SC allows RBI to take action, refuses to interfere with Calcutta HC order

Introduction

In the verge of increase in globalisation, there was need of some reliable source to secure and reduce the risk in business transaction, therefore the concept of bank guarantee was introduced which not only secure the performance between the parties engaged in business transactions over the years, but also encourages new companies/firms to start up efficiently by increasing their credibility by involving the bank as a guarantor.

Over the period of time, the Courts have laid down stern standards and threshold for judicial intervention, and held by the Apex Court in matters such as UP Co-op Federation Private Limited vs Singh Consultant and Engineers Pvt Ltd (1988 IC SSC 174) and other courts that only in rarest cases would courts allow an Injunction against invocation of a bank guarantee. Never in the history, the courts have ever considered cancellation of license of banking companies not adhering to the terms of bank guarantee, however the time has been revolving and recently the Supreme Court (“SC”) on June 22, 2020 had dismissed the special leave petition filed by the Bank of Baroda and upheld the Calcutta High Court’s order that directed the Reserve Bank of India (RBI) to take appropriate steps including cancellation/revocation of license against the Bank of Baroda for not honouring the commitments of an unconditional bank guarantee.

Background of the case

In this case, Indian Oil Corporation Limited (“Respondent”) and Simplex Projects Limited (“Simplex”) entered into contract in the year 2017 for undertaking certain work at the Bongaigaon facility of the oil marketing company in Assam. As per the terms of the contract, Simplex was required to furnish a bank guarantee on account of security deposit and Respondent was obliged to make a mobilisation advance against said bank guarantee. An unconditional bank guarantee was furnished by the Bank of Baroda (“Petitioner”) on behalf of Simplex for about Rs.6.97 crores. Simplex did not honour the terms of the contract; consequently, several notices were issued to Simplex which went unheeded and resultantly Respondent invoked the bank guarantee vide its Letter dated April 26,2018. As per the contract, Petitioner was required to pay the proceeds of bank guarantee on the invocation thereof.

Succeeding this, Simplex initiated proceedings under section 9 of the Arbitration and Conciliation Act, 1996 against the Petitioner and Respondent before the Delhi High Court (“DHC”) in accordance with the arbitration clause contained in the contract, which was disposed by the DHC vide order dated May 5, 2018 (“Order”).

In its Order, the Delhi HC, while dismissing an application, observed that bank guarantee was composite bank guarantee and payment thereunder could not be avoided once it has been invoked. Therefore, an appeal was filed against the said DHC order which stood dismissed by Order dated May 2, 2018. The Petitioner, however did not adhere to the DHC order and did not released any payment resultantly, Respondent invoked the writ jurisdiction (“Petition”) of Calcutta High Court (“CHC”) for directing Petitioner to release the payment of the guarantee.

CHC’s verdict

After considering the factual matrix and the contentions of the parties, the CHC in the Petition held that being the unconditional bank guarantee, the Petitioner cannot merely avoid its encashment once it is invoked by the Respondent.

The CHC further in the Petition opined that the parties are bound by DHC’s order dated May 5, 2018 and held that in any event the bank guarantee in question is unconditional and Petitioner is obliged to pay the proceeds immediately upon its invocation.

The CHC further held that repeated opportunities were given to Petitioner to act in terms of the invocation and in terms of DHC Order, however Petitioner did not adhere to it and writ Petition was disposed of. The CHC directed the Petitioner to pay an interest calculated at the rate of credit card defaults from the date of payment of the Invocation till the date of receipt of payment to the Respondent.

An appeal was preferred by the Petitioner against the said order before the CHC where the CHC opined that considering the conduct of the Petitioner, the RBI should consider what “appropriate steps” can be taken against the Petitioner including revoking its license or the authority to carry on banking business, if necessary and held that the conduct of the Petitioner was unbecoming of a nationalised bank. Hence, CHC dismissed the appeal.

SC’s verdict

The Petitioner approached the SC against an order passed in the Petition by the CHC in February, 2020.

The SC while dismissing the plea held that they did not find any ground to interfere against the impugned order of CHC in the Petition and held that it would be open for the RBI to take such necessary steps against the Petitioner as per the facts and circumstances call for “in modifications of the direction of the CHC.”

Conclusion

In moving forward, there has been no specific “appropriate action ” to be taken by RBI has been mentioned in an order passed by the SC and CHC, however the RBI have a power to cancel a license granted to the Petitioner under Section 22(4) of the Banking and Regulation Act, 1949 (“Banking Regulation Act”) which states that the RBI may cancel a license granted to a banking company; if the company ceases to carry on banking business in India; if the company at any time fails to hold the license in accordance with the conditions imposed by the RBI from time to time.

Apart from that, RBI has power to revoke the license granted to Petitioner under section 22(1) of the Banking Regulation Act and hence petitioner would not be able to carry on banking business. The RBI also has power to file an application of winding up of Petitioner under section 38 of the Banking Regulation Act, 1949 if the Petitioner is unable to pay its debts.

RBI have been regularly issuing directions to banks regarding bank guarantees and released master circular on July 1, 2013 which has specifically mentioned that where guarantees are invoked, the payments shall be made without any demur. When the letter invoking the same is sent to the beneficiary in terms of the bank guarantee, it is obliged on the bank to make payment to the beneficiary and any non-compliance of the instructions in regard to honouring the commitments of guarantee shall be viewed seriously by the RBI and deterrent action can be taken against banks.

Bank guarantee is an independent contract between bank and beneficiary and it is always obliged on the bank to honour its guarantee as long as it is unconditional and irrevocable. The court ordinarily do not interfere with invocation and encashment of bank guarantee so long as the invocation is as per terms of the contract, however fraud, irretrievable injustice and special equities are exception to this rule.

When negotiating a contract, it is always advisable for the parties to consider the phrasing of the clause relating to a bank guarantee, particularly any pre condition for having recourse to the bank guarantee and provisions related to its return.

This update is by Harshita Sharma, Advocate & Associate at Agarwal Jetley & Co., Advocates & Solicitors. Contact: Email: harshitasharma@agarwaljetley.com or Mob: (+91) - 99226 28447