Author: Nikitha Panchagnula, Student at University College of Law, Osmania University.
Citation: 1991 (1) Bom CR 26
Date of decision: August 29, 1990
Bench: D. R. Dhanuka
Original copy: N/A
Statute involved: The Arbitration and Conciliation Act, 1940
Issues in question:
- If the dispute relating to enforcement of bank guarantee can be included under the subject matter in an arbitral proceeding or in an arbitration agreement?
- If the arbitration clause contained in the main contract stands binding on the bank which is furnishing the bank guarantee?
- If an injunction order restraining the respondents from encashing the bank guarantee be seeked by the petitioner?
Background of the case:
- The petitioners are contractors who carry on business in the name of Devidas Construction. The petitioner invited tenders from the respondent in order to carry out certain construction work which was accepted by the respondent. The petitioner was to complete the work by a certain date. It was stipulated in the tender that the petitioner shall deposit Rs. 1,00,000/- in cash as a security in the favour of the respondent. The petitioner was allowed to furnish a bank guarantee to complete the said transaction. The Vijaya Bank had accepted to pay an amount not exceeding Rs.1,00,000/- to the respondent on mere demand. This bank guarantee was an independent contract between the Vijaya bank and the Union of India which contained no arbitral clause. The liability of the bank was mentioned to be unambiguous and absolute.
- The respondents had invoked the said bank guarantee and wrote a letter to the bank asking it to pay a sum of Rs. 1,00,000/-. Upon receiving this, the petitioner was called upon by the bank to remit the agreed amount so that the bank could make the payment to the respondent under the bank guarantee.
- The petitioner then filed an application by invoking Section 41 of The Arbitration and Conciliation Act, 1940 before the Hon’ble high Court of Bombay to seek an interim injunction against the first respondent and their officers or other agents from encashing the said bank guarantee pending disposal of his application under Section 20 of the Arbitration and Conciliation Act, 1940.
- The bank was not impleaded as a party to this petition seeking interim relief or to the main petition in the Arbitration Suit since the Vijaya bank was not a party to the arbitration agreement.
- The Hon’ble High Court of Bombay while giving its judgement has relied majorly upon Hindustan Paper Corporation Limited Vs. Keneilhouse Angami, [(1990) 68 Com Cas 361] which had similar case facts with that of the present case. It was held by the Division bench of Hon’ble high Court of Calcutta that:
- The parties to the bank guarantee are only the bank and the beneficiary or the beneficiaries
- The right of the beneficiary under a bank guarantee is not governed by the terms in the original contract but by the bank guarantee alone
- The bank is not the party to the arbitration clause or to the main contract
- The arbitration clause contained in the main contract cannot be made a part of the bank guarantee.
- Having regard to the above conclusions, the court held that disputes with regard to enforcement of bank guarantee cannot be referred to arbitration. Hence, Section 41 was not applicable.
- The court also referred to a major judgement of the apex court in Tarapore and Co. Vs. Tractoro Export Moscow, [(1970) AIR 891] which has laid down that the obligation on part of the bank to pay a certain amount under a bank guarantee is absolute regardless of any disputes between two parties in the main contract.
- It concluded that the claim in relation to the enforcement of bank guarantee is not covered under the arbitration clause and hence cannot be referred to arbitration. Therefore, Section 41 of the Arbitration and Conciliation Act, 1940 has no application in the present case. The petition was hence dismissed as the application filed by the petitioner was not maintainable.
- This case clearly elucidates the relation between a contract which contains an arbitration clause and a contract of bank guarantee.
- It is a well established principle as decided by the Apex Court and other High Courts in various occasions that a bank guarantee is a contract which is separate and independent of the main contract between the bank and the beneficiary which can be enforced on its own terms regardless of any disputes between the parties to the main contract.
- The parties to the main contract are the person at whose instance the bank agrees to pay the bank guarantee and the beneficiary. The bank is not a party to the main contract and is unconcerned with it. Likewise, the parties to a bank guarantee are the bank and the beneficiary alone and the person at whose instance, the bank guarantee is given is not a party. Hence, the arbitration clause contained in the main contract shall not bind the bank.