Case Note & Summary
The case involved a contract dated 18 January 1980 between National Thermal Power Corporation Ltd. (appellant) and Flowmore Private Ltd. (respondent No.1) for supply of pumps, butterfly valves, motors, etc. The contract contained an arbitration clause. In connection with payments under the contract, respondent No.1 furnished five bank guarantees issued by Canara Bank in favour of the appellant: two performance guarantees dated 27 February 1980 for Rs.11,54,290 and 26 July 1986 for Rs.85,000; and three advance guarantees dated 26 July 1986 for Rs.2,53,250, Rs.63,411.42, and Rs.3,79,875. All guarantees were payable on demand. The guarantee for Rs.85,000 expressly stated that any demand by the owner would be conclusive and binding on the bank notwithstanding any dispute pending before any court, tribunal, arbitrator or authority. The other guarantees did not contain that express clause but provided that the bank guaranteed to pay the owner on demand any monies payable by the contractor by reason of any breach of the terms of the contract. Disputes arose regarding supply of pumps. By letter dated 15 March 1990, the appellant demanded from respondent No.1 payment of Rs.13,22,466.80 as net recovery, failing which it threatened to invoke bank guarantees. On 11 June 1990, respondent No.1 invoked the arbitration clause and appointed its arbitrator; the appellant appointed its arbitrator, and a third arbitrator was appointed by the Institute of Engineers, India. The bank guarantees were kept alive by renewal from time to time. The time for making the award expired in January 1992, and an application under Section 28 of the Arbitration Act, 1940 for extension of time was filed by respondent No.1 and was pending before the Delhi High Court. As the bank guarantees were to expire on 31 March 1993, the appellant by letters dated 22 March 1993 invoked the guarantees for Rs.11,54,290 and Rs.85,000, and partially invoked the guarantee for Rs.3,79,875 by demanding Rs.2,30,910. It asked Canara Bank to extend the other two guarantees and the balance amount by six months, failing which the letters be treated as invocation. After Canara Bank objected to partial invocation, the appellant invoked the guarantee for Rs.3,79,875 in full on 26 March 1993. On the same day, respondent No.1 filed a petition under Section 41 of the Arbitration Act before the Delhi High Court seeking an injunction to restrain the appellant from invoking the guarantees and the bank from remitting amounts. A learned Single Judge of the Delhi High Court by order dated 20 October 1994 granted an injunction restraining the appellant from encashing the bank guarantees. The Division Bench dismissed the appeal as not maintainable. The appellant then approached the Supreme Court under Article 136 of the Constitution. The Court noted that the question of jurisdiction of the Division Bench to entertain an appeal from an order under Section 41 read with the Second Schedule need not detain it because it was examining the Single Judge's order under Article 136. On merits, the Court relied on Svenska Handelsbanken v. Indian Charge Chrome and U.P. Cooperative Federation v. Singh Consultants & Engineers, holding that courts should not lightly interfere with unconditional bank guarantees. The bank cannot be prevented by the party at whose instance the guarantee was issued from honouring the credit guaranteed, except in cases of egregious fraud or irretrievable injustice. Fraud must be of an egregious nature vitiating the entire underlying transaction; irretrievable injustice must be genuine, immediate and irreversible, not speculative. The Court rejected the respondent's two submissions. First, the respondent contended that except for the Rs.85,000 guarantee, the guarantees were not invoked in terms. The Court found that all guarantees were payable on demand; the Rs.85,000 guarantee contained an additional conclusive demand clause, but the others were similarly unconditional for any breach. Second, the respondent argued that after arbitration was invoked and arbitrators appointed, the parties proceeded on the basis that bank guarantees would not be invoked until the award was made, and the appellant's conduct estopped it. The Court held that mere invocation of arbitration and pending disputes did not bar invocation of unconditional bank guarantees; no fraud or irretrievable injustice was shown. Accordingly, the Supreme Court allowed the appeals and set aside the injunction order of the Single Judge, permitting the appellant to encash the bank guarantees.
Headnote
A) Bank Guarantee - Unconditional Guarantee - Injunction Against Invocation - Arbitration Act, 1940, Section 41 - Courts should not restrain encashment of unconditional bank guarantees absent egregious fraud or irretrievable injustice; bank's obligation is independent and must be honoured. In this case, the Single Judge granted injunction contrary to established principles; the Supreme Court set aside the injunction. Held that injunction cannot be sustained. B) Bank Guarantee - Fraud Exception - Egregious Fraud - Arbitration Act, 1940, Section 41 - Fraud must be of an egregious nature so as to vitiate the entire underlying transaction; mere allegations of dispute do not suffice. No such fraud was established by the respondent. Held that fraud exception not applicable. C) Bank Guarantee - Irretrievable Injustice - Irreparable Harm - Arbitration Act, 1940, Section 41 - Irretrievable injustice must be of kind arising in irretrievable situation, genuine and immediate irreversible harm, not speculative. No irretrievable situation existed. Held that injunction not justified. D) Bank Guarantee - Invocation in Terms - Demand Conclusive Clause - Arbitration Act, 1940, Section 41 - The Rs.85,000 guarantee contained express clause making demand conclusive; other guarantees were payable on demand for any breach. Invocation letters were proper. Respondent's contention that guarantees were not invoked in terms rejected. Held invocation valid. E) Arbitration - Parallel Proceedings - Conduct of Parties - Arbitration Act, 1940, Sections 28, 41 - Mere invocation of arbitration and appointment of arbitrators did not create estoppel preventing beneficiary from invoking bank guarantees. No agreement to hold guarantees till award. Held appellant not precluded by conduct. F) Constitution of India - Appeal to Supreme Court - Article 136 - Constitution of India, Article 136 - Supreme Court entertained appeal directly against Single Judge's order after Division Bench dismissed appeal as not maintainable. Held that merits could be examined under Article 136.
Issue of Consideration
Whether the Division Bench of the Delhi High Court had jurisdiction to entertain an appeal against a Single Judge's order granting injunction under Section 41 of the Arbitration Act, 1940; whether injunction restraining encashment of bank guarantees could be sustained in absence of fraud or irretrievable injustice; whether guarantees were invoked in terms; whether appellant's conduct barred invocation
Final Decision
The Supreme Court allowed the appeals and set aside the injunction order passed by the Single Judge of Delhi High Court. It held that the bank guarantees were unconditional and payable on demand; except for the guarantee of Rs.85,000 which had a conclusive demand clause, the other guarantees also required payment on demand for any breach. Invocation was in terms. The respondent's contention regarding conduct was rejected; mere invocation of arbitration did not prevent invocation of guarantees. No fraud or irretrievable injustice existed. Therefore, injunction was vacated.
Law Points
- Unconditional bank guarantees must be honoured
- injunction only in case of egregious fraud or irretrievable injustice
- arbitration proceedings do not bar invocation
- guarantee payable on demand
- fraud must be of beneficiary
- courts should not lightly interfere with performance guarantees
