Is ‘Special Equities’ a Distinct Exception to Invocation of Bank Guarantees?

The law on invocation of bank guarantees is well-settled. The Supreme Court has consistently held that the beneficiary of a bank guarantee is entitled to invoke it (in accordance with its terms) irrespective of any dispute between the beneficiary and the party at whose behest the guarantee is given. For, a bank guarantee is an independent contract, and grant of injunction by courts against invocation of bank guarantees would irreparably damage commercial transactions. The Court has also held in a plethora of judgments that there are only two exceptional circumstances in which an injunction may be granted against invocation of a bank guarantee: (i) fraud of an egregious nature which vitiates the entire underlying contract; and (ii) where the invocation of guarantee would cause irretrievable injury to the party at whose behest the guarantee is given. The Court has referred to ‘special equities’ synonymously with the second exception. However, two recent judgments of the Supreme Court – Andhra Pradesh Pollution Control Board v. CCL Products (India) Ltd. and Standard Chartered Bank v. Heavy Engineering Corporation Ltd. – have seemingly added special equities as a distinct category of exception. Relying on Standard Charter Bank, the Delhi High Court in Halliburton Offshore Services Inc. v. Vedanta Limited has held that special equities does constitute a distinct ground for grant of injunction against invocation of bank guarantees. In this post, I argue that this is incorrect, and the observations in CCL Products and Standard Chartered Bank must be construed in the context of the development of law on this issue and the precedent relied upon in these decisions.

The first instance when special equities was craved out as an exception to the bank’s obligation to honour a guarantee was in the Calcutta High Court’s decision in Texmaco Ltd. v. State Bank of India. Sabsyasachi Mukharji, J. (as he then was) referred to judgments on English law where fraud had been held to be an exception to invocation of a bank guarantee and added special equities as an additional ground. Texmaco Ltd. was subsequently endorsed by a Division Bench of the Supreme Court in U.P. Cooperative Federation Ltd. v. Singh Consultants and Engineers (P) Ltd. (which also involved Sabyasachi Mukharji, J.). In U.P. Cooperative Federation Ltd., the Court expressly held that there are only two situations in which courts can interfere with the invocation of a bank guarantee – fraud and ‘special equities in the form of preventing irretrievable injustice’. The Court explained that the phrase ‘special equities’ used in Texmaco “may be a situation where the injunction was sought for to prevent injustice which was irretrievable”. While this may suggest that the Court referred to irretrievable injustice only as one of the instances of special equities, the Court’s unequivocal finding that there exist only two exceptions to the invocation of bank guarantee dispels the notion that ‘special equities’ and ‘irretrievable injustice’ are distinct exceptions (fraud being the other one). This reading of U.P. Cooperative Federation Ltd. is confirmed by subsequent Supreme Court judgments, discussed below.

Two decisions of the Supreme Court in General Electric Technical Services Company Inc. v. Punj Sons (P) Ltd. and Svenska Handelsbanken v. Indian Charge Chrome approved the two exceptions to invocation of bank guarantee laid down in U.P. Cooperative Federation Ltd., i.e. fraud and ‘special equities in the form of preventing irretrievable injustice’. According to Svenska Handelsbanken, ‘special equities in the form of irretrievable injustice’ meant nothing more than irretrievable injustice and special equities did not constitute an independent exception. This is evident from the following excerpts:

“72. Again in [General Electric Technical Services Company Inc.] Shetty, J. referred to the observations of Mukharji, J. [in U.P. Cooperative Federation Ltd.] that there should be prima facie case of fraud and special equities in the form of preventing irretrievable injustice between the parties. Mere irretrievable injustice without prima facie case of established fraud is of no consequence in restraining the encashment of bank guarantee.”

“88. …In law relating to bank guarantees, a party seeking injunction from encashing of bank guarantee by the suppliers has to show prima facie case of established fraud and an irretrievable injury. Irretrievable injury is of the nature as noticed in the case of Itek Corpn.”

The Supreme Court in Hindustan Steel Workers Construction Ltd. v. Tarapore & Co. yet again clarified that special equities is not a distinct exception to the invocation of bank guarantees. The Court held that the ratio of U.P. Cooperative Federation Ltd. was that fraud and irretrievable injustice are the only two exceptions to invocation of bank guarantees and reiterated this position of law. Subsequently, in U.P. State Sugar Corpn. v. Sumac International Ltd., Dwarikesh Sugar Industries Ltd. v. Prem Heavy Engineering Works (P) Ltd., Himadri Chemicals Industries Ltd. v. Coal Tar Refining Co., Vinitech Eletrconics Pvt. Ltd. v. HCL Infosystems Ltd., Gujarat Maritime Board v. L&T Infrastructure Projects Ltd. and several other judgments, the Supreme Court categorically recognized only these two exceptions to the invocation of a bank guarantee. In fact, in BSES Ltd. v. Fenner India Ltd., the Court refused to import other exceptions from English law and Singapore law. In view of this overwhelming precedent, a learned Single Judge of the Bombay High Court in Felguera Gruas India Pvt. Ltd. v. Tuticorin Coal Terminal Pvt. Ltd. rejected the contention that special equities constitutes a third exception to the invocation of bank guarantees (the Division Bench in appeal noted the findings of the learned Single Judge on this issue but did not comment on them).

Now, let us examine the decisions in CCL Products and Standard Chartered Bank. In neither of these decisions was the Court called upon to consider the scope of exceptions to the invocation of bank guarantees or as to whether special equities and irretrievable injustice constitute distinct exceptions to invocation of a bank guarantee. The Court simply took note of its previous decisions in Ansal Engineering Projects Ltd. v. Tehri Hydro Development Corporation Ltd., State Bank of India v. Mula Sahakari Sakhar Karkhana Ltd. and Hindustan Construction Co. Ltd. v. State of Bihar and held that the exceptions to invocation of a bank guarantee are fraud, irretrievable injustice and special equities. However, none of these decisions hold that special equities and irretrievable injustice are separate exceptions. The additional judgments – in Himadri Chemicals Industries Ltd. and Gujarat Maritime Board – relied upon in Standard Chartered Bank also do not support this proposition. On the contrary, all the decisions referred to in CCL Products and Standard Chartered Bank had categorically held that there are only two exceptions to invocation of a bank guarantee – fraud and irretrievable injustice.

In this background, it is submitted that the observations in CCL Products and Standard Chartered Bank cannot be construed to mean that the Court has laid down special equities as a distinct exception to the invocation of a bank guarantee and altered the position of law which had been reiterated in innumerable previous judgments for more than two decades. Indeed, the Court in CCL Products and Standard Chartered Bank was bound by decisions of larger bench strength, rendered in General Electric Tehnical Services Company Inc., Svenska Handelsbanken, Ansal Engineering Projects Ltd., and Dwarikesh Sugar Industries Ltd., which have all held that there are only two exceptions to the invocation of a bank guarantee and referred to special equities synonymously with irretrievable injustice. It is well-settled that observations of courts in a judgments cannot be read like a statute or out of context. Therefore, the Delhi High Court’s reliance on Standard Chartered Bank to hold that special equities is a distinct category of exception is misplaced and ignores the long line of precedent on this issue.

Even from a normative perspective, construing special equities as being independent of irretrievable injustice would have far-reaching consequences. The Supreme Court has time and again emphasized on the importance of banks honouring their commitments under bank guarantees and therefore, the two exceptions of fraud and irretrievable injury have consciously been construed extremely narrowly. Fraud must be such that it vitiates the very foundation of the guarantee and irretrievable injustice must be of the kind which would make it impossible for the guarantor to reimburse herself. A third exception on the ground of special equities will needlessly expand this further. Disputes arising out of the underlying contract will increasingly influence the performance of the contract of guarantee, diminishing the independent nature of the latter. The fluid nature of the phrase ‘special equities’ may lead to injunctions being granted more frequently against invocation of bank guarantees. This will have an insidious effect on the efficacy of bank guarantees.