The Rare Case of Special Equities in Arbitration

Introduction

Bank guarantee acts as a safety net, especially in long-term projects, involving the Government as a contracting party. In unfortunate cases that a party fails to discharge its contractual obligations, leading to defaults occurring before or during the course of the project.

Bank guarantees act as a risk reduction option for contracting parties and in light of the same, as and when issues and disputes occur, emanating from an enforceable agreement, the guarantor’s bank is obligated to release the secured amount to the aggrieved party when the request is made for such discharge of the safety net.

The principle of autonomy separates the bank guarantee from its underlying contract.¹ The principle of autonomy in bank guarantees is supplemented with the doctrine of strict compliance, which ensures that a demand for payment or invocation of a bank guarantee must be met with payment by the guarantor as long as the requirements of the guarantee are fulfilled.²

In today’s legal scenario, the Supreme Court and various High Courts have clarified that the enforcement of bank guarantees cannot be interfered with, subject to a few exceptions being fraud, irretrievable and irreversible loss, and “special equities” being proven by the contracting party. These exceptions to invocation have to be proved beyond a reasonable doubt and with evidentiary support. However, in common law jurisprudence, the injunction to bank guarantee invocation is only to the exception of fraud being proven, i.e., the party seeking encashment of bank guarantee is attempting the same under the garb of fraud, misrepresentation or suppression.

In a crucial judgment passed by the Delhi High Court in Director General Project Varsha v. Navayugavanoordjv³ it was held that:

91. If a Bank Guarantee is unconditional, restraint against invocation can be granted only if one or more of three conditions is shown to exist. The party seeking injunction has to establish that the injunction is vitiated by egregious fraud, or that invocation would result in irretrievable injustice, or that there exist special equities which justify grant of injunction against invocation. The use of the adjectives ‘egregious’, ‘irretrievable’ and ‘special’, preceding these stipulations, is significant. It is not merely fraud, or injustice, or existence of equities, which can justify injunction against invocation of an unconditional Bank Guarantee. The fraud must be egregious, the injustice must be irretrievable and the equities must be special. It is only, therefore, if these standards are met that a Court can injunct the invocation of an unconditional Bank Guarantee.

The subject of divergence shown by courts in India is that of interpreting the exception of “Irretrievable Injury/Harm/Injustice” and “Special Equities” to justify the grant of injunctions. Indian courts have largely been attuned to exercise equitable jurisdiction in cases where there are “special equities” in favour of an injunction which create “irretrievable injury” or “irretrievable injustice”.⁴

What are special equities?

Special equities are exceptional circumstances, apart from the recognised exception of fraud, which justify granting of an injunction against invocation of bank guarantees.

Special equities are considered by the Court in such circumstances wherein an apparent prima facie case is made, combined with the non-grant of the relief, shall cause irreparable loss or injury. Pertinently, all three ingredients go together when making a Section 9 application under the Arbitration and Conciliation Act, 1996 to plead equities seeking injunctive relief.

The Delhi High Court in Zee Entertainment Enterprises Ltd. v. Railtel Corpn. of India Ltd.⁵, held that special equities shall include such extraordinary circumstances that cause irreversible injury, which, for instance, may cause the guarantor to be reimbursed at a later stage, if found entitled to the money and the invocation of the guarantee not being in terms of the agreement or guarantor’s explicit written down liability. The courts have further clarified in numerous cases now that a competent court shall have to undertake the exercise to assess that prima facie, an extraordinary case of special equities is being made out by the guarantor, or it is merely a contractual dispute, given the mirage of special circumstances to seek injunctive relief.

In Texmaco Ltd. v. SBI⁶, the Calcutta High Court, on special equities, observed that the same have been given judicial recognition, which has emerged as a recent exception, apart from fraud that needs to be shown by the aggrieved party in order to seek an injunction against the invocation of performance guarantee and/or bank guarantees. The Calcutta High Court further observed that the requirement of special equities is akin to that of irretrievable justice, i.e., the resulting irretrievable injury that must be such that it makes it impossible for the guarantor to reimburse himself and/or would be impossible to recover the amount from the beneficiary through restitution.

It is trite law that in order to seek injunctive relief under Section 9, Arbitration and Conciliation Act, the guarantor is obligated to pass the test akin to Order 39 Rules 1 and 2, Civil Procedure Code, 1908. Injunctive reliefs are serious in nature as they bound down the other contracting party from exercising certain rights, duties and obligations that otherwise may make them financially and other forms of gains. The Delhi High Court in Hindustan Construction Co. Ltd. v. National Hydro Electric Power Corpn. Ltd.⁷ has made it clear that courts are not to interfere in the enforcement of a bank guarantee without the pleader being able to show fraud or special equity that is prima facie made out. This finding has been recently examined and upheld by the Supreme Court in Jindal Steel & Power Ltd. v. Bansal Infra Projects (P) Ltd.⁸, whereby the Supreme Court has reiterated the assessment of a prima facie case when exceptional circumstances are being pleaded by the guarantor, in the cases of an unconditional bank guarantee

Extraordinary circumstances in the defence of special equities

A serious aspect of the consideration of special equities is also where there exist a breach in the underlying contract leading to the beneficiary taking such drastic steps for invocation. In KKSPUN India Ltd. v. OFB Tech (P) Ltd.⁹ the Delhi High Court took an analytical and thorough look into the fact that, in order to trigger the event of invocation, there has to be a lapse or default on the part of the contracting party in order to enable the beneficiary to “invoke” the guarantee. In view thereof, the Delhi High Court observed that:

16. … It is also the law that invocation must be in terms of the bank guarantee; and if there is a lapse on the part of the invoking party in complying with the terms of invocation, the invocation itself will be bad in law. It has accordingly been held that invocation of a bank guarantee must fulfil the requirements for invocation as contained in the terms thereof, failing which the invocation would be bad in law.

Another critical aspect for consideration when special equities are pleaded is invocation of the guarantee by a third party. The law in terms of the invocation of a bank guarantee has been settled by the Supreme Court in United Commercial Bank v. Bank of India¹⁰ and Hindustan Steelworks Construction Ltd. v. Tarapore & Co.¹¹ It was clarified by the Supreme Court that if a bank is to be interdicted, at the instance of a third party, who is a stranger to the bank guarantee between the bank and the beneficiary, from honouring the bank guarantee.¹²

As a bank guarantee is a separate and distinct contract between the bank and the beneficiary, therefore, it could not be invoked by a third party. In circumstances where the same may take place, then “special equities” lie in the favour of the contesting party wholly. The Supreme Court has also stressed upon the fact that there exists an element of public interest in banks honouring their commitments, however, in circumstances where a stranger approaches the bank for the invocation of a guarantee and the same is obliged by the bank, it would lead to erosion of faith and reputation of the bank.

The Delhi High Court in Hindustan Construction Co. Ltd. v. National Hydro Electric Power Corpn. Ltd.¹³ was posed with circumstances where the petitioner, Hindustan Construction, despite having certain arbitral awards in their favour, filed a Section 9 application seeking to restrain the respondent, National Hydroelectric Power Corporation (NHPC), from invoking/encashing the bank guarantee. The Court took a firm view that mere existence of a dispute between the parties shall not entitle a party to an injunction against the invocation of a guarantee. The ground for special equities cannot kick in on mere force majeure event, but the aggrieved party has to unravel fraud before the Court or show irretrievable injustice and loss that cannot be restored.

In the Hindustan Construction case¹⁴, Delhi High Court analysed that though it is settled principle that the bank guarantee is a separate contract that exist between the bank and the beneficiary party, however, the said case unequivocally demonstrated special equities in favour of the petitioner as NHPC attempted to invoke guarantee whereas the arbitral award was in favour of the petitioner and the counterclaims of NHPC stood rejected by the Tribunal. The High Court further held that, despite the fact that the rejection of the counterclaim has been challenged by NHPC under Section 34, Arbitration and Conciliation Act, 1996, they would have to start afresh if the Section 24 petition succeeds and the same will not result in the invocation of the guarantee.

Duty of care of the banks

It is to be noted that in cases of unconditional bank guarantees, furnished during commercial transactions, beneficiaries are enabled to revoke such guarantees without any adjudicatory process. The obligor’s bank is not concerned with the commercial and contractual disputes arising between the contracting parties, the bank, however, is only concerned with the mandate and the confirmation under the guarantee contract being complied with. In Consortium of Deepak Cable India Ltd. & Abir Infrastructure (P) Ltd. (Dcil-Aipl) Thr Abir v. Teestavalley Power Transmission Ltd.¹⁵, the Division Bench of the Delhi High Court has held that:

145. The legal position which can be summarized would be that a bank guarantee is an independent contract between the bank and the beneficiary and disputes pertaining to bank guarantees have to be resolved de-hors the terms of the main contract between the parties or disputes relatable to the main contract between the parties.

However, even an unconditional bank guarantee is not immune to injunctive reliefs under Section 9, Arbitration and Conciliation Act, 1996 in cases of fraud as well as special equities, as has been held in Himadri Chemicals Industries Ltd. v. Coal Tar Refining Co.¹⁶, A.P. Pollution Control Board v. CCL Products (India) Ltd.¹⁷, U.P. Coop. Federation Ltd. v. Singh Consultants and Engineers (P) Ltd.¹⁸, amongst others.

In terms of letters of credit and bank guarantees, it is incumbent on banks to adhere to the uniform customs and practice for documentary credit that describes the duty of care to be exercised by the banks when dealing with the event of invocation of such guarantees and letters of credit. The Supreme Court in Federal Bank Ltd. v. V.M. Jog Engg. Ltd.¹⁹ held that the banks are duty-bound to exercise principles of reasonable caution in terms of examining the documents, compliance in terms of representation, as well as scrutinising the refusals of the same in terms of discrepant documents. The Supreme Court was further pleased to hold that the encashment of the guarantee or letter of credit cannot be avoided if, prima facie, the beneficiary compels the said encashment/invocation.

The money secured in the form of a bank guarantee is recoverable when the beneficiary party has genuinely suffered losses that can be equated in terms of liquidated damages under the contract, however, the banks are to analyse said encashment with a fine-tooth comb, exercising extra precaution in analysing the genuineness of the documents seeking reimbursement.

The Delhi High Court, in Garg Builders v. Hindustan Prefab Ltd.²⁰, neatly distilled the foundational principles governing bank guarantees and their invocation. The Court reminded us that such guarantees, whether furnished as bid security, performance security, or for mobilisation advances, are central to commercial contracts and must be honoured strictly in accordance with their terms. While a contractor may facilitate issuance of the guarantee, the contract itself is an independent one between the bank and the beneficiary, leaving the contractor a legal stranger to its enforcement. Courts have repeatedly underscored, most notably in United Commercial Bank v. Bank of India²¹ and Hindustan Steelworks Construction Ltd. v. Tarapore & Co.²², that interference with this autonomy undermines public confidence in banking institutions. Therefore, unless rare and extraordinary grounds are established, disputes between the contractor and the beneficiary do not justify restraining the bank from honouring its unequivocal commitments.

The responsibility of banks to exercise due care when invoking guarantees is a vital aspect of their operations, carrying substantial legal and ethical implications. As this field undergoes ongoing legal examination, banks must stay attentive to maintaining rigorous standards to safeguard their clients’ interests while meeting their own commitments.

Conclusion

Commercial certainty combined with equitable judicial intervention are central to the jurisprudence revolving around injunctions against the invocation of bank guarantees. Courts in India have increasingly demarcated and reiterated the contours of judicial restraint while emphasising the autonomy of bank guarantees being sacrosanct barring exceptional circumstance such as fraud, irretrievable injustice and demonstrable special equities; each of which must be examined rigorously under an evidentiary lens.

Ensuring that bank guarantees retain their character as risk-allocating instruments is pivotal to infrastructural and contractual stability and this clarity is key in cultivating a robust commercial confidence in India apart from significantly reinforcing a world-wide standard of the Indian legal system. In recognising special equities as a ground for injunctive relief under exceptional circumstances, the judiciary demonstrates its responsiveness to the realities of commercial hardships alongside the necessities of substantive justice. A cautious and prudent case by case balancing exhibited in recent court decisions, particularly regarding the alignment or discord between arbitral outcomes and attempted guarantee invocations, signals a maturing approach; one which is mindful both of contractual autonomy and the spectre of irreparable harm.

Additionally, the evolution of these principles has imposed concomitant duties on both financial institutions as well as litigants. Banks are called upon to exercise sharper due diligence, recognising their role as guardians of financial integrity and trust. Litigants who invoke claims of special equities are burdened with the onus to provide compelling evidence of irreversible injustice and prejudice.

With the increasing transnational nature of India’s commercial and arbitral landscape, future disputes in relation to special equities doctrine are bound to arise. However, the prevailing legal framework which achieves a delicate equilibrium between upholding the sanctity of financial guarantees while reserving judicial invocation for only exceptional circumstances is reassuring to all stakeholders. This prevailing ecosystem is imperative for fostering a robust commercial arena in India in times where with the increasing dissolution economic boundaries, trade and infrastructure continue to globalise and expand.