A recurring issue during the Covid-19 crisis has been the alleged impossibility of performance of contractual obligations and its consequence on invocation of bank guarantees and negotiation of letters of credit. Does the frustration of the underlying contract entitle a party to seek an injunction against the invocation/encashment of a bank guarantee or a letter of credit? In this post, I discuss the law on this issue along with recent orders of the High Courts of Bombay and Delhi where the current lockdown was cited to seek an injunction against invocation/encashment of a bank guarantee or a letter of credit.
The Supreme Court has time and again held that a bank guarantee or a letter of credit constitutes an independent contract and any dispute concerning the underlying contract is irrelevant to the invocation/encashment of a bank guarantee or a letter of credit. The Court in Industrial Finance Corporation of India Ltd. v. Cannanore Spinning and Weaving Mills Ltd. has held that the frustration of the underlying contract does not have any bearing on the contract of guarantee. The Court has applied this principle to bank guarantees as well. In Gujarat Maritime Board v. L&T Infrastructure Projects Ltd., the respondent sought an injunction against the invocation of a bank guarantee on the ground that it had become impossible to perform the underlying contract. The Court rejected this contention and reiterated that an “injunction against the invocation of an absolute and an unconditional bank guarantee cannot be granted except in situations of egregious fraud or irretrievable injury”. The Court also endorsed its ruling in Himadri Chemicals Industries Ltd. v. Coal Tar Refining Co., where it was noted that the same principles are applicable to encashment of a letter of credit.
The independent nature of a bank guarantee or a letter of credit does not imply that frustration can never constitute a ground for seeking an injunction. It only implies that frustration of the underlying contract is irrelevant. In the event that the contract of guarantee or the letter of credit itself is shown to be frustrated, it would entitle, or indeed, compel, the bank to refuse payment under the contract of guarantee or letter of credit, as it would be impossible or illegal (as the case may be) to do so. So, for instance, where the payment mechanism of the bank is crippled, or where a legislation is enacted prohibiting payment to entities based in a given sovereign State, the bank may be excused for failing to honour its obligations under the contract of guarantee or letter of credit.
Now, let us examine the orders on frustration/force majeure passed during the current lockdown.
In Standard Retail Pvt. Ltd. v. G.S. Global Corp & Ors., the petitioner sought an injunction against the encashment of letters of credit on the ground that the performance of the underlying contract had been frustrated due to the lockdown. The Bombay High Court rightly rejected this plea at the ad-interim stage, holding that the letters of credit constituted an independent transaction with the bank and the disputes arising out of the underlying contract had no bearing on this issue. (In two earlier posts, I have discussed the detailed facts of the case and certain other aspects of the Court’s reasoning.)
The Delhi High Court’s decision in Halliburton Offshore Services Inc. v. Vedanta Limited is in marked contrast to the Order in Standard Retail Pvt. Ltd. In Vedanta Limited, the petitioner had entered into a contract with the respondent for completion of certain drilling work by 31st March 2020. The respondent was entitled to invoke bank guarantees furnished by the petitioner through ICICI Bank in the event that the petitioner failed to complete the work in accordance with the contract. The petitioner filed a petition under Section 9 of the Arbitration and Conciliation Act, 1996 and contended that but for the lockdown, it would have completed the work by 31st March 2020, and sought an injunction against the respondent from invoking the bank guarantees.
The Court upheld the petitioner’s plea at the ad-interim stage, finding that: (i) prima facie the lockdown constitutes a force majeure event; (ii) the petitioner had established that it was only due to the lockdown that it could not complete the work by the contractual deadline of 31st March 2020; (iii) ‘special equities’ constitutes a ground distinct from irretrievable injury for grant of injunction against invocation of a bank guarantee; (iv) the petitioner had proved that special equities existed in this case for grant of an injunction; and (v) the petitioner would suffer irretrievable injury if the injunction is not granted, even if the petitioner succeeds in the arbitration proceedings and recovers the amount from the respondent. There can be no quarrel with the Court’s reasoning that the lockdown constitutes a force majeure event, since it is an event beyond the petitioner’s control which precluded the petitioner from completing the drilling work (See Dhanrajamal Gobindram v. Shamji Kalidas & Co and Esjay International Pvt. Ltd. v. Union of India for the definition of force majeure). However, it is submitted that this does not justify the grant of ad-interim injunction against the invocation of bank guarantees.
First, as discussed above, a bank guarantee is an independent contract and a dispute as to the alleged impossibility of performance of the underlying contract is irrelevant to the invocation of a bank guarantee. Second, I have argued in the previous post that ‘special equities’ does not constitute a distinct exception to the invocation of a bank guarantee; instead, it has been referred to by courts synonymously with irretrievable injury. Third, the Delhi High Court’s finding that the petitioner will suffer irretrievable injury if the injunction is not granted is contrary to the well-settled definition of irretrievable injury. Contrary to what the Court held, the contours of irretrievable injury are not elastic. In Svenska Handelsbanken v. Indian Charge Chrome, U.P. State Sugar Corpn. v. Sumac International Ltd. and Himadri Chemicals Industries Ltd. v. Coal Tar Refining Co. (all of which were cited before the Delhi High Court), the Supreme Court has held that irretrievable injury must be of the kind in Itek Corpn. v. First National Bank of Boston, i.e. which would make it impossible for the guarantor to reimburse itself. No such impossibility of recovery was highlighted before the Delhi High Court. On the contrary, the respondent emphasized on the fact that the petitioner could very well recover the guarantee amount from the respondent if it succeeded in the arbitration proceedings. In such circumstances, a finding of irretrievable injustice cannot be justified.
The Delhi High Court has passed two other orders temporarily restraining Indian Oil Corporation Limited (“IOCL’) from invoking and encashing bank guarantees. These orders were passed by the Court in exercise of its writ jurisdiction under Article 226 of the Constitution, as the petitioner had been unable to move the National Company Law Tribunal (‘NCLT’) during the lockdown to have its plea of injunction heard. One cannot take exception to the grant of these temporary injunctions, since the basis for these injunctions is the impairment of the petitioner’s constitutional right of access to justice and have the matter heard on its merits.