Bank Guarantee

A Legal Perspective

Abhijith S R Roll no 826 Semester IV

Abstract:

This project deals with bank guarantee. The Project examines the nature and scope of bank
guarantee system in India. The present study is concerned with the law relating to the bank
guarantees particularly embodied in the Indian Contract Act 1872. Besides that, this project also
explains the various types of guarantees issued by the banks in India. For this research, relevant
statutory material has been examined. The decisions of the Supreme Court regarding bank
guarantees had been consulted. The purpose of the project is to make systematic evaluation of law
and judicial approach relating to bank guarantee system in India.

Introduction:

According to Dr H.L. Hart ‘A banker or a bank is a person or a company carrying on the business
of receiving moneys, and collecting drafts, for customers subject to the obligation of honouring
cheques drawn upon them from time to time by the customers to the extent of the amounts available
on their current accounts’1. Section 3 of the Negotiable Instruments Act 1882, states that the term
‘banker’ includes persons or a corporation or a company acting as bankers. Under Section 5(1) of
the Banking Regulation Act, 1949, a banking company is defined as ‘any company which transacts
the business of “banking” ’. Under Section 5(1) (b) ‘banking’- means the accepting for the purpose
of lending or investment, of deposits of money from the public, repayable on demand or otherwise
and withdrawable by cheque, draft, order or otherwise. A bank Guarantee is a guarantee whereby
a bank undertakes to pay the guaranteed amount to the person in whose favour the guarantee is
issued, called the beneficiary. 2 Bank Guarantees are issued for some purpose and for a tenure
which automatically get revoked on fulfilment of such purpose and/or completion of such specified
period or vice versa. For example a bank guarantee might be revoked by the seller (beneficiary)
when the buyer fails to pay the seller for the goods supplied. In such a situation, the bank pays the
beneficiary to the extent of the amount of Bank Guarantee. Similarly, on the other side if the Seller
fails to deliver the goods or complete the terms of agreement, the bank guarantee may be cancelled
by the buyer. Issuance of Bank guarantee is a secured transaction as the client needs to mortgage

1
KC Shekhar & Lekshmy Shekhar , BANKING THEORY AND PRACTICE 20TH Edition, 2010, Vikas Publishing
House , P 753
2
S.R. MYNENI, LAW OF BANKING, , ASIA LAW HOUSE , 1 ST EDITION REPRINT 2010, P 536
the properties and cash in the form of Fixed Deposit Receipt (FDR) for is suing of same. The bank
will not give guarantee without securing itself.

Contract of Guarantee

Section 126 of the Indian Contract Act defines 'Contract of guarantee', 'surety', 'and principal-
debtor ‘and ‘creditor’. According to it a 'contract of guarantee' is a contract to perform the
promise, or discharge the liability, of a third person in case of his default. The person who gives
the guarantee is called the 'surety', the person in respect of whose default the guarantee is given
is called the 'principal-debtor', and the person to whom the guarantee is given is called the
'creditor'. A guarantee may be either oral or written. According to English Law, for a valid
contract of Guarantee, it is necessary that it should be in writing and signed by the party to be
charged therewith.

In order to constitute a contract of guarantee, there must be concurrence of the principle-debtor,

the creditor and the surety, but that does not mean that there must be evidence showing that the
principal-debtor undertook his obligation at the express request of the principal-debtor as
implied request will be quite sufficient to satisfy this requirement. The function of a contract of
guarantee is to enable a person to get a loan on goods on credit, or an employment. Some person
comes forward and tells the lender, on the supplies on the employer that he may be trusted and
in case of any default 'I undertake to be responsible'.

For example, A takes a loan from a bank. B promises to bank saying that if A does not repay the
loan “then I will pay”. In this case A is the principal debtor, who undertakes to repay the loan; B
is the surety, whose liability is secondary because he promises to perform the same duty in case
there is default on the part of A. The bank, in whose favour the promise has been made, is the
Creditor. The object of a contract of guarantee is to provide additional security to the creditor in
the form of a promise by the surety to fulfill a certain obligation, in case the principal debtor fails
to do that.3

3
Halsbury’s Laws of England, “Guarantee and Indemnity”, 4th edn, reissue, vol.20, para 101
In Hindustan Steelworks Corpn Ltd v Tarapore & Co4 the Supreme Court laid down the law in
terms of the following propositions:

“(A) A bank guarantee is an independent and instance contract between the bank and the
beneficiary and is not qualified by the underlying transaction and the primary contract between the
person at whose instance the bank guarantee is given and the beneficiary.

(B) In the case of an unconditional bank guarantee the nature of the obligation of the bank is
absolute and not dependent upon any dispute or proceeding between the party at whose instance
the bank guarantee is given and the beneficiary.

(C) …….

(D) the commitment by banks must be honored free from interference by the court and it is only
in exceptional cases, that is to say, in case of fraud, or in a case where irretrievable injustice would
be done if bank guarantee is allowed to be encashed, that the court would interfere.”

In Punjab National Bank v. Sri Vikram Cotton Mills, MANU/SC/0032/1969 : AIR 1970 SC
1973: it was held that there must be conditional promise to be liable on the default of the
principal-debtor. A liability which is incurred independently of a default is not within the
definition of guarantee.

In Interior's India v. Balmer Lawrie, AIR 2007 Del 16: It was held that a bank guarantee is
the common mode of securing payment of money in commercial dealing as the beneficiary
under the guarantee, is entitled to realize the whole of the amount under that guarantee in terms
thereof irrespective of any pending dispute between the person on whose behalf the guarantee
was given and the beneficiary.

In Daewoo Motors India Ltd. v. Union of India, MANU/SC/0152/2003 : (2003) 4 SCC 690:
it was held that once it becomes apparent that there was no chance to fulfil the condition in the
bank guarantee, invocation of the bank guarantee would not be premature or unjustified.

In Syndicate Bank v. Vijay Kumar, MANU/SC/0196/1992 : AIR 1992 SC 1066: It is well-

settled that bank guarantee is an autonomous contract. It is in common parlance that the issuance

4
(1996) 5 SCC 34
of guarantee is what a guarantor creates to discharge liability when the principal-debtor fails in
his duty and guarantee is in the nature of the collateral agreement to answer for the debt.

Liability under Bank Guarantee

A bank guarantee is a sort of an absolute undertaking to pay the amount whenever demanded by
the guarantee-holder. It has nothing to do with the state of relations between the guarantee-holder
and the person on whose behalf the guarantee was given. While ordinary guarantees are linked to
and dependent on the underlying transaction, a bank guarantee is an arrangement where the
guarantee is independent of the underlying transaction. There are professional guarantors for
whom the issue of guarantees or bonds is a financial service, namely, banks, insurance companies
who issue guarantees at a certain fees.

By issuing the guarantee, the issuing bank is assuring payment of the certain amount of money
(as specified in the bank guarantee) to the beneficiary in case of non-performance of a certain
contract according to the terms and conditions contained in the same.

By furnishing the Bank Guarantee, the buyer binds itself with the seller that it has an implied
commitment to fulfill the terms and conditions of the agreed contract. If it fails to comply with the
same, the bank will honour it. The party to whom the Bank Guarantee is given cannot go to its
bank and encash it. It is just a comfort that if we do business with some unknown party, we might
not be on loss as we are not aware honesty, sincerity and authenticity of that party.

In Larsen & Toubro Ltd v Maharashtra State Electricity Board5 the court held that in case of
confirmed bank guarantees/irrevocable letters of credit, it cannot be interfered with unless there is
fraud and irretrievable injustice involved in the case and fraud has to be an established fraud
irretrievable injustice which was made the basis for grant of injunction really was on the ground
that the guarantee was no encashable on its terms 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.
Liability under Bank Guarantee

5
1996 AIR 334, 1995 SCC (6) 68
Some litigation in connection with bank or demand guarantees is generated by the fact that there
can be abusive or unfair callings , which is to a large extent due to the independent nature of both
documentary credits and unconditional on demand guarantees. The beneficiary’s right to payment
is absolute or almost absolute. Apart from the court stay order, one method which has been
suggested has to state in his letter invoking bank guarantee that there has been some kind of breach
of the underlying transaction and what is the type of breach which is involved. 6 The person
claiming under the guarantee must establish that conditions for invoking the guarantee do exist. In
this case the Government made a counter-offer to the highest bidder and entered into negotiations
which did not materialize into a contract. Hence, the guarantee could not be invoked.7 A contract
was held to have been formed where the parties, though not accepting all the printed terms, agreed
to some of them. A contract thus came into existence outside the form. Stay of encashment of bank
guarantee could not be ordered on the ground that no contract was formed. 8 Where the bank
guarantee is conditional, the beneficiary cannot have unfettered right to invoke the guarantee and
the court can issue an injunction against invocation on the facts of the case.9 Where there was no
reference in the invocation letter to any breach of the guarantee required such conditions to be
fulfilled the plaintiff was allowed the relief of injunction.10

The Supreme Court again emphasized in U.P. Coop Federation Ltd v Singh Consultants and
Engineers Ltd11 that the operation of a bank guarantee should be stayed only in cases of serious
dispute, fraud or special equities.

Two bank guarantees were furnished by a contractor for the proper construction and
successful commissioning of a Vanaspati plant. The bank was not to revoke the guarantees
up to a fixed date and was to make unconditional payment on demand. The board was to be
the sole judge of the fact whether the contractor had fulfilled the terms of the contract.
Disputes arose between the contractor and the Board as to the erection and performance of
the plant.

6
Avatar Singh Laws of Banking and Negotiable Instruments, , Eastern Book Company, First Edition,2007, P183
7
Basic Tele Services Ltd v Union of India, AIR 2000 Del 1
8
International(India) v Indian Sugar & General Industries Export Import Corpn, AIR 2001 Guj 227
9
Hindustan Construction Co Ltd v State of Bihar, (1999) 8 SCC 436
10
V.V Gupta v New Delhi MC, AIR2006 Del 1035(NOC)
11
(1988) 1 SCC 174
The contractor sought an injunction to restrain the Board from enforcing the guarantee. The court
found no serious ground for doing so. The court felt that respectability and reliability of the assured
mode of payment through confirmed letters of credit in international trade and bank guarantees in
national trade is necessary for the growth and promotion of trade. SHETTY J cited Lord
DIPLOCK12:

“the whole commercial purpose for which the system of confirmed irrevocable documentary
credits has been developed in international trade is to give to the seller an assured right to be paid
before he parts with control of the goods and that does not permit of any dispute with the buyer as
to the performance of the contract of sale being used as a ground for non-payment or reduction of
deferment of payment.”

The court alleviated the feelings of contractors and buyers who provide guarantees which go
beyond their reach by saying that no irretrievable injustice is likely to be done because the party
withdrawing the amount would remain accountable and, if he cannot justify himself, he would
have to offer restitution or compensation.13

“ the wholly exceptional case where an injunction may be granted is where it is proved that the
bank knows that any demand for payment already made or which may hereafter be made will
clearly be fraudulent. But the evidence must be clear both as to the fact of fraud and as to the
bank’s knowledge. It would certainly not normally be sufficient that this rests on the
uncorroborated statement of the customer. A bank acting on such a statement may cause
irreparable damage to its credit.”14

In reference to the meaning of irretrievable injury, the Supreme Court said that it must be of the
kind which was the subject-matter of the decision in Itek Corpn v First National Bank of Boston15:

“ to avail of the exception, therefore, exceptional circumstances which make it impossible for the
guarantor to reimburse himself if he ultimately succeeds will have to be decisively established.
Clearly, a mere apprehension that the other party will not be able to pay is not enough.”

12
U.C.M.(Investments) v Royal Bank of Canada, (1982) 2 A11 ER 720 HL.
13
Avatar Singh Laws of Banking and Negotiable Instruments, , Eastern Book Company, First Edition,2007, P 185
14
Sir John Donaldson MR in Bolivinter Oil SA v Chase Manhattan Bank, (1984) 1 AII ER 351 cited in U.P. Co-
Operative Federation Limited v Singh Consultants And Engineers (P) Ltd 1988 1 scc 174
15
566 Federal Supp 1210.
In General Electric Technical Services Co Inc v Punj Sons (P) Ltd16, While dealing with a case
of bank guarantee given for securing moblisation advance, it was held that the right of a contractor
to recover certain amounts under running bills would have no relevance to the liability of the bank
under the guarantee given by it.

The high Court of Delhi followed this decision so as to hold that the enforcement of the bank
guarantee would not be stayed but that the authority would be told that they should enforce the
guarantee only for the balance amount minus the amount already recovered from the contractor’s
running account payments.17

In Escorts Ltd v Modern Insulators Ltd18, the High Court of Delhi refused to stay the payment
because the alleged ground only showed an inconsistency in the two letters about the installation
and working of machines and not a fraud or the possibility of an irretrievable injustice. The
Supreme Court reiterated this in U.P. Co- operative federation Ltd v Singh Consultants and
Engineers Pvt Ltd, the bank must pay except in case of fraud or irretrievable injustice.

In Dai-ichi Karkaria P Ltd v Oil and Natural Gas Commission19, the Bombay High Court held
that the law cannot allow the benefit of a bank to be claimed by unscrupulous methods. Here the
party in question was compelled at the pain of stopping business with him to drop from his bank
guarantee the original requirement that it would be encashable only when the parallel amount of
import duty paid by him was refunded to him. As soon as ONGC attempted to enforce the altered
guarantee, he applied for and was granted a stay against such encashment. He was the victim of
undue influence bordering on fraud and the special equities generated created the necessity of
rescuing the party from being victimised.

In Binfro Electronics (P) Ltd v Bharat Sanchar Nigam Ltd 20, no purchase order was place upon
the bidder so that there was no concluded contract at all, invocation of bank guarantee was held to
be not justified.

16
(1991) 4 SCC
17
Contract & Specific Relief , Avatar Singh, tenth Edition, Eastern Book Company, pg no 620, 621
18
AIR 1988 Del 345
19
AIR 1992 Bom 309.
20
AVATAR SINGH ,Laws of BANKING & NEGOTIABLE INSTRUCTIONS- AN INTRODUCTION, , Eastern
Book Company, 1st Edition 2007, P 188
Invocation of Bank Guarantee

The beneficiary of the Bank guarantee can invoke the guarantee any time before the expiry
period for lodgment of the claim. It is not necessary for the beneficiary to satisfy the bank, about
the default or the amount of actual loss suffered by him. Only when the bank has received an
order of injunction/restrain from a competent Court, the bank can withhold payment under Bank
guarantee till the Court case is decided, the liability of the bank under Bank Guarantee will
continue. The bank should also send a notice subsequently to the applicant invoking the counter
guarantee.21

Bank Guarantee and Arbitration Clause

The Enforcement of a bank guarantee cannot be made the subject-matter of arbitration

proceeding.22 But where a bank found that there was a pending arbitration under which the
liability of all the parties had to be ascertained, the Karnataka High Court upheld the decision
of the bank to withhold payment.23

In HVS Technologies Inc., USA v Aeronautical Development Agency 24 , it was held that
though the amount encashed is subject to adjustment under the final award to be passed by the
arbitrator, the right of the beneficiary of the guarantee to recover the guaranteed amount could
not be stayed pending arbitration and the bank could not be restrained from honouring its
obligation.

Period of Limitation

The period of limitation for enforcing a guarantee is three years from the date on which the
letter of guarantee was executed.25 In Annama Jose v Kerala Financial Corpn26, , it was held
that recovery proceedings instituted after 3 years from the date of guarantee were liable to be
quashed. Here against the advancement of a loan to a company, the guarantee deed was

21
LAW OF BANKING, S.R. MYNENI, ASIA LAW HOUSE , 1 ST EDITION REPRINT 2010, PG no 538
22
AVATAR SINGH ,Laws of BANKING & NEGOTIABLE INSTRUCTIONS- AN INTRODUCTION, , Eastern
Book Company, 1st Edition 2007, P 191
23
Ibid
24
(2001) 4 Kar LJ 211.
25
New Bank of India v Sajitha Textiles, AIR 1997 Ker 201, the guarantee deed was not allowed to be enforced
against he guarantor under a suit filed after expiry of the period. Art 55 of the Limitation Act, 1963 is applicable.
26
AIR 2002 Ker 396
executed by its directors and subsequently a letter acknowledging the loan was issued by the
same directors on behalf of the company, it was held that the letter did not have the effect of
extending the period of limitation.

A guarantee has to be invoked within its validity period, i.e. before its expiry date. Once it is
invoked within time actual proceedings can be commenced within the period of three years
from that date. Any clause in the contract cutting short this period would be hit by Section 28.
In Maharashtra State Financial Corpn v Magna Elastometrics Rollers (P) Ltd, Misc Petition
NO 49 of 1999 decided on 14-1-2005, limitation as against the guarantor starts only from
invocation of the guarantee.27

The period of limitation cannot, except in certain specific cases as specified in Limitation Act,
be extended or altered by agreement, express or implied, between the parties concerned and no
suit instituted or appeal preferred after the prescribed period will be entertained.28

The period of limitation for filing a suit for recovery of the money due can be extended29:

1. If prior to expiry of the period of limitation, fresh documents are taken in replacement
of the old ones.

2. If an acknowledgment of debt is duly made by the borrower or his authorized agent

on a revenue stamp before the expiry of the period of limitation.

3. If a part payment is made by the borrower or his authorized agent before the expiry of
the period of limitation.

4. Where the Court is satisfied that the sufficient cause was there for not filing the suit
or preferring the appeal or making the application within the period such as Court
remaing closed etc.

In Margaret Lalitha v. Indo Commercial Bank 30 , the Supreme Court has held that the
limitation period for a suit by a creditor against the guarantor under a continuing guarantee is

27
Contract & Specific Relief , Avatar Singh, tenth Edition, Eastern Book Company, pg no 627
28
LAW OF BANKING, S.R. MYNENI, ASIA LAW HOUSE , 1 ST EDITION REPRINT 2010, PG no 538
29
LAW OF BANKING, S.R. MYNENI, ASIA LAW HOUSE , 1 ST EDITION REPRINT 2010, PG no 538
30
Ibid
three years from the date of demand by the kin or the notice of termination where the guarantor
has himself rescinded the guarantee.

In Bombay Dyeing & Mfg. Co. v. State of Bombay and other31, the Supreme Court held that a
creditor is entitled to recover the debt from surety even though a suit on it is time-barred against
the principal debtor.

Types of Bank Guarantees

1. Financial Guarantee:

Financial Bank Guarantee is a bond which is not cancellable and ensures the payment of the
interest and repayment of the principal amount as per the schedule agreed upon by both the
borrower and the lender. A guarantor to this debt security is liable to pay off the liability in case
the first party or the issuer of the Financial Bank Guarantee fails to make the payment.

Example: Suppose the company has taken loan from bank/financial institution which are being
guaranteed by another company and/or the personal guarantee of the promoter-director and/or the
guarantee given by the property owner. Again in case of buyers credit the bank guarantees of
payment in case the client fails to good the payment.

2. Performance Guarantee:

The seller issues a Performance Bank Guarantee to ensure or give concrete commitment to the
buyer through its bank. This method ensures the buyer the timely execution of an agreement to
have the goods exported or delivered or services performed. In case the seller defaults on execution
of the terms agreed upon the Performance Bank Guarantee ensures the buyer the payment of the
guarantee amount by the issuing bank. Generally the performance Bank guarantee is 10 percent of
the total assignment or project value.

Example: Guarantee to government department for bidding the projects, guarantee to contractors
and seller in normal course of business.

31
1958 SCR 1122
In Vinay Engineering v. Neyveli Lignite Corporation Ltd32, it was held that when under a bank
guarantee the bank had irrevocably undertaken to pay to the purchaser up to a certain sum of money
upon the purchaser’s first demand and without demand provided the purchaser advised the bank
that the contractor had failed to fulfil his delivery obligations under a contract with the purchaser,
the bank was bound to make the payment on the necessary advice given by the purchaser. It was
also held that the purchaser in such a case need not prove to the bank that the contractor had failed
to perform his obligations under the contract, as the fact of the purchaser’s advice to the bank was
all what was required for the payment of the guarantee amount.

In Pesticides India v State Chemical and Pharmaceutical Corporation Ltd33, pesticides India
wanted to purchase some goods from S.C. & P. Corporation and they gave some earnest money
and also bank guarantee by the State Bank of Bikaner & Jaipur. On the supply of goods by the
Corporation, Pesticides India were not satisfied with the performance and according to them the
supply had been wrongly made on ‘ex godown’ basis instead of ‘high seas’ basis. The Corporation
demanded the amount of the bank guarantee from the Bank but the Pesticides India sought to
restrain the bank from making the payment. It was found that in this case the Bank had undertaken
to pay ‘on first demand’ without protest or demur and without reference to Pesticides and
notwithstanding ‘existence of any dispute whatsoever’ between the parties. It was held that the
Bank was bound to honour the guarantee, and the Pesticides India cannot prevent the Bank from
honouring its promise to pay.

3. Deferred payment guarantee

Under deferred payment guarantee, the banker guarantees payment of instalments spread over a
period of time, on their due dates. It is basically a financial guarantee. The guarantee issuing bank
undertakes to make payment of instalments plus interest on their due dated in the event of
constituent’s default. It is also issued to guarantee repayment of instalments plus interest on their
due dated in the event of constituent’s default. It is also issued to guarantee repayment of loans
raised abroad by means of External Commercial Borrowings. It has been treated as a term loan for
the purpose of appraisal, sanction etc. while issuing a deferred payment guarantee, the banker has
to assess the ability and sources of funds of the customer to honour the payment of instalment on

32
AIR 1985 Mad. 213
33
(1983) 54 Com Cas 147 (Del.)
due dates. The banker’s liability to pay does not cease even if the customer advises not to pay on
account of defective quality of goods/machinery. Etc.

4. Advance Payment guarantee:

An advance payment guarantee is used when the contract provides for advance payment to be
made to the seller, and it guarantees that the advance payment will be returned to the buyer if the
seller does not fulfil its obligations on delivery of goods or services. It is a contract under which
the issuer undertakes to be responsible for the fulfilment of a contractual obligation owed by one
person to another if the first person defaults. The issuer's obligation may be primary (as in an on-
demand obligation or indemnity) or secondary (as in a guarantee). An advance payment guarantee
or bond is typically used to underpin or guarantee the performance of a commercial contract, such
as a contract for the sale of goods (where the buyer is the beneficiary) or a construction contract
(where the employer is the beneficiary). For example, a buyer or employer may make down or
advance payments to a seller or contractor to provide it with funds to purchase necessary materials
or machinery or otherwise prepare itself to perform the contract. The buyer or employer will wish
to ensure that if the seller or contractor fails (perhaps because of insolvency) to deliver the goods
or perform the services in accordance with the contract then, at the very least, it can recover the
payments made to the seller or contractor. The buyer or employer will, therefore, require the seller
or contractor to provide an advance payment guarantee or bond for these payments. The guarantee
or bond will provide that if the seller or contractor fails to meet its contractual obligations, the
issuer will refund the advance payments made by the buyer or employer.

5. Bid Bond Guarantee

A Bid guarantee issued by a bank is a guarantee to the effect that the bidder would not withdraw
its bid during the stipulated period or if the contract is awarded to him (bidder. Tenderer) he will
comply with the terms of the tender and enter into the contract. A bid bond is normally required to
be issued on behalf of a customer to enable him to participate in a bid for a contract. Bid bond
guarantees are akin to security deposits/earnes money deposits.

Sometimes, a party responding to a tender call also submits a false bid to weed out his competitors.
The bidders may also form their own group in order to eliminate inter se competition and to quote
a higher price. The firm / organisation calling a tender taken certain precautionary measures to
avoid any false bid or unethical competition such as, requiring the bidders to deposit a sum of
money which is normally up to five percent of the tender value or a bank guarantee for equivalent
amount. The guarantee so issued in lieu of tender deposit is known as bid bond. A bid bond is
designed to prove to the buyer that the seller’s tender is serious.

Bank Guarantee and Letter of Credit

A bank guarantee is frequently confused with letter of credit (LC), which is similar in many ways
but not the same thing. A letter of credit is an obligation taken on by a bank to make a payment
once certain criteria are met. Once these terms are completed and confirmed, the bank will transfer
the funds. This ensures the payment will be made as long as the services are performed. Whereas
a bank guarantee, like a line of credit, guarantees a sum of money to a beneficiary. Unlike a line
of credit, the sum is only paid if the opposing party does not fulfill the stipulated obligations under
the contract. This can be used to essentially insure a buyer or seller from loss or damage due to
nonperformance by the other party in a contract.

The basic difference between the two is that of the parties involved. In a bank guarantee, three
parties are involved; the bank, the person to whom the guarantee is given and the person on whose
behalf the bank is giving guarantee. In case of a letter of credit, there are normally four parties
involved; issuing bank, advising bank, the applicant (importer) and the beneficiary (exporter).

Also, as a bank guarantee only becomes active when the customer fails to pay the necessary
amount where as in case of letters of credit, the issuing bank does not wait for the buyer to default,
and for the seller to invoke the undertaking.

In United Commercial Bank v. Bank of India, MANU/SC/0003/1981 : AIR 1981 SC 1426: it

was held that whether it is a bank guarantee, or a letter of credit or contract of indemnity the
enforceability of such an instrument against the Bank depends on this terms and conditions of
the same.
SAFE GUARDS TAKEN BY BANKS34

To reduce the risks to which the banks are exposed while furnishing bank guarantees on behalf of
their clients, banks resort to the following to safeguard their interest.

(a) Limits

Banks lay down maximum monetary limits upto which they would furnish guarantees and open
letters of credit at any point of time. The limits are fixed on the basis of the financial standing,
extent to which the account has been maintained by customers satisfactorily, the volume of
transactions, past track record of the client in-respect of such guarantees etc. The limits are
reviewed are refixed periodically along with monetary limits for overdrafts, cash credits etc.

(b) Margins

Banks lay down maximum monetary limits upto which they would furnish guarantees and open
letters of credit at any point of time. The limits are expired on the basis of the financial standing,
extent of which the account has been maintained by the customers satisfactorily, the volume of
transactions, past track record of the client in respect of such guarantee etc. The limits are reviewed
and refixed periodically along with monetary limits for overdrafts, cash credits etc. The percentage
of margin money could range from ten to fifty percent of the value of the guarantees. The margin
money will be released once the bank guarantee has expired and is returned to the bank duly
discharged.

(c) Counter Guarantee

In addition to fixing limits and taking ‘margin money’ as security, banks invariably obtain counter
guarantees from the client’s for equal value before furnishing bank guarantees on their behalf. This
document provides the basis for the bank to debit the clients’ accounts when it has to honour a
bank guarantee invoked by the beneficiary, and to proceed legally against the client, if it is unable
to fully reimburse itself of the amount from the client.

34
MOHD YASIN WANI, A LEGAL PERSPECTIVE OF BANK GUARANTEE SYSTEM IN INDIA, , VOLUME
NO. 3 (2012), ISSUE NO. 9 (SEPTEMBER) INTERNATIONAL JOURNAL OF RESEARCH IN COMMERCE &
MANAGEMENT. Available at: http://ijrcm.org.in/download.php?name=ijrcm-1-vol-3_issue-9-art-
30.pdf&path=uploaddata/ijrcm-1-vol-3_issue-9-art-30.pdf
Conclusion

It is obvious that a Bank Guarantee is a Contract of guarantee where a bank undertakes the
responsibility to pay the creditor in case of debt, default or miscarriage of the principal debtor.
The bank guarantee is a separate contract from the contract between the beneficiary and the
guarantor. It is not qualified by the underline transaction and the primary contract between the
people at whose instance the bank guarantee is given. Therefore the bank should pay the sum
specified in the guarantee on demand unconditionally and without demur to the beneficiary.
Through various judgments judiciary has decided to minimise its interference in the matter of
bank guarantee. The limitation period once the bank guarantee is invoked is three years for the
private parties. It cannot be extended by any means. There are different types of bank guarantees
which include deferred bank guarantee, performance guarantee, bid bond guarantee, advance
payment guarantee and financial guarantee.