THE STATE TRADING CORPORATION OF INDIA LTD.

A v.

JAINSONS CLOTHING CORPORATION AND ANR.

SEPTEMBER 14, 1994

[K. RAMASWAMY AND N. VENKATACHALA, JJ.) B

Indian Contract Act, 1872: Section 126--Contract of Guarantee-What is.

Plea _of fraud-Held fraud must be of egrgious nature.

Contract between Principal Supplier and foreign buyer-Contract also between Principal Supplier and its agent-Contract with agent not co-terminus with non performance of contract with buyer-Held cancellation of contract with foreign buyer does not have the effect of frustrating the contract with agent.

Section 17-Fraud-Meaning of.

Code of Civil Procedure, 1908: Order 39--Rule i:-Temporary injuction-Grant of-Necessary conditions for-What are.

The appellant-Corporation (Principal Supplier) entered into a contract with Abu Dhabi Municipality (foreign buyer) for supply of 7, SOO M.T. of 'B' grade basmati rice. In turn the appellant-Corporation also entered into an agreement with the respondent for supply of 'B' grade basmati rice.

In terms of clause 17 of the contract, the respondent executed a contract

of guarantee, the terms of which were: (i) the bank guarantee was ir- F revocable and unconditional; (ii) In the event of default by respondent for whatsoever reason to perform all or any of its obligations under the contract the appellant was entitled to invoke the guarantee; and (iii) the default certificate issued by the Corporati!)n was not only sufficient for invoking guarantee but was also conclusive, final and binding on the Bank. G

On June 15, 1986 the appellant-Corporation issued a certificate that the respondent had committed a default in the performance of the contract and accordingly it invoked the bank guarantee. The respondent filed a suit in the High Court seeking a perpetual injunction restraining the appellant from enforcing the bank guarantee as well as an application under Order H 527

A 39 Rule 1 of Civil Procedure .Code, 1908 for grant of temporary injuction, which was rejected. On appeal, the Division Bench of the High Court issued injunction against which the appellant-corporation filed appeal in this Court.

On behalf of the Respondent it was contended that the appellant- Corporation having cancelled the. contract with foreign buyer and also having intimated the same to the respondent committed fraud in invoking the Bank guarantee.

Allowing the appeal, this Court

HELD : 1. The High Court was wholly wrong in its conclusion that the respondent has proved prima facie case for granting injunction in favour of enforcement of the bank guarantee. The Single Judge was quite right in refusing to issue the injuction in terms of clause 17 of the contract and the bank guarantee given by the respondent. [536-G]

2. None of the conditions postulating fraud as mentioned in Section 17 of Indian Contract Act, 1872 are satisfied or applicable to the facts in this case. It is not the case that there is any fraud committed by the appellant in entering into contract with the respondent in particular with E reference to clause 17 of the Contract. Nor is there any fraud into formation or execution of bank guarantee. There is no clause in the contract entered into between the appellant and the respondents that the contract with the respondents is co-terminus with nonperformance or frustration of the contract with the foreign buyer. Under those circumstances, it is not a case of any fraud, but at best, it is a case of cancellation of the contract F by the appellant-principal supplier with the foreign buyer. But that does not have the effect of frustrating or cancelling the contract which the respondent had entered into with the appellant. [533-E, F, 534-B]

3. Before issuing the injunction under Order 39, Rule 1 and 2 of Civil Procedure Code, the Court should prima facie be satisfied that there is G triable issue, strong prim a f acie case of fraud or irretrievable injury and balance of convenience in favour of issuing injunction to prevent irremedial injury. The Court should normally insist upon enforcement of the bank guarantee and the court should not interfere with the enforcement of the contract of guarantee unless there is a specific plea of fraud H or special equities in favour of the plaintiff. One must necessarily plead

S.T.C.l LTD. v. JAINSONS CLOTIIlNGCORPN. 529

and produce all the necessary evidence in proof of fraud in execution of A the contract of the guarantee, but not the contract either of the original contract or any of the subsequent events that may happen as a ground for fraud. [536-D to F]

4. From the affidavit evidence given in support of the application for injunction, not only no plea of fraud was made but also there was no plea B of irretrievable injustice that the respondent was likely to suffer on account of the enforcement of the bank guarantee. [534-B]

5. The grant of injunction is a discretionary power in equity jurisdiction. The contract of guarantee is trilateral contract which the bank C bas undertaken to unconditionally and unequivocally abide by the terms of the contract. It is an act of trust With full faith to facilitate free now of trade and commerce in internal or international trade or business. It creates an irrevocable obligation to perform the contract in terms thereof.

On the occurrence of the events mentioned therein the bank guarantee becomes enforceable. The subsequent disputes in the performance of the D contract does not give rise to a cause nor is the court justified on that basis, to issue an injunction from enforcing the contract, i.e. bank guaran tee. The parties are not left with no remedy. In the event of the dispute in the main contract ending in the party's favour, he is entitled to damages or other consequential reliefs. [536-B, C] E

U.P. Cooperative Federation Ltd. v. Singh Consultants and Engineers (P) Ltd., [1988] 1 S.C.C.174; General Electric Technical Services Co. Inc. v.

Punj Sons (P) Ltd. &Anr., [1991) 4 S.C.C. 230; Maharashtra State Electricity Board, Bombay v. Official Liquidator, High Court, Emakulam & Anr., [19S2] 3 S.C.C. 358 and Syndicate Bank v. Vijay Kr. and Ors., [1992) 2 S.C.C. 330, F relied on.

CIVIL APPELLATE JURISDICTION : Civil Appeal No. 3586 of 1986.

From the Judgment and Order dated 4.8.86 of the Delhi High Court G in F.A.O. (OS) No. 97 of 1986.

B. Dutta, R.K. Joshi, S.K. Jain, AP. Dhamija, P.R. Jain and K.K.

Gogna for the Appellant.

Arun Jaitley, Sanjay Karol, M.V. Goswami and Vibha Makhija for H

A the Respondents.

The following Order of the Court was delivered :

The appellant had entered into a. contract with Abu Dhabi Municipality, Abu Dhabi for supply of 7,500 M.T. of 'B' Grade Basmati

~ B Rice. It in turn had entered into an agreement with the respondent on April 20, 1985 for supply of 3000 M.T. and in case of necessity another

1500 M.T. at the option of the STC, for shipment, of the B-Grade Basmati rice to foreign buyer M/s Abu Dhabi Municipality, Abu Dhabi. In clause 17 of this contract envisages execution of a bank guarantee by the respon-

' c dent for due performance of the contract, which reads thus :

17. Bank Guarantee - "The supplier shall within three days of the signing of this contract furnished to the STC a Bank Guarantee from a scheduled bank for an amount of Rs. 11,70,000/- (Rupees Eleven lacs seventy thousand only) which is equivalent to 5% value D of the contract as per the proforma attached hereto as Annexure III for the performance of its obligations under this contract and the export contract. The Bank Guarantee should be made valid upto 22nd July 1985. In the event of supplier's failure to perfo(m - any of its obligations under the Back-to-Back contract and/or the

E export contract, STC shall without prejudice have the right to claim eventual damages, be entitled to invoke the Bank Guarantees and forfeit the amount realised thereunder. Supplier's liability and on . account of their failure to fulfil their obligations will not be restricted upto the value of the Bank Guarantee to be furnished by supplier." F In furtherance thereof, the respondent had executed the contract of guarantee of even date, namely, April 20, 1985 in the following manner :

''That the Bank hereby irrevocably and unconditionally guaran-

G tee to the Corporation that in the event of any failure/default for whatever reason on the part of Mis. Jainsons Clothing Corporation in performing all or any of its obligations under the said contract and or the export contract and the L/C established thereunder and 4. as may be amended from time to time, the Bank shall pay to the Corporation forthwith on corporation's first demand an amount of H Rs. 11,70000 (Rupees eleven. lacs seventy thousand only) being

S.T.C.l.LID. v.JAINSONSCLOTIIlNGCORPN. 531

approx. 5% of the contract value of the export. The payment shall A be made by the Bank of the Corporation without any demur, protest or contestation and without any reference to supplier notwithstanding any dispute(s) whatsoever pending between the Corporation and the buyer. A certificate of the Corporation that supplier has defaulted in the fulfilment of its obligations shall be B sufficient for the purpose of filing claim on the Bank under the Guarantee and the same shall be final, conclusive and binding on the Bank. The Bank shall forthwith pay to the Corporation the amount claimed by the Corporation upto the amount guaranteed herein. In case Bank fails to pay the amount claimed by the Corporation within 15 days of the date of demand of the Corpora- C tion, then the Bank shall also be liable to pay to the Corporation interest @ 22.75% per annum from the date of Corporation demand upto the date of actual payment and the guarantee amount shall stand enhanced to the extent of the interest thus due and payable by the Bank." D

On June 15, 1986 the Officer of the S.T.C. in terms of the guarantee had issued a certificate that the respondent had committed default in the performance of the contract and called upon the Bank to pay the sum of Rs. 11,70,000 contracted under the bank guarantee. The respondent filed Suit No. 1086/85 in the High Court, Delhi for perpetual injunction restrain- E ing the appellant from enforcing the bank guarantee. I.A No. 3455/85 was filed for temporary injuction, pending Suit. By Order dated March 11, 1986, the learned Single Judge of the High Court refused to grant injunction under Order 39, Rules 1 and 2, CPC. On appeal, the Division Bench in PAO (OS) No. 97 of 1986 by Order dated August 4, 1986 issued the F injunction as prayed for. Thus, this appeal by special leave.

Shri Arun Jaitley, the learned Senior counsel for the respondent contended that the High Court was justified in issuing the injuction. In support thereof, he placed before us two contentions, namely, that the foreign buyer and the STC had by their agreement dated May 15, 1985 G cancelled the contract of supply under which the respondent had to act as an agent of the appellant for the supply of 3000 M.T. of basmati B-Grade rice and that having got the c.ontract cancelled with the foreign buyer and intim3:tion in that behalf having duly been given to the respondent on May 22, 1985, the appellant committed fraud in invoking the bank guarnatee. H

A The Analyst Report, dated May 15, 1985 was sought to be relied upon to show that the respondent had sought to supply shipment of sub-standard B-Grade basmati rice contrary to the contract had been procured to show that the respondent has committed breach of the contract. He also contended that having done these fraudulent acts, the appellant is not entitled B to invoke the bank guarantee and the Division Bench, therefore, was right in issuing the inj'unction pending the respondent's suit for permament injunction. We find no substance in the contentions.

It is seen that the appellant in terms of clause 17 of the contract, extracted hereinbefore, had clearly agreed to execute an unconditional and C irrevocable bank guarantee for the performanace of the contract to supply

3000 M.T. in terms of the Contract dated April 20, 1985. The contract of guarantee is independent of and unconditional one. Its enforcement is not hedged with or conditional upon the performance of or frustration of the contract which either the appellant had with the foreign buyr or of the D respondent. Only pre-condition for enforcement of the contract of guarantee is a certificate by the named officer to the bank of the default committed by the respondent in the performance of the contract. The grounds for the breach of contract are irrelevant. Bank guarantee clearly mentions

that the bank guarantee, thereby, given by the respondent is "irrevocable and unconditional". In the event of the respondent committing default or failure for whatever reason on its part to perform all or any of its obligations under the said contract or the export co.ntract or letters of credit established thereunder, the appellant is entitled to make a demand from the Bank and the Bank shall pay fo the appellant on first demand, a sum of Rs. 11, 70,000 and interest at contracted rate for delayed payment. It is only hedged with a condition that the S.T.C. shall give a certificate that the respondent had committed default or failed to perform the contract. The certificate given by the officer is "conclusive, final and binds the Bank".

Admittedly, the officer had given the certificate and on its basis the appellant called upon the bank to pay a sum of Rs. 11, 70,000 in terms of G the contract.

The question, therefore, is whether there is any fraud committed by the respondent as regards the contract of guarantee which the appellant was entitled to invoke. Under s.126 of the Indian Contact Act 1872 a H contract of guarantee is a distinct separate contract to discharge the

S.T.C.I. LTD. v. JAINSONS CLOTIIING CORPN. 533

liability of a third person in case of his default. Section 17 of the Contract A Act postulates fraud that :

"17. "Fraud" defined. - "Fraud" means and includes any of the following acts committed by. a party to a contract, or with his connivance, by his agent, with intent to deceive another party thereto or his a'""nt, or to induce him to enter into the contract B

{1) the suggestion, as a fact, of that which is not true, by one who does not believe it to be true;

(2) the active concealment of a fact by one having knowledge C or belief of the fact;

{3) a promise made without any intention of performing it;

( 4) any other act fitted to deceive;

(5) any such act or omission as the law specially declares to be fraudulent."

None of the conditions are satisfied or applicable to the facts in this case. It is not the case that there is any fraud committed by the appellant E in entering into contract with the respondent in particular with reference to clause 17 of the Contract dated April 20, 1985. Nor is there any fraud into formation or execution of bank guarantee. From the contention of the appellant it would appear that on account of negotiations bet\veen the appellant the principal foreign buyer-Abu Dhabi Municipality, the supply F of 7000 M.T. of B-Grade basmati rice was not made in terms of the principal contract etered into by the appellant with the foreign b'uyer. But there is no clause in the contract dated April 20, 1985 entered between the appellant and the respondents that the contract with the respondents is co-terminus with non-performance or frustration of the contract with the foreign buyer. In the absence of such recital the necessary consequences is G that irrespective of the . frustration of the contract or cancellation of the contract between the principal supplier, namely, the appellar:*; and the foreign buyer, namely, Abu Dhabi Municipality, the respondent was under the contract obligated to make supply of 3000 M.T. of B-Grade basmati rice in terms thereof. The certificate issued by the officer clearly shows that H

A there was a failure or default committed by the respondent in supplying the rice as contrcted for. Under those circumstances, it is not a case of any fraud, but at best, it is a case of cancellation of the contract by the appellant-principal supplier to the foreign buyer. But that does not have the effect of frustrating or cancelling the contract which the respondent B had entered into with the appellant. Therefore, even from the affidavit evidence given in support of the application for injunction, not only no plea of fraud was made but also there was no plea of irretrievable injustice that the respondent was likely to suffer on account of the enforcement of the bank guarantee - an exception carved out by this Court in U.P. Cooperative Federation Ltd. v. Singh Consultants and Engineers (P) Ltd., [1988) 1 SCC C

174. Therein this Court after elaborate consideration of all the decisions, held in para 34 that on the basis of these principles the commitments of bank guarantee must be honoured free from interference by the courts.

Otherwise, trust in commerce internal and international would be irreparably damaged. It is only in exceptional cases, that is to say, in case of D fraud or in case of irretrievable injustice, the court would interfere.

While elaborating the plea of fraud, in the concurrent judgment, Jagannatha Shetty, J. had elaborately dealt with and stated that : ·

''The wholly exceptional case where an injunction may be granted is where it is proved that the bank knows that any demand for payment already made or which may thereafter be made will clearly be fraudulent. But the evidence must be clear, both as to the fact of fraud and as to the bank's knowledge. It would certainly not normally be sufficient that this rests on the uncorroborated statement of the customer, for irreparable damage can be done to a bank's credit in the relatively brief time which must elapse betwee.1 the granting of such an injunction and an application by the bank to have it discharged."

Under those circumstances, it was also held that the plea of fraud must be G in the nature of an egregious nature as to vitiate the entire underlying transaction of the bank guarantee. It is fraud of that beneficiary and not the fraud of somebody else that would make th.e Court to grant the Order of injunction as asked for. If the bank detects with the minimal investigation the fraudulent action of the seller, the payment could be refused is not a H fraud as contemplated under the guarantee. We respectfully agree with the

S.T.C.I. LID. v. JAINSONS CLOTIIlNG CORPN. 535

above ratio. This view was reiterated in General Electric Technical Services A Co. Inc. v. Punj Sons (P) Ltd. & Anr., [1991] 4 SCC 230. This Court has held in paragraph 9 thns :

"The question is whether the court was justified in restraining the Bank from paying to GETSCO under the bank guarantee at the instance of respondent 1. The law as to the contractual obliga- B tions under the bank guarantee h'as been well settled in a catena of cases. Almost all such cases have been considered in U.P. Coop.

Federation Ltd. v. Singh Consultants and Engineers (P) Ltd."

Following that ration it was observed that : c

"the Bank must honour the bank guarnatee free from interference by the courts. Otherwise, trust in commerce internal and international would be irreparably damaged. It is only in exceptional cases that is to say in case of fraud or in case of irretrievable injustice, the court should interfere. In the concurring opinion one D of us (K. Jagannatha Shetty, J.) has observed that whether it is a traditional bond or performance guarantee, the obligation of the Bank appears to be the sam.e. If the documentary credits are irrevocable and independent, the Bank must pay when demand is made. Since the Bank pledges its.pwn credit involving its reputa- E tion, it has no defence except in the case of fraud. The Bank's ob.ligations of course should not be extended to protect the unscrupulous party, that is, the party who is responsible for the fraud.

But the banker must be sure of his ground b"1fore declining to pay.

The nature of the fraud that the courts talk about is fraud of an "egregious nature as to vitiate the entire underlying transaction". F It is fraud of the beneficiary, not the fraud of somebody else."

To the same effect is the decision of this Court in Maharashtra State Electricity Board, Bombay v. Officer Liquidator, High Court, Emakulam & Anr., [1982] 3 SCC 358, where this Court has reiterated that the injunction G shall not be issued in honouring the bank guarantees which jeopardises the sanctity attached to the commercial transactions and such a payment, if made, is open to the bank to have recourse to the securities given by the company on whose behalf the bank guarantee was given.

It was also further reiterated in Syndicate Bank v. Vijay Kr. & Ors., H

A [1992) 2 sec 330.

The grant of injunction is a discretj.onary power in equity jurisdiction.

The contract of guarantee is a trilateral contract which the bank has undertaken to unconditionally and unequivocally abide by the terms of the contract. It is an act of trust with full faith to facilitate free flow of trade and commerce in internal or international trade or business. It creates an irrevocable. obligation to perform the . contract in terms thereof. On the occurence of the events mentioned therein the bank guarantee becomes enforceable. The subsequent disputes in the performance of the contract does not give rise to a cause nor is the court justified on that basis, to issue C an injunction from enforcing the contract, i.e. bank guarantee. The parties are not left with no remedy. In the event of the dispute in the main contract ends in the party's favour, he/it is entitled to damages or other consequential reliefs.

D It is settled law that the Court, before issuing the injunction under Order 39, Rules 1 and 2, CPC should prime face be satisfied that there is triable issue strong prima f acie case of fraud or irretrievable injury and balance of convenience is in favour of issuing injunction to prevent irremedial injury. The court should normally insist upon enforcement of the bank guarantee and the court shWUld not interfere with the enforcement of E the contract of guarantee unless there is a specific plea of fraud or special equities in favour of the plaintiff. He must necessarily plead and produce all the necessary evidence in proof of the fraud in execution of the contract of the guarantee, but not the contract either of the original contract or any of the subsequent events that may happen as a ground for fraud.

Under these circumstances, the High Court was wholly wrong in its conclusion that the respondent has proved prima facie case for granting injunction in favour of enforcement of the bank guarantee, admittedly entered into by the respondent with the appellant. The learned Single G Judge was quite right in refusing to issue the injunction in terms of clause 17 of the contract and the bank guarantee given by the respondent. "

Pending appeal, this Court directed the respondent to deposit the amount in the Registry and the Registry was dierected to keep the amount in fixed deposit which would earn interest. Since the amount has already H been deposited and it is earning interest, it is open to the appellant to

S.T.C.I. LID. v. JAINSONS CLOTIIlNGCORPN. . 537

withdraw the same from the Registry.

The appeal is accordingly allowed. It is made clear that it shall not be taken that we have expressed any final opinion on the merits of the contract entered into between the appellat and the respondent. However, we award costs quantified at Rs. 20,000 and the same shall be payable by respondent to the appellan~.

T.N.A.

Appeal allowed.