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Invocation Of Bank Guarantees In Times Of Covid-19

A Letter of credit is a globally accepted payment method and is indispensable in international trade and commerce. Foreign trade and business come with numerous risks for both importer and exporter. Importers run on the risk of non-receipt of goods after payment and exporters run on the risk of non-payment on the supply of goods.

To hedge this risk, parties use Letter of Credit (hereinafter referred to as LC), which is an instrument used by the buyer's bank guaranteeing payment to the seller upon fulfilment of conditions such as producing documents to show that goods are shipped. It is for this reason that LC's are widely used as bank guarantees in cross border trade and commerce.

The COVID-19 pandemic has disrupted supply chains across the globe and ensuing lockdowns have made the situation even worse. One can imagine a situation where the seller has shipped the goods but the buyer is not able to take it from the port on account of lockdown. In several such cases, the buyer invokes force majeure clauses in their contracts and approaches the courts to restrain the bank from honouring the LC.

The pertinent question here is, Can the banks be restrained from honouring the LC's or bank guarantees on account of invocation of the Force Majeure Clause in the contract between parties? In this article, we will analyze the jurisprudence around LC's in times of COVID-19 and its bearing on the contract between parties in the Indian context and judgments.

This is not a new issue in Indian law. However, during the COVID-19 pandemic, this issue has been re-deliberated once again. It is pertinent to mention here that LC transactions are governed by UCP (Uniform Custom & Practice for Documentary Credits). UCP is a set of guidelines by International Chambers of Commerce (ICC), formulated with a view to alleviating the confusion caused by individual countries promoting their own national rules on LC. UCP guidelines are followed in more than 175 countries across the globe, including India. These guidelines are not legally binding in nature but have universal acceptance in governing LC transactions.

Since the outbreak of COVID-19 the first case that came before the court was Standard Retail Private Limited v. G.S Global Corp. In this case, Standard Retail, a steel importer based out of India, has filed an application under section 9 of the Arbitration and Conciliation Act, 1996 seeking ad-interim relief in form of directions from the court, to restrain the respondent's bank from encashing the letter of credit. G.S Corp, the seller, had already shipped the goods from South Korea. Standard Retail relied on section 56 of the Indian Contract Act, 1872 to state that since the contract stands frustrated, the LC should not be honoured. The Court refused the ad-interim relief and recorded:

The Letters of Credit are an independent transaction with the Bank and the Bank is not concerned with underlying disputes between the Petitioners who are buyers and Respondent No. 1 who is the seller.

In the case of Halliburton Offshore Services Private Inc. v. Vedanta Limited, the court vide order dated 20th April, 2020 has restrained the invocation of LC on account of special equities. The Court recorded that since COVID-19 is unprecedented, and incapable of having been predicted by either party and hence a case of special equities is established. In the subsequent hearing of the case, the ad-interim injunction granted on 20th April was vacated.

The court relied on the judgment in Global Steel Philippines v. STC of India Ltd., ILR 2009 VI Delhi 1 and Global Steel Philippines v. STC of India Ltd., [FAO (OS) No. 186/2009, decided on 12th May, 2009 wherein it was recorded that the question of Force Majeure has to be decided in terms of the arbitration clause. It was held that contractual conditions are not part of the letter of credit.

The SC observed that interference with international commercial transactions supported by LC, contrary to the UCP (Uniform Custom & Practice for Documentary Credits) adversely impacts international trade. The Court categorically observed that if the appellant is able to prove his claim in an arbitration proceeding against the respondent, then in such cases, the amount paid under the LC can also be adjudicated. The remedy available to the respondent is the recovery of the amount paid in such LC transaction.

In a recent case of M/s Rajesh Export Limited v. Canara Bank, a writ of mandamus was filed before the Karnataka High Court praying deferment of payment of LC's in light of the COVID-19 pandemic contending that the beneficiary has agreed for deferment of the dues. M/s Rajesh Export Limited, the petitioner, contended that due to pandemic, he is not able to export gold and earn foreign exchange and Canara bank, to make payment will buy forex at the prevalent price which would cause loss to him. The petitioner also requested for the extension of the duration of LC which was not granted by the Reserve Bank of India.

The court recorded that the contention of the petitioner, that the consent of the beneficiary was obtained is irrelevant as the beneficiary is a subsidiary company of the petitioner. Also, such a claim is preposterous in the sense that if the beneficiary has agreed for deferment, the LC's would have not been discounted.

The Court relied on the judgment in U.P. State Sugar Corporation vs M/S. Sumac International Ltd which clearly states that when bank guarantees are given or accepted in a commercial transaction, the beneficiary is entitled to realize bank guarantees irrespective of any disputes between the parties. The bank giving such a guarantee is bound to honour it as per the terms irrespective of any dispute raised by its customer.

The perusal of the above cases concludes that LCs are not dependent on the contract between the parties and are separate for all practical purposes. However, this position is not without exceptions. There are a few instances where the courts can interfere with the honouring of bank guarantees.

A fraud concerning bank guarantee which the beneficiary seeks to take advantage of and encashment of bank guarantee which leads to irretrievable harm or injustice to one of the parties are circumstances where the courts can interfere in honouring bank guarantees (U.P State Sugar Corporation Case, Supra). This also makes the position very clear that the fraud should be on part of the beneficiary and nobody else. The fraud must be egregious such as to vitiate the entire underlying transaction (U.P. Co-Operative Federation Ltd vs Singh Consultants & Engineers (P)).

The threshold for proving irretrievable harm is kept very high by the courts in India. In the Case of U.P State Sugar Corporation, the court relied on the judgment in Itek Corporation v. The First National Bank of Boston etc. (566 Fed Supp. 1210) to substantiate on irretrievable harm and recorded that one has to prove the existence of exceptional circumstances which makes it impossible for the guarantor to reimburse himself. A mere apprehension that the other party will not be able to pay is not enough.

From the perusal of the above cases, it becomes very evident that the courts in India are in line with the precedents on the subject even in times of COVID-19. The court diverted from the well-settled position in the recently decided Halliburton Case, wherein during the initial hearings the court tilted in favour of granting ad-interim relief and restraining the invocation of bank guarantees, but on subsequent hearings held that the case of special equity is not established and hence vacated its earlier order.

The underlying principle is that the contract between the parties for the sale and purchase of goods has no bearing on the LC transaction between parties. This means that the parties cannot restrain the banks from invoking bank guarantees on account of disputes between them subject to two exceptions i.e; Fraud and irretrievable harm. Courts in India are reluctant to interfere and indulge in the invocation of bank guarantees as it would defeat the very purpose of bank guarantees.

Such an intervention is also not required as it is against UCP (Uniform Customs & Practice for Documentary Credits) 600. Interference with the UCP guidelines would adversely impact international trade and commerce. Particularly, Article 15 of the UCP states that if the Seller has complied with the conditions of the LC, the Banks are bound to honour the LC. It is for the reasons stated above, courts in India have taken an approach of limited interference in matters concerning LCs and have kept abreast with the International guidelines on the subject.

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