securities. In addition to the tangible assets a borrower arranges to furnish a personal security given by surety (guarantor). This is called third party guarantee, who undertakes to pay the money to the bank inclusive of interest and other charges, if any, in case the principal borrower fails to repay or if the borrower commits default. Banks also obtain Corporate guarantees issued by companies who execute corporate guarantee as authorized by the Board of Directors’ resolution.
As per Sec 128 of the Contract Act,1872, the surety’s liability is co-extensive with that of the principal debtor.
For example, Bank MNC has sanctioned a term loan of Rs 10 lakhs to P on the personal guarantees of Q and S. In this case Bank MNC is the creditor. P is the borrower or the principal debtor. Both Q&S are the sureties or guarantors. In case P commits a default, in repaying the debt to the Bank MNC ( as per the terms and conditions of bank’s sanction letter) then both Q&S (as sureties/guarantors) are liable to pay the dues to the bank.
(2) Guarantees issued by the Bank:
A Bank Guarantee is a commitment given by a banker to a third party, assuring her/ him to honour the claim against the guarantee in the event of the non- performance by the bank’s customer. A Bank Guarantee is a legal contract which can be imposed by law. The banker as guarantor assures the third party (beneficiary) to pay him a certain sum of money on behalf of his customer, in case the customer fails to fulfill his commitment to the beneficiary.