Bank Guarantee(“BG”), enables the beneficiary to realize the payment under guarantee from the bank issuing BG, irrespective of any ongoing dispute between the beneficiary and the person at whose instance, the guarantee is issued by the concerned Bank. Arrangement of a Bank Guarantee is common and normally required in connection with the participation of tenders from PSUs and many other commercial circumstances.

On a demand made by a beneficiary under a BG, RBI guidelines provide that Bank must pay the amount without delay or demur.  Judicial pronouncements are broad to the effect that autonomy of Letters of Credit or BG is not affected owing to any dispute under an underlying contract.   In the cases beginning from U.P. State Sugar Corporation v. Sumac International Ltd., Supreme Court has consistently held that fraud in connection with an unconditional bank guarantee must be such that “it vitiates the very foundation of such a bank guarantee”

Such fraud has been very difficult to establish as in some way, it necessitated establishing fraud in obtaining the bank guarantee and did not arguably cover the cases where the fraud was practised subsequently through the wrongful invocation of bank guarantees.  Essentially, this meant that even if a BG was wrongly invoked against contract terms or for a purpose foreign to the purpose for which BG was issued, invocation may not be stayed.  However, in the case of Gangotri Enterprises Ltd. v UOI, Supreme Court, granted injunction to appellant restraining respondents from encashing the BG on the grounds that, arbitration proceedings were pending in respect of underlying contract; the sum claimed did not even relate to the contract for which the BG was furnished; sum claimed was in the nature of damages that required adjudication so as to be payable.  While many argue that Supreme Court, by this decision, undermined the sanctity of BGs by expanding the scope of injunction on BG, it is the author’s view that the decision gives much-needed respite to arrangers of BG now fraudulent invocation of a BG against terms of the underlying contract or for a purpose foreign to the purpose for which a BG might have been issued could be taken before the court of law.

Additionally, it is the author’s view that eventualities noted by the Supreme Court in the case of Gangotri Enterprise v UOI are nothing but examples of fraud in the invocation of a BG and there may be many more circumstances on which invocation of BG could have stayed if it is found to be fraudulent.

From a practical perspective, however, invocation of BG almost invariably results in the bank paying to the beneficiary under an unconditional LC or BG on the same or very next working day, rarely with any time to approach the court and it may be wiser to negotiate a conditional BG, in which case it may be easier to argue with the bank about non-fulfilment of conditions. 

# RBI # Unconditional Bank Guarantee # Fraud

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