Case: Hindustan Steelworks Construction Limited Vs. Tarapore and Company and Another

The HSCL awarded a contract to the contractor for construction of civil works in its Visakhapatnam Steel Plant. On March 16, 1984, a letter of intent was issued and the formal contract was signed on October 25, 1984. It was a lump sum contract for Rs. 19, 21, 36, 804 and was to be completed on or before November 15, 1985. The contractor was not able to complete the work within the stipulated time and at its request the time for completion of the work was extended till March 31, 1987. Even during this extended period the contractor could not complete the work. It appears that some disputes arose between the appellant and the contractor and on August 28, 1986, the contractor appointed an arbitrator and called upon the appellant to appoint its arbitrator for deciding those disputes. Now those disputes are pending before the two arbitrators appointed by the parties. In August, 1988, by mutual agreement the contract work was reduced and the contract price was fixed at Rs. 4.5 crores. This reduced work also was not completed within the extended time and at the request of the contractor the time for completing the work was extended till September 30, 1988. As the contractor did not complete the work by that time the HSCL rescinded the contract on October 17, 1988.In between January 30, 1984, and December 8, 1987, the Bank of India gave 14 guarantees in favour of HSCL at the instance of the contractor. Bank guarantees Nos. 3/21 was furnished on January 28, 1984 and 3/39 on February 21, 1984, for Rs. 10 lakhs and 40 lakhs, respectively, towards mobilisation advances. The bank guarantee No. 3/58, dated March 28, 1984 for Rs. 17, 04, 580 was towards security deposit. The bank guarantee No. 6/175 given on July 31, 1987, initially for Rs. 45 lakhs and, subsequently, reduced to Rs. 36, 25, 000, was to secure the working funds provided by HSCL to the contractor and also for due performance of the contract. The rest of the bank guarantees were furnished on different dates as and when security deposits were released by HSCL. By these bank guarantees, except bank guarantee No. 6/175, the bank has undertaken to indemnify HSCL against any loss or damage caused to or suffered by it by reason of any breach by the contractor of any term and condition of the contract. It is also stipulated in the bank guarantees that HSCL shall be the sole judge on the question as to whether the contractor has committed any breach of the contract and what is the extent of loss or damage. It is further stipulated therein that the decision of HSCL in this behalf shall be treated as final and binding on the bank. By furnishing bank guarantee 6/175, the bank has undertaken to pay HSCL on demand any amount payable by the contractor without any demur and protest, without any reference to the contractor and such demand by HSCL has to be regarded as conclusive and binding on the bank notwithstanding any difference between the HSCL and the contractorOn the very day on which the appellant rescinded the contract, that is on October 17, 1988, HSCL by three separate demand letters informed the bank that the contractor has failed to fulfil its obligations under the contract and has committed breach of its terms and conditions and by reasons thereof it has suffered loss/damage far exceeding the amount guaranteed by the bank, but for the purpose of invoking the bank guarantees it has assessed such loss/damage at Rs. 1, 49, 76, 580. By those letters it also called upon the bank to pay to the appellant the said sum without any demur or protest.The contractor on coming to know of this demand filed O. P. Nos. 456 of 1988, and 457 of 1988, under section 41(b) read with Schedule II to the Arbitration Act in the court of the Principal Subordinate Judge at Visakhapatnam and prayed for an injunction restraining HSCL from encashing the bank guarantees. Original Petition No. 457 of 1988 was in respect of bank guarantees Nos. 3/21 and 3/39 and O. P. No. 456 of 1988 for the other bank guarantees. The ground urged for granting the injunction was that there are genuine disputes between the parties and those disputes have been referred to the arbitrators for adjudication. The court finding that the bank guarantees are unconditional refused to grant injunction and dismissed both the petitions by a common judgmentThe contractor thereupon filed two revision petitions before the Andhra Pradesh High Court. Civil Revision Petition No. 3865 of 1989 was filed against the judgment and order passed in O. P. No. 456 of 1988 and Civil Revision Petition No. 3866 of 1989 was filed against the judgment and order passed in O. P. No. 457 of 1988. It was contended on behalf of the contractor that the bank guarantees were given by way of security for due performance of the contract and for the purposes connected therewith and, therefore, they would be encashable only when the arbitrators decide that the contractor has committed a breach of the contract and the amount of loss or damage caused to or suffered by HSCL is quantified. It was submitted that as the disputes in this behalf are pending before the arbitrators the demand for encashment of the bank guarantees was premature. After referring to this contention the High Court observed as under :"It is now well established that unless there is fraud or special circumstances or equities exist, the beneficiary cannot be restrained from encashing the letter of credit, even if there are disputes between the beneficiary and the person at whose instance the letter of credit was given by the bank. The same principle is extended in regard to the performance guarantees or performance bonds executed by the bank in favour of the beneficiaries. So injunctions have to be refused restraining the beneficiary from encashing the letter of credit or performance guarantee or bond and the only exceptions are in cases of fraud or where special equities exist or where special circumstances warrant issue of injunction to prevent irretrievable injustice being caused." *The High Court after taking note of the fact that fraud is not pleaded in this case, went on to examine whether there were special equities or special circumstances justifying granting of an injunction. It then considered the reasons why the courts refuse to grant injunction against encashment of confirmed letter of credit and the case law on the point. Thereafter it referred to Edward Owen Engineering Ltd. v. Barclays Bank International Ltd. (CA), wherein it is held that a performance guarantee stands on the same footing as a confirmed letter of credit and then observed that the principles underlying the letters of credit are made applicable in England even in regard to performance guarantees or bonds. It distinguished the decision of this court in U. P. Co-operative Federation Ltd. v. Singh Consultants and Engineers (P.) Ltd. on the ground that"it is not a case where it was observed that in our country also the performance guarantee should be treated which is like confirmed letter of credit in order to consider whether injunction has to be refused or granted." *After noticing that bank guarantees in this case except bank guarantees Nos. 3/21, 3/39 and 6/175 were given towards security deposits only it observed that :"neither of the learned counsel had drawn attention of this court to any decision granting or refusing injunction in regard to a bank guarantee given by way of security deposit to indemnify against any loss or damage caused by breach of the terms and conditions of the contract." *It then considered the position of law with respect to liquidated damages in our country and observed that : "Hence there cannot be any agreement in regard to the amount that has to be allowed except the upper limit that can be fixed, in case of breach"Relying upon the decision of this court in Union of India v. Raman Iron Foundry, the High Court held that "any term in the agreement that one of the parties shall be the sole judge to quantify the same has to be held as invalid." According to the High Court, the liability to pay damages would arise only after it is established that there is a breach of the contract and it is for the court or the arbitrator to decide as to who has committed the breach. Till the liability is ascertained, it cannot be said that there is a "debt due or debt owing". On these grounds the High Court rejected the contention raised on behalf of HSCL that it was the sole judge to decide as to whether the contractor has committed a breach of the contract and what is the extent of damage caused to it. It also held that in absence of any determination by the court or the arbitrator no amount can be said to be payable by the contractor to HSCL by way of damages and, therefore, it will be just and proper to restrain HSCL from enforcing the bank guarantees. It also held that no irretrievable injustice would be caused to HSCL as it can recover damages from the bank and the contractor in case it succeeds in the case and that the interest of HSCL can be safeguarded by directing the contractor to go on extending the bank guarantees till the matter is settled by the arbitrators. The High Court, therefore, allowed both the revision petitions and by an order of injunction has restrained HSCL from enforcing the bank guarantees, except bank guarantee No. 6/175, till the arbitrators pass an award in its favour. As regards bank guarantee No. 6/175 also it has restrained HSCL from encashing the said guarantee till the balance of the amounts advanced together with interest and the value of the material supplied is ascertained. For ascertaining the amount due, the High Court has remanded O. P. No. 456 of 1988 to the lower court.

Court's reasoning:
It is, therefore, difficult to appreciate the attempt of the High Court to distinguish that decision and to raise a doubt whether in India also the same principles apply in case of a performance guarantee issued by a bank. In our opinion, the High Court was not right either in its attempt to distinguish that decision or to raise a doubt regarding the correct position of lawThe High Court also committed a grave error in restraining the appellant from invoking the bank guarantees on the ground that in India only a reasonable amount can be awarded by way of damages even when the parties to the contract have provided for liquidated damages and that a term in a bank guarantee making the beneficiary the sole judge on the question of breach of contract and the extent of loss or damages would be invalid and that no amount can be said to be due till an adjudication in that behalf is made either by a court or an arbitrator, as the case may be. In taking that view the High Court has overlooked the correct position that a bank guarantee is an independent and distinct contract between the bank and the beneficiary and is not qualified by the underlying transaction and the primary contract between the person at whose instance the bank guarantee is given and the beneficiary. What the High Court has observed would be applicable only to the parties to the underlying transaction or the primary contract but can have no relevance to the bank guarantee given by the bank, as the transaction between the bank and the beneficiary is independent and of a different nature. In the case of an unconditional bank guarantee, the nature of obligation of the bank is absolute and not dependent upon any dispute or proceeding between the party at whose instance the bank guarantee is given and the beneficiary. The High Court thus failed to appreciate the real object and nature of a bank guarantee. The distinction which the High Court has drawn between a guarantee for due performance of a works contract and a guarantee given towards security deposit for that contract is also unwarranted. The said distinction appears to be the result of the same fallacy committed by the High Court of not appreciating the distinction between the primary contract between the parties and a bank guarantee and also the real object of a bank guarantee and the nature of the banks obligation thereunder. Whether the bank guarantee is towards security deposit or mobilisation advance or working funds or for due performance of the contract if the same is unconditional and if there is a stipulation in the bank guarantee that the bank should pay on demand without a demur and that the beneficiary shall be the sole judge not only on the question of breach of contract but also with respect to the amount of loss or damages, the obligation of the bank would remain the same and that obligation has to be discharged in the manner provided in the bank guarantee. In General Electric Technical Services Company Inc. v. Punj Sons (P.) Ltd. while dealing with a case of bank guarantee given for securing mobilisation advance it has been held that the right of a contractor to recover certain amounts under running bills would have no relevance to the liability of the bank under the guarantee given by it. In that case also the stipulations in the bank guarantee were that the bank had to pay on demand without a demur and that the beneficiary was to be the sole judge as regards the loss or damage caused to it. This court held that notwithstanding the dispute between the contractor and the party giving the contract, the bank was under an obligation to discharge its liability as per the terms of the bank guarantee. Larsen and Toubro Limited v. Maharashtra State Electricity Board and Hindustan Steel Workers Construction Ltd. v. G. S. Atwal and Co. (Engineers) Pvt. Ltd. were also cases of work contracts wherein bank guarantees were given either towards advances or release of security deposits or for due performance of the contract. In both those cases this court held that the bank guarantees being irrevocable and unconditional and as the beneficiary was made the sole judge on the question of breach of performance of the contract and the extent of loss or damages an injunction restraining the beneficiary from invoking the bank guarantees could not have been granted. The above referred to three subsequent decisions of this court also go to show that the view taken by the High Court is clearly wrongThis observation would clearly go to show that the three-judge Bench has approved the view that fraud and other exceptional circumstances leading to irretrievable injustice are exceptions to the ruleIn this case fraud has not been pleaded and the relief for injunction was sought by the contractor/respondent No. 1 on the ground that special equities or the special circumstances of the case required it. The special circumstances and/or special equities which have been pleaded in this case are that there is a serious dispute on the question as to who has committed breach of the contract, that the contractor has a counter claim against the appellant, that the disputes between the parties have been referred to the arbitrators and that no amount can be said to be due and payable by the contractor to the appellant till the arbitrators declare their award. In our opinion, these factors are not sufficient to make this case an exceptional case justifying interference by restraining the appellant from enforcing the bank guarantees. The High Court was, therefore, not right in restraining the appellant from enforcing the bank guarantees.