A bank guarantee is a commercial instrument in the nature of a contract, intended between two parties, to secure compliance with the contract. It is an off-shoot of the main contract between two parties.
A bank guarantee is a guarantee made by a bank on behalf of a customer (usually an established corporate customer) should it fail to deliver the payment, essentially making the bank a co-signer for one of its customer's purchases.
Q: How do bank guarantees help in commercial contracts?
Guarantees are important instruments used to minimize the risks that are involved in commercial contracts. For the enforcement of ordinary guarantees, as construed dependence of the guarantee on the main contract may lead to unnecessary disputes and litigation, arising from the main contract. These disputes may have a material effect on the guarantee, thereby blocking funds in litigation. Hence, there was a need for an innovative instrument which would enable the guarantee to serve its original purpose; namely, providing a form of security.
The bank guarantee is one such innovative financial instrument whereby, if the beneficiary perceives that there has been a breach of contract by the other party, he can encash the guarantee and avail of the amount immediately, without having to undergo the hassles of litigation. Thus, the relevance of a bank guarantee achieves relevance.
Q: How can a beneficiary restrain the invocation of a bank guarantee?
The invocation of a bank guarantee by the beneficiary can be restrained by an injunction under the Civil Procedure Code, 1908, or the Specific Relief Act, 1963. However, the normal considerations, which apply in granting an injunction, will not apply in cases of a bank guarantee.
Courts are usually reluctant to grant an injunction against a bank guarantee. If a bank guarantee has to be restrained, it has to satisfy the following conditions:
Fraud;
Irretrievable injustice or injury
Q: Can the invocation of a bank guarantee be prevented by initiating arbitration proceedings?
If the bank guarantee is unconditional, arbitration proceedings would in no way affect the enforcement of the guarantee. This is because an unconditional bank guarantee is independent of the main contract which refers disputes to arbitration.
However, if the bank guarantee includes a clause to the effect that it could not be invoked prior to the decision of the arbitrators, such a bank guarantee, which is conditional, cannot be invoked and an injunction can be granted.
Q: What is the difference between a bank guarantee and a usual guarantee?
Following are some points of difference between a bank guarantee and a usual guarantee:
- A usual guarantee is governed by Sec. 126 of the Indian Contract Act, 1872. A bank guarantee is not directly governed by Sec. 126.
- An ordinary guarantee is a tri-partite (3 parties) agreement involving the surety, the debtor and the creditor. But a bank guarantee is a contract involving two parties i.e. the bank and the beneficiary.
- In an ordinary guarantee, the contract between the surety and the creditor arises as a subsidiary to the contract between the creditor and the principal debtor. The bank guarantee is independent of the main contract.
- In an ordinary guarantee, the inter se disputes between the debtor and the creditor have a material effect upon the surety's liability. However, the bank guarantee is independent of the disputes, arising ex contractu (arising out of the contract).
- An ordinary guarantee does not have any time limit before which the debt has to be claimed. Bank guarantees generally have a specific time within which they are functional.
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