Supreme Court Undermines Sanctity of Bank Guarantees

The state of commercial law in India is in doldrums. This is exemplified by a recent decision of the Supreme Court in Gangotri Enterprises v. Union of India (Civil Appeal No. 4814/2016 dt. 05.05.2016) which not only erroneous but against the settled principles regarding restraint of bank guarantees.

Some of the salient facts in the case are that Northern Railways wanted to encash bank guarantee given by the Contractor in respect of a contract which was apparently satisfactorily performed. Northern Railways wanted to do so in respect an alleged breach of another contract. Northern Railways took support of a clause in the Contract which entitled it to encash bank guarantees given under a contract to set-off “any moneys… due” under that contract or any other contract.

The Contractor approached the court to restrain Northern Railways from encashing the bank guarantee. The question went up to the Supreme Court. The Supreme Court held, inter alia, the following:

• The sum due meant a sum for which is presently payable and due and therefore, such sums may be recovered from the security deposit only if the sum which is to be set-off is payable. Northern Railways has sought encashment in respect of an amount which is in the nature of damages. But the Contractor has disputed the same and is a subject matter of an arbitration.

• Sum sought to be recovered was in respect of a contract distinct from the contract under which the bank guarantee was furnished.

On the basis of the above, the Court concluded that there was “a prima facie case in their favour for granting of injunction against the respondents so also they have made out a case of balance of convenience and irreparable loss in their favour…”

It is humbly submitted that this decision is grossly erroneous. The decision of the Supreme Court does not seem to be a decision on injunction against bank guarantee but on a claim for damages for wrongful invocation of bank guarantee. Following are the reasons:

The Court has not taken into consideration the settled position of law that injunction will lie against bank guarantees only if there is fraud or special equities. In this case, no fraud was made out by the Contractor. Special equities would mean that the Contractor should establish that it would be impossible to reimburse himself even if he ultimately succeeds in a case for damages for wrongful invocation of bank guarantee. The Supreme Court in the instant case has not gone into such an enquiry at all! 

It is well-established that the three pronged test of prima facie case, balance of convenience and irreparable loss would alone not be sufficient in the case of injunctions against bank guarantees but the petitioner should establish fraud or special equities.

The Supreme Court fell in gross error when it went on to the merits of correctness of the decision of Northern Railways in invoking the bank guarantee. This is not required in a proceeding relating to injunction against a bank guarantee.

For all these reasons, the decision of the Supreme Court is grossly erroneous and has to be held per incurium. The decision of the Supreme Court is binding on all courts in India. This decision is likely to be cited in several courts in India in support of injunction against bank guarantees thereby undermining the sanctity of bank guarantees and thereby commerce. It is sad that when there is an urgent pressing need to overhaul commercial law in India, decisions like these take the Indian legal system several steps backwards.