Invoking Bank Guarantees Due To Covid-19 for Non-performance

Authors – Rashi Suri (Managing Partner) and Pradyun (Associate)

The Covid-19 viral outbreak has caused persisting threats and health risks for citizens of India (and also world over) for which the Government of India has been deft in intervening with its containment strategy of lockdowns, restrictions on movement and public assembly while allowing specific essential services to be carried out during the continuing period of a nation-wide lockdown. As the aforementioned measures has caused impediment to business operations and fulfilment or performance of contractual obligations, there is a possibility that affected companies may invoke Performance Bank Guarantees (“PBG”) on the failure of the other party to carry out its duties under the contract, for reason of hindrances due to the intervening national lockdown.

Background

The outbreak of Covid-19 was stated to be considered as a case of natural calamity under force majeure clauses appearing in the Manual for Procurement of Goods, 2017 of the Government of India by the Ministry of Finance, Department of Expenditure Procurement Policy Division vide its Office Memorandum dated February 19, 2020.

As per the order of Ministry of Home Affairs which was notified on March 24, 2020 (and further modified on 25.03.2020 and 27.03.2020) most economic activities and business operations were suspended with certain exemptions for essential services. By the said order, a nationwide lockdown has been imposed which is now extended till May 17, 2020, that has caused obvious hindrances and near impossibility of performance of obligations under a business contract for the affected companies. 

Recently in the case of M/s. Halliburton Offshore Services vs. Vedanta Limited, the High Court of Delhi held that the countrywide lockdown should be prima facie considered in the nature of force majeure and therefore same were to be a justifiable ground for granting injunction and invoking of bank guarantees by the respondent company in the present case.

Through this article we will understand about PBG’s, its invocation by companies and the grounds for their injunction in the light of the recent Delhi High Court judgment on this issue and rules regarding invoking of bank guarantees.

WHAT IS MEANT BY A BANK GUARANTEE?

A bank guarantee or a contract of guarantee is an agreement for the due performance of a pre-stated promise or the discharge of a liability of a third person in case he commits a default. 

Simply put, a bank guarantee is a promise from a bank or a financial institution that if a debtor defaults on a loan or fails in the performance of certain pre-agreed obligations with the creditor or the beneficiary, the bank will cover the loss or pay the pre-stated amount to such a beneficiary. 

·         Parties To A Bank Guarantee:

1.    The bank or the financial institution giving the guarantee is called the ‘Surety’.

2.    The company or business (“C1”) in respect of whose default the guarantee is given is called the ‘Principal Debtor’, and

3.    The company or business (“C2”) to whom the guarantee is given is called the ‘Creditor’ or the ‘Beneficiary’.

Through a PBG, a bank as a Surety will take the responsibility for payment of the amount in case of default by C1 for performance of its contractual obligations. Thereby C2 as the Beneficiary will receive payment from the Bank when it presents a demand as per terms of the contract.

It is to be noted that a bank guarantee is a separate contract. In case of any dispute between C1 (Principal Debtor) and C2 (Beneficiary), the Surety bank’s obligation to pay (on the request of the Beneficiary and according to the terms of the contract) will not be affected anyhow. 

·         Types of Bank Guarantee:

1. Unconditional Guarantee - In this the bank is bound to pay immediately upon the Principal Debtor failing to perform the contract.

2. Conditional Guarantee - In this type, before invoking of bank guarantee by a Beneficiary, the Beneficiary is required to adhere to certain conditions in the Bank Guarantee or the main contract with the Principal Debtor.

GROUNDS FOR INJUNCTION BY COURTS

1.    In case of Fraud: In such a case, the Surety bank cannot be compelled to honour its guarantee under the contract. It is to be noted that the fraud would be of the Beneficiary and not of any other unrelated person/entity. If it is found out by the bank that any fraudulent action has been committed on the Beneficiary’s behalf then the payment can be lawfully declined. However, mere allegation of fraud is not sufficient, there must be evidence of fraud which should be cogent enough, both as to the fact of fraud and as to the bank's knowledge regarding the same. 

2.    For preventing irretrievable injustice or injury: In such cases, the Courts will injunct the invoking of bank guarantee where the payment of money by a Surety bank would adversely affect the bank and its customer at who's instance the guarantee was given. In this the injury or injustice is of such an extreme degree and of irretrievable nature that fulfilling the terms of the guarantee would cause a detrimental effect. To take the benefit of this ground and for overriding the terms of the guarantee the Principal Debtor has to showcase that exceptional and emergent circumstances are present which renders it impossible for the fulfillment or repayment of the guaranteed sum by the Principal Debtor to the Surety.

3.    Special Equities: “Special Equities”, in recent times has been accepted as a separate ground for the injunction on invoking of bank guarantees. While earlier, the understanding of Special Equities was a conformation to a scenario causing irretrievable injustice, of late the decision by the Supreme Court of India in Standard Chartered Bank Ltd v Heavy Engineering Corporation Ltd has provided for an enabling distinction of circumstances prevailing, the existence of which is a justified ground for passing an order of injunction.

In the aforementioned case, the Supreme Court had observed that “there appears to be no gainsaying the proposition that, where “special equities” exist, the court is empowered, in a given set of facts and circumstances, to injunct invocation, or encashment, of a bank guarantee”.

Conclusion

The decision by the Delhi High Court to grant an interim relief of injunction for reasons of special equities on account of force majeure event incapacitating a company from performance of its obligation is a welcome move for the businesses vulnerable and suffering in this regard. 

However, it is to be noted that the negative effect in the respective case was on account of carrying out of a business which did not fall on the exemptions listed in the relevant orders of MHA and therefore, in another case the Bombay High Court refused to grant an injunction on invoking of Bank Guarantee in the case of Standard Retail Pvt. Ltd. vs. M/s. G. S. Global Corp. where the lockdown was not considered as a force majeure event, as distribution of steel was declared an essential service and there was no restriction on its movement for it during the period of the lockdown.