Bank Guarantee and Liability of the Banker

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Bank guarantees as well as Letters of credit are common features of commercial transactions
today. A bank guarantee and a letter of credit are similar in many ways but theyre two different
things. Bank Guarantee is a guarantee from a lending institution ensuring that the liabilities of a
debtor will be met. In other words, if the debtor fails to settle a debt, the bank will cover it. Letters
of credit ensure that a transaction proceeds as planned, while bank guarantees reduce the loss if
the transaction doesnt go as planned.
A bank guarantee, like a line of credit, guarantees a sum of money to a beneficiary. Unlike a line of
credit, the sum is only paid if the opposing party does not fulfill the stipulated obligations under the
contract. This can be used to essentially insure a buyer or seller from loss or damage due to
nonperformance by the other party in a contract.A letter of credit is an obligation taken on by a
bank to make a payment once certain criteria are met. Once these terms are completed and
confirmed, the bank will transfer the funds. This ensures the payment will be made as long as the
services

are

performed.

For example a letter of credit could be used in the delivery of goods or the completion of a service.
The seller may request that the buyer obtain a letter of credit before the transaction occurs. The
buyer would purchase this letter of credit from a bank and forward it to the sellers bank. This letter
would substitute the banks credit for that of its client, ensuring correct and timely payment.
A bank guarantee might be used when a buyer obtains goods from a seller then runs into flow
difficulties and cant pay the seller. The bank guarantee would pay an agreed-upon sum to the
seller. Similarly, if the supplier was unable to provide the goods, the bank would then pay the
purchaser the agreed-upon sum. Essentially, the bank guarantee acts as a safety measure for the
opposing

party

in

the

transaction.

BANK

GUARANTEE

A bank guarantee is a tripartite agreement between the banker, the beneficiary and the customer,
whereby the bank gives an undertaking to pay the beneficiary a definite sum of money, or arrange
the performance of the obligations of the client in the possible event of his default. Banks are
usually approached to give such guarantees, as they possess the financial capability to meet such
obligations.
The
(i)it

ingredients
should

of

be

for

(ii)for

valid

period

well

defined

(v)grace

of

default

are;

definite

period,

for
under

amount,

defined
period

period
events

or

guarantee

specified

(iv)a

bank

specified

(iii)for

(vi)The

purpose,

of
enforcing

which

the

validity,
rights,

guarantee

can

and
be

enforced.

A bank guarantee contract is independent and totally different from the underlying contract that
subsists between the beneficiary and the creditor. It is extremely important in determining the
liability

of

the

banks

in

the

event

of

default

by

the

debtor.

In, Jacsons Veneers and Panels Pvt. Ltd. v. State Bank of Travancore and Anr. , the Court was
required to enforce the bank guarantee simplicities without probing into the nature of the
transactions between the Bank and the customer that led to the furnishing of the bank guarantee.
It is well settled that the Bank guarantee is an autonomous contract and imposes an absolute
obligation on the Bank to fulfill the terms and the payment in the Bank guarantee becomes due o

the happening of contingency on the occurrence of which the guarantee becomes enforceable.
The Supreme Court has further reiterated in the case of Ansal Engineering projects Ltd v. Tehri
Hydro Development Corporation Ltd 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
validity of the primary contract between the person at whose instance the bank guarantee is given.
As the bank unconditionally and unequivocally promised to pay, on demand, the Court thus held
that the liability of the bank was absolute and unconditional and could not be circumvented in any
manner.
It is settled law that bank guarantee is an independent and distinct contract between the bank and
the beneficiary and is not qualified by the underlying transaction and the validity of the primary
contract between the person at whose instance the bank guarantee was given and the beneficiary.
Unless fraud or special equity exists, is pleaded and prima facie established by strong evidence as
a treatable issue, the beneficiary cannot be restrained from en-cashing the bank guarantee even if
dispute between the beneficiary and the person at whose instance the bank guarantee was given
by the bank, had arisen in performance of the contract or execution of the works undertaken in
furtherance

thereof.

The bank unconditionally and irrevocably promised to pay, on demand, the amount of liability
undertaken in the guarantee without any demur or dispute in terms of the bank guarantee. The
object behind is to inculcate respect for free flow of commerce and trade and faith in the
commercial banking transactions unhedged by pending disputes between the beneficiary and the
contractor.
INVOCATION

OF

BANK

GURANTEE

Invocation of a bank guarantee is dependent upon the terms of the guarantee. It was held that,
when an unconditional bank guarantee is given or accepted, the beneficiary is entitled to realize
such bank guarantee irrespective of pending disputes and that a bank guarantee constituted a
bargain between the two parties, by which the banker creditor was unconditionally required to pay
the

amount

in

question

The law relating to invocation of such bank guarantees is well settled. When the course of
commercial dealings an unconditional bank guarantee is given or accepted, the beneficiary is
entitled to realize such a bank guarantee in terms thereof irrespective of any pending disputes. The
bank giving such a guarantee is bound to honour it as per its terms irrespective of any dispute
raised by its customer. The very purpose of giving such a bank guarantee would otherwise be
defeated. The courts should, therefore, be slow in granting an injunction to restrain the realization
of

such

bank

guarantee.

The courts have carved out only two exceptions. A fraud in connection with such a bank guarantee
would vitiate the very foundation of such a bank guarantee. Hence if there is such a fraud of which
the beneficiary seeks to take the advantage, he can be restrained from doing so. The second
exception relates to cases where allowing the encashment of an unconditional bank guarantee
would result in irretrievable harm or injustice to one of the parties concerned. Since in most cases
payment of money under such a bank guarantee would adversely affect the bank and its customer
at whose instance the guarantee is given, the harm or injustice contemplated under this head must
be such an exceptional and irretrievable nature as would override the terms of the guarantee and
the

adverse

effect

of

such

an

injunction

on

commercial

dealings

in

the

country.

It was observed that, the invocation of a bank guarantee does not necessarily have to be initiated
by setting out the entire case in the form of a plaint with a specific cause of action, and that it was
a commercial document and not a statutory notice or a pleading. It was further stated that if the

bank concerned understood that the beneficiary in terms of the guarantee was invoking the
guarantee, the bank guarantee may be invoked. It is sufficient if there is substantial compliance in
terms of the guarantee in the notice that may be issued. However, banks may even delay giving a
response to the demand for notice in the hope that the specified claim period expires.
To the effect that a bank guarantee should be invoked in an exact and punctilious manner setting
out the entire case of the beneficiary under the guarantee in the same way as setting out a cause
of action in a plaint. A bank guarantee is a commercial document and is neither is statutory notice
nor

pleading

in

legal

proceeding.

Generally there will be clauses in bank guarantees to the effect that the guarantees would be
honoured only by an initial written demand without any demur and would also mention that the
principal debtor has committed default in payment of the loaned amount. The amount demanded
must be contemplated within the contract of guarantee. The bank guarantee contracts may also
contain clauses that give unilateral right to the beneficiary to determine the question of default of
the debtor. In such cases there is no discretion on the part of the banks and the bank guarantee
essentially

becomes

absolute

in

nature.

It is the duty of beneficiary to intimate the bank or the guarantor that the event for which the
guarantee was issued has happened or did not happen and that, in terms of the guarantee, it has
been invoked demanding payment. However, the guarantee should be invoked within the specified
period stated within the documents, and not afterwards as the contract would have come to an
end.
The terms of the bank guarantee are very important in determining the nature of the bank
guarantee, and whether or not it is a conditional one or an absolute guarantee. In my view, a bank
guarantee may be invoked in a commercial manner. The invocation would be sufficient and proper
if the bank concerned understands that the guarantee is being invoked by the beneficiary in terms
of

the

guarantee.

The general rule is that, irrespective of any dispute between the customer and the bank with
respect to the primary contract, the banks must honour their commitments as per the terms of the
contract. The Courts are therefore reluctant to grant an injunction preventing payment or
interfering with the liability of the bank to pay the amount due on the guarantee.
Thus the Honourable Supreme Court has made it clear that, the liability of the bank remains
integral and does not cease with any pending disputes with respect to the primary underlying
transaction between the beneficiary and the creditor. However, there are two exceptions to the
general rule of non-interference by the Courts, namely (a) fraud and (b) the resulting of
irretrievable

injustice

or

harm.

The Supreme Court affirming long standing jurisprudence on this matter stated that, the bank is
bound to honour the guarantee irrespective of any dispute raised by the customer against the
beneficiary. This is however subject to two exceptions that is, a fraud committed in the notice of
the bank which would vitiate the very foundation of the guarantee or encashment of the bank
guarantee would result in irretrievable harm or injustice of the kind which would make it impossible
for

the

guarantor

to

reimburse

himself.

However an injunction may be granted where it is proved that the bank knows that any demand for
payment already made or which may thereafter be made will clearly fraudulent; though the
evidence must be clear as to the fact of fraud and as to the banks knowledge, and it cannot rest
on the uncorroborated statement of the customer or else irreparable damage can be done to a
banks
CONCLUSION

credit.

Banks play very important role in the economic life of the nation. The health of the economy is
closely related to the soundness of its banking system. Although banks create no new wealth but
their borrowing, lending and related activities facilitate the process of production, distribution,
exchange and consumption of wealth. In this way they become very effective partners in the
process

of

economic

development.

Today, modern banks are very useful for the utilization of the resources of the country. The banks
are mobilizing the savings of the people for the investment purposes. The savings are encouraged
and saving rate increases. If there would be no banks then a great portion of a capitalof the
country would remain idle. A bank as a matter of fact is just like a heart in the economic structure
and

the

Capital

provided

by

it

is

like

blood

in

it.

In day to day financial transaction, person needs the help of Banks to assure other persons that
their money is safe. This is done by issuing of letter of credit or bank guarantee under Section 6 of
Banking Regulation Act. These guarantee or letters of credit are irrevocable. The law is that in
respect of irrevocable guarantee, the banks cannot be restrained from making the payment.
The general rule is that, irrespective of any dispute between the customer and the bank with
respect to the primary contract, the banks must honour their commitments as per the terms of the
contract. Therefore the bank is not concerned with the disputes between the parties. However,
bank can be restrained from making payment in cases of fraud and undue influences. In case of
economic duress also injunctions can be granted.
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