DR.

RAM MANOHAR LOHIYA NATIONAL LAW

UNIVERSITY, LUCKNOW

CONTRACT II PROJECT

ESSENTIAL NATURE OF BANK GUARANTEE

SUBMITTED TO: SUBMITTED BY:

DR. MANOJ KUMAR VINAYAN SINGH | ER. NO- 230101087

ASSISTANT PROFESSOR B.A. L.L.B. 2nd YEAR

(LAW)

DR. RAM MANOHAR LOHIYA NATIONAL LAW UNIVERSITY, LUCKNOW

1
 TABLE OF CONTENTS

Cover Page .................................................................................... 01

Table of Contents .......................................................................... 02

Declaration.................................................................................... 03

Introduction .................................................................................. 04

Contract of Guarantee .................................................................. 05

Nature of Bank Guarantee ........................................................... 07

Bank Guarantee under Contract of Guarantee ............................ 09

Key Concepts and Landmark Judgements .................................... 14

Conclusion .................................................................................... 17

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 DECLARATION
I hereby declare that the project “Essential Nature of Bank Guarantees” submitted by
me to Dr. Ram Manohar Lohiya National Law University, Lucknow, Uttar Pradesh, in
partial fulfilment of the requirement for the award of the degree of B.A. L.L.B. (Hons)
is a recorded project work carried out by me under the guidance of Professor Dr. Manoj
Kumar. I further declare that the work reported in this project has not been submitted
earlier and will not be submitted by me, either in part or in full, for the award of any
other degree or diploma to me in this institute or any other University.

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 INTRODUCTION

A bank guarantee is one of the basic financial instrument that facilitates commerce
between businesses and people. This research paper provides information on the basic
nature of a bank guarantee, beginning with discussions on the definition of its various
parts, the underlying statutes on which it is based, and the judicial interpretation adopted
in each case. The paper has been divided broadly into four main sections, which include
the nature of the bank guarantee, how it correlates with the contract of guarantee,
whether the bank guarantee represents a contract of guarantee, and the landmark
judgments of Indian courts in interpreting bank guarantees.
Bank Guarantee and its Nature: Bank guarantee can be classified into two types:
Conditional and Unconditional. In common parlance, a bank guarantee is an assurance
to the creditor that in case everything else goes wrong, the bank will undertake the
obligation of the debtor. Bank guarantee helps improve business credibility and
decreases the risk of non-performance, which is especially helpful in big commercial
transactions such as infrastructure, exports, and government contracts. Bank guarantees
are a cut above letters of credit. The following section on this topic shall give an
overview of the various bank guarantees and puts in perspective its various types and
modes of bank guarantees.
Contract of Guarantee: A contract of guarantee, according to contract law, is a
tripartite agreement between the guarantor, a debtor, and a creditor. The guarantor
essentially agrees to fulfill the obligation of the debtor/step into debtor’s shoes when
the latter fails to perform it. It is a type of security in commercial transactions, meaning
to create confidence and minimize risks in the sense that a creditor could have more
assurance regarding the security of his money with a debtor. Therefore, in this chapter,
we examine the nature of a contract of guarantee, elements of a contract of guarantee.
We shall also look at the requirements for a valid contract of guarantee, such as
minimum requirement parties, definite definition of the principal debt, and
consideration.
Bank Guarantee a Contract of Guarantee?: A bank guarantee is a separate, distinct
and independent contract between the bank and the beneficiary, the assurance given by
the bank to pay a stated amount of money if the principal debtor fails to make payment,
without reference to the underlying contract between the debtor and creditor. In this,
liability under a contract of guarantee is qualified liability because the responsibility of
the guarantor comes into play only when the default is established. Will the bank
guarantee fall under the category of contract of guarantee? This paper tries to evaluate
up to what extent bank guarantees, especially unconditional and irrevocable ones, can
be held to fall under the legal definition of a contract of guarantee or alternatively as
part of a different financial instrument/vehicle.

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 CONTRACT OF GUARANTEE

“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.”
A contract of guarantee is thus a tripartite agreement, constating of three parties:
 Creditor
 Principal Debtor
 Surety
Moreover, the liability of surety to pay to the creditor, in a contract of guarantee, is
dependent upon the underlying contract between the creditor and principal debtor. Thus,
a contract of guarantee is dependent upon the underlying contract between creditor and
debtor.
For a liability of surety to arise, there exist certain essentials to be taken into
consideration.
 The general principles of contract are applicable to contract of guarantee. Thus,
it must be with free consent, lawful consideration, legal object with the parties
having capacity to contract.1
 Pre-existence of debt- for a contract of guarantee to formulate, there must exist
a recoverable debt.
 Consideration- supplied to the principal debtor by doing anything for him, by the
creditor shall be sufficient consideration.
Invocation Clause:
The bank shall immediately repay to the beneficiary the amount covered upon valid
invocation in line with the terms and conditions agreed in the guarantee. Payment may
not be withheld on orders from the customer, as the delay will tarnish the bank's
character. Upon default or customer inability to refund the sum within reasonable
time, recovery will be initiated by the bank.

Limitation Clause:
The bank guarantee should also refer to the sum of monetary liability or amount and
the duration of its validity. Under Section 28 of the Indian Contract Act, 1872, it is
held that even if any specific time period is given in the guarantee then too the

1
S. 10, Indian Contract Act, 1872

5
beneficiary can claim his compensation within the period of limitation which in case
of government beneficiaries is 30 years, and in others it is 3 years.
Under section 128 of the Indian Contract Act, 1872, "unless otherwise agreed upon
between the parties, the liability of the surety is co-extensive with that of the principal
debtor." In simple words, the liability of the surety is just like the liability of the
principal debtor. The creditor can sue the surety directly without suing the principal
debtor. The surety is made to pay immediately upon defaulting by the principal debtor.
Still, the obligation for the payment is left largely upon the principal debtor while that
of the surety remains supplementary. If it happens that the document flaw doesn't hold
the principal debtor liable, then that surely wouldn't hold the surety liable for paying.

6
 NATURE OF BANK GUARANTEE

A bank guarantee, to put simply- is a promise by a lending institution to cover a loss if

a business transaction doesn't unfold as planned. The buyer receives compensation if a
party doesn't deliver goods or services as agreed or fulfill contractual obligations. It is
sometimes also referred to as standby letter-of-credit. These are normally contractual
undertaking by banking institutions to pay/repay a specified sum in the event of any
default by the debtor (principal debtor) who is party to some other contract. However,
it must be noted that a bank guarantee though appearing to be a type of contract of
guarantee, is not explicitly a type of guarantee, since in most cases it may simply be
invoked by the creditor (party to whom the guarantee is given) a need so arises. Here,
the default by a principal debtor is not necessarily warranted. Guarantor refers to the
person which stands as the surety, i.e. the party supplying discharging the duty of
principal debtor.
Some common types of bank guarantee include:
 Payment guarantee
 Retention money guarantee
 Performance guarantee
 Advance payment guarantee
 Bid bond/tender guarantee:
 Warranty guarantee:
Standby letter-of-credit (SLOC): The Supreme Court has endorsed SLOCs to hold
the same position as a bank guarantee. In international trade agreements, particularly
those in the US, Canada, Australia and South America, SLOCs are more prevalent than
bank guarantees. A Standby Letter of Credit (SLOC) is a guarantee that is made by a
bank on behalf of a client, which ensures payment will be made even if their client
cannot fulfill the payment. It is a payment of last resort from the bank, and ideally, is
never meant to be used.
However, for our purposes, bank guarantee shall be classified into two types:
1. Conditional &
2. Unconditional
Under a conditional bank guarantee, upon failure/breach of duty on the part of principal
debtor, the creditor may call upon the surety (guarantor) to step into the shoes of
principal debtor and discharge its function.
However, a conditional bank guarantee may also be presented in a form of contingent

7
contract, whereby the discharge of duty by the guarantor depends upon fulfilment of
conditions or terms mentioned therein2.
Whereas in an unconditional bank guarantee, the guarantor becomes liable to pay the
creditor upon a demand by him, notwithstanding any underlying condition or stipulation
between the creditor and principal debtor. This is important to understand since, here,
the bank guarantee is not collateral to the contract between creditor and debtor, or in
other words, the contract of surety herein is not dependent upon the contract between
the creditor and debtor. Thus, this raises the questions, whether a bank guarantee
(unconditional in nature) can be regarded as a contract of guarantee; since a contract of
guarantee is a tripartite agreement with the contract of surety being dependent upon the
contract between creditor and principal debtor. Similarly, in an ordinary contract of
guarantee, the liability of the surety is co-extensive with principal debtor. In our case
however, a guarantee by the guarantor may simply be invoked by the creditor; and the
bank is obligated to perform its duty without any delay or demur. The fourth part of this
research paper explains this issue in detail.

2
Karnataka State Khadi & Village Industries Board v. Punjab National Bank (2014) 1 SCC 625 (Para 9, 10).

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 BANK GUARANTEE UNDER CONTRACT OF GUARANTEE

Having established a basic understanding of fundamental of bank guarantee and

contract of guarantee, we shall look into the peculiarities surrounding conditional and
unconditional bank guarantees.
It is well-settled law that when the operative part of a bank guarantee does not refer to
any condition for payment, it would amount to an unconditional bank guarantee. Merely
because a bank guarantee makes a reference to the principal agreement between the
parties in its preamble, it does not make the said bank guarantee a conditional bank
guarantee, unless any particular clause of the agreement has been made a part of it. The
recitals in the preamble of the bank guarantee do not control the operative part of the
deed3. Relevant is also the mention of the fact that if any confusion is caused by the
interpretation of the wording of a guarantee, then the same are construed contra
preferentem, i.e. against the guarantor. But it must be remembered also that the
guarantor cannot, at any rate, be held liable beyond the terms of his engagement. 4
Thus, in order to determine whether a bank guarantee is conditional or unconditional,
the terms in the agreement must be looked into. If a bank guarantee merely makes a
mention of the underlying contract, it cannot be regarded as a conditional guarantee.
“The question whether the guarantee is a conditional one or an unconditional one,
payable on demand, is a matter of construction in each case from the terms of the
bond.”5
Thus, our question becomes, whether or not, an unconditional bank guarantee can be
regarded as a contract of guarantee. As mentioned by the learned authors Sir Frederick
Pollock and Sir Dinshaw Fardunji Mulla in their publication 6 , unconditional bank
guarantees are really an undertaking by the bank to pay against the beneficiary’s first
written demand, without any proof of default, and hence the use of term ‘guarantee’
though customary, is a misnomer.
Moreover, in addition to being independent of the underlying contract, some other
characteristics differentiate and unconditional bank guarantee from an ordinary
(conditional) bank guarantee. In general, bank guarantees are immune from judicial
action, unless a prima facie miscarriage of justice or fraud is evident 7, unlike contract
of guarantee which must adhere to basic tenets of a contract. In Hindustan Steelworks
Construction Ltd. v. Tarapore & Co.8 the Supreme Court held that:

3
Vinitec Electronic Ltd. v. HCL Infosystems Ltd., (2008) 1 SCC 544 (Para 19, 22, 23).
4
State of Maharashtra v. Dr. M.N. Kaul (Deceased), AIR 1967 SC 1634 (Para 7).
5
Maihar Cement v. Krishna Gears Pvt. Ltd. AIR 2000 Del 362.
6
Pollock and Mulla, Indian Contract & Specific Relief Acts 1778 (LexisNexis, New Delhi, 2008)
7
RD Harbottle (Mercantile) Ltd. v. National Westminister Bank Ltd. [1977] 2 All ER 862, p 870 per Kerr J.
8
(1996) 5 SCC 34.

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  The Bank guarantee is an independent and independent contract between the
beneficiary and the bank so not qualified by the underlying transaction and the
primary contract amongst the person at whose instance the bank guarantee is
given and the beneficiary.

 In the case of unconditional bank guarantee, the nature of the bank is absolute
and free from any kind of dispute or obligation of the proceeding between the
party at whose instance the bank guarantee is given and the beneficiary.

 The commitment by banks must be honoured 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.
Further, an irrevocable performance bank guarantee being a separate transaction, cannot
be injuncted or swayed, by any pending settlement of disputes between the beneficiary
and person at whose instance the guarantee is invoked; barring S. 20 of the Arbitration
Act, 1940.
In NTPC Ltd. v. Flowmore (P.) Ltd.9, the Supreme Court reiterated the banks duty to
pay on demand in matter of bank guarantees. However, one key element to be noted
here was that if there is apparently no dispute between the parties, that is to say no
apparent obligation to pay arises, the courts may, if they think so fit, grant an injunction.
As previously mentioned by the Supreme Court in Hindustan Steelworks, the courts
shall ordinarily refrain from granting injunctions to restrain performance or any other
contractual obligation arising out of bank guarantee/letter-of-credit. Furthermore, the
courts shall refuse to look into the terms of the underlying contract, and only those
obligations mentioned in SLOCs shall be observed 10. There exist two broad exceptions
when courts will look into granting an injunction to the performance of bank guarantee.
1. In the case of an egregious fraud.
2. Extraordinary special equities11 or irretrievable injustice/injury
“Fraus et jus nunquan cohabitant”. However, mere apprehension that the other party
will not be able to pay is not enough. Furthermore, the evidence of any fraud should be
apparent prima facie. The reason why courts are weary of admitting these cases is linked
to the principle of freedom of contract and inter/intranational trade. Thus, the courts
seek to implement freedom of parties based on the terms to which they have agreed

9
(1995) 4 SCC 515
10
Drive India Enterprise Solutions Ltd. v. Haier Telecom (India) Pvt. Ltd., 2011 SCC OnLine Bom 1666 (Para
8,11,12,13).
11
Aditya Mehta, Pritvish Shetty, Shreya Bansal and Agneya Gopinath, “The Law Pertaining to Injunctions against
the Invocation of Bank Guarantees Legal Compendium” Cyril Amarchand Mangaldas, 2022.

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upon; interference with which would shake international trust and foundation of trade
and commerce.
The very first instance of judicial recognition of fraud by the Supreme Court occurred
in United Commercial Bank v. Bank of India & Ors. 12 in 1981. Further, in U.P.
Cooperative Federation Ltd. v. Singh Consultants and Engineers 13 , certain bank
guarantees were invoked by the Appellant on account of delay in performance of the
contract. The Supreme Court went on to lay down certain principles in respect of
exceptions for an injunction against invocation of a bank guarantee. In doing so, the
Court relied on several foreign decisions to arrive at the conclusion that the only defence
available against the invocation of a bank guarantee is fraud, which, as per the Court,
must be present in the underlying contract and the bank ought to have notice thereof.
Supreme Court has reiterated, this settled principle in the law, that an injunction against
the invocation of a bank guarantee is allowed only in fraud going to the root of the
agreement; of which the beneficiary intends to avail himself of; and where its
unconditional invocation would cause irreparable harm or injustice to the parties
concerned. Moreover, the court held that breach of contract cannot lead to the
conclusion that a fraud has been committed. Regarding allegations of fraud, it should
be proved that the fraudulent act vitiates the entire contract and has nexus with acts of
parties before entering into the contract. In Millenium Wires (P) Ltd. and Ors. v. The
State Trading Corporation of India Ltd. & Ors.14, the Court has stated that although not
all the evidence relating to the allegations by the petitioner is to be present in a plaint,
nonetheless, a comprehensive narration of facts that constitute the cause of action will
have to be given; thus, it is not enough to merely allege fraud, but the plaintiff must
prove that the knowledge fact of fraud was present with the surety (the bank).
Thus, with respect to the exception of fraud, the same is predicated on the age-old settled
principle that "fraud vitiates everything". It follows that a bank guarantee obtained
fraudulently would be void and unenforceable. For this, it must be shown that the
underlying contract itself stands vitiated owing to such fraud, more so, that the fraud
sought to be alleged is of an "egregious" nature, which is to the notice
of the bank. In fraud cases not vitiating the contract underneath, it is
always open to the parties to go for their legal remedies and claim damages, warranting
limited judicial intercession at the stage of invocation of the bank
guarantee. Moreover, the fraud sought to be established must be specifically
pleaded in the plaint and substantiated with particulars, failing which the mere
allegation of fraud may stand rejected.
While dealing with irretrievable injustice/injury, it must be noted that legislature has not
assigned any meaning to the term. Therefore, these are open to interpretation of the
courts and shall vary from facts and circumstances of cases. "Special equities" refer to

12
AIR 1981 SC 1426.
13
(1988) 1 SCC 174.
14
(2015) 14 SCC 375.

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special circumstances that render it proper to award the exceptional relief for injunction
to restrain a bank guarantee, as its denial would lead to irreparable harm or injury to the
party who has otherwise established a compelling case. It is necessary to bear in mind
that unconditional bank guarantees are offered during commercial transactions to enable
the beneficiary to draw on the same without recourse to any adjudication process.
Supreme Court in the landmark verdict of United Commercial Bank v. Bank of India 15
has dictated two key points:
 Due regard for ‘balance of convenience’ &
 The apparent nature (prima facie) of the wrong.
The word prima facie herein does not mean that the case should be able to formulate
‘prima facie’, but rather a legitimate apprehension of damage of irretrievable nature
would be caused if an injunction is not granted by the courts.
As far as the issue of special equities goes, the bar cannot
Thus, it becomes regarded as only a commercial nuisance or financial setback to be
overcome the beneficiary once money is invoked from. With the passing of time, many
factual scenarios have been pleaded by litigants in India under the garb of special
equities, for instance, existence of disputes and/ or breach in the underlying contract;
and/ or lack of assets of
is the beneficiary in India; however, Courts have refused to accept such pleas and
have interpreted a bank guarantee as always being independent of the underlying.
The relevance of the absolute duty of the bank to pay, subject to the invocation being
consistent with the terms.
To conclude, bank guarantees may be succinctly summed up in words of Bombay High
Court as stated by it in Kisan Sahakari Chini Mills Ltd. v. Richardson and Cruddas
(1972) Ltd.16
 A bank guarantee is ordinarily a contract distinct and independent from the
original underlying contract such as in the case of guarantee contracts. Once a
duty has been undertaken by bank in contracts, it must perform so. The purpose
which these contracts serve is to secure payment by commercial entities.
 International trust and commerce is reliant on these bank guarantees, and thus,
courts must be weary of interference into these contracts unless the
circumstances necessitate the same.
 As to the nature of fraud in bank guarantees, it must be egregious in nature and
must be of the beneficiary and no other person. Furthermore, there must exist a
plea of fraud with specific allegations and evidence to back up the same. If the
fraud, is not apparent prima facie, injunction on any such transaction shall not be
granted. Moreover, the fraud, like any criminal charge must be established
beyond reasonable doubt.

15
United (n 12).
16
1996 SCC OnLine Bom 384

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 Secondly, for irretrievable justice to be a ground, the harm should not merely be
speculative but immediate. This remedy like that provided under Article 142 of
the Indian Constitution, should be used as a last resort- i.e. when no other remedy
can be achieved in other courts of law.
 The injunction sought after, thus cannot be instituted against the party seeking to
invoke bank guarantee (is all else fails), since the resultant effect of such
injunction would be the same as- indirectly restraining the bank from performing
its duty.

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 KEY CONCEPTS AND LANDMARK RULINGS

Activating Bank Guarantees and Limited Ground for Injunction:

One of the several propositions enunciated by the judgments is that the jurisdictions of
the courts under such a situation to grant an injunction restraining invocation of the
bank guarantee are extremely very limited. In United Commercial Bank v. Bank of
India17, the Supreme Court had ruled that bank guarantees are independent contracts.
Therefore, banks are generally obligated to honor these guarantees on demand,
regardless of any disputes between the main parties to the underlying contract.
Generally, courts do not interfere with bank guarantees unless the case is one of gross
fraud or irretrievable injustice, which underlines the autonomy of bank guarantees to
protect commercial transactions.
In fraud claims, the standard of proof is very high. As such, courts have further
demanded that fraud must be "egregious," aimed at defeating the very bank guarantee
itself, not being present in the broader relation of the contractual relationship. Thus,
this principle keeps intact the commercial integrity of these bank guarantees by
preventing frivolous acts to impede them to settle unrelated grievances.
Fraud as an exception to injunctions against bank guarantees:
Of all these very rare exceptions the court may provide injunction, but such is only in
U.P. Cooperative Federation Ltd. v. Singh Consultants and Engineers18. While
elaborating over this point, it further explained fraud to be at such level that frauds are
touching almost invalidates the base of that entire transaction upon which basis that
bank guarantee was issued.
Such fraud is said to "unravel all" and therefore void the guarantee if it threatens to
vitiate the very contract the underlying one that is at stake. As a consequence, to deter
this form of abuse of process, the fraud nonetheless must be substantial, particular,
and directly related to the bank guarantee's issue or activation.
This principle would prevent parties from resting their case on minor or incidental
frauds as a ruse for delaying or blocking the invocation of a bank guarantee. For
instance, if the breach of contract happens to be independent of the fraud over the
bank guarantee, it cannot be proceeded with. This would ward off the sacrilegious
dilution of the status of a bank guarantee in commercial transactions, but merely
provide for rare exceptions concerning frauds both substantive and contract-defeating.
Irreparable Harm and the Rule of "Special Equities":

17
United (n. 7).
18
U.P. (n. 13).

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Another basis for granting an injunction is irretrievable injury, where the act of the
beneficiary encashing a bank guarantee would hurt the issuing party in excess of
financial reparation.
In Svenska Handelsbanken v. Indian Charge Chrome19, the Supreme Court considered
the principle of irretrievable injury based on the case of Itek Corporation v. First
National Bank of Boston20, USA, wherein courts in America accepted the application
of the doctrine of irretrievable injury if the moving party could not obtain remedy
because of geopolitical reasons or blocked assets. It would be a case of special
equities under the Indian umbrella, something courts define as where preventing the
encashment would have caused loss incapable of remedy. Courts, for example, may
consider that this be a basis upon which they would grant the injunction should the
beneficiary of the amount in question lack any asset whatsoever within India.
However, courts hold that assertions of irremediable injury must be supported by
proof of an actual and present impossibility of redress to ensure this doctrine applies
only in the most exceptional cases.
Condition bank guarantee and unconditionally bank guarantee:
There is also a classification into conditional and unconditional bank guarantees. For
both, the standards are different. For unconditional bank guarantees, banks are always
liable to pay on demand without even thinking about the disputes or breach in the
underlying contract. The Court restated the same while pronouncing the judgment in
Karnataka State Khadi & Village Industries Board v. Punjab National Bank,
observing that the unconditional guarantees are such which would bind the banks to
honour the demands as envisaged thereunder without further examination.
However, conditional guarantees do require the beneficiary to meet some contractual
stipulations before the guarantee can be invoked. For example, under a performance
guarantee, where conditions such as proof of non-performance are expressed clearly,
the beneficiary must satisfy such conditions before demanding payment. This
judgment highlights the significance of the terms of the bank guarantee; that if the
terms indicate that they are conditional, then it is only upon the satisfaction of those
conditions that the guarantee can be invoked.
Obligations and responsibilities of the Bank in verifying authentic documents:
A bank has a duty of care to honour guarantees but its liability is restricted to ensuring
compliance with the express terms of the bank guarantee or letter of credit. The
Supreme Court in Federal Bank Ltd. v. V.M. Jog Engineering Ltd 21held that a bank
owes a duty to exercise due care diligence by ascertaining whether the documents
tendered fall within the requirements listed in the guarantee.

19
1994 SCR (1) 264
20
Itek (n. 20).
21
AIR 2000 SC 3166

15
This duty of care extended only to examining documents rather than the resolution of
underlining disputes between the two contracting parties. This court case simply
reaffirmed the understanding that, once documentation is appropriate, the function of
a bank is strictly procedural. It has to honor an encashment demand pending no
specific contract condition left unmet.
In practice, it is some restraint over the activity of the bank without making it an
expert of the main contract. The Indian law framework on bank guarantees is in a
sensitive balance where it respects the sovereignty of commercial guarantees and yet
at the same time prevents abuse by courts through intervention, but on very rare
occasions, namely when substantial fraud has taken place or when irretrievable injury
would result. With such stringent standards to demonstrate fraud and irreparable harm,
such judgments have acted to protect the sanctity of bank guarantees as prudent
financial instruments in trade. The decisions lay down landmark clarifications to the
particular circumstances where the courts may intervene for bank guarantees to
remain useful in financial transactions while granting redress for exceptional
situations. The subtle approach which has been taken by courts by these decisions
underscores how commercially useful it is that this should be kept free of the risk of
abuses arising from such guarantees, with the consequence of encouraging further
confidence in domestic as well as international trade practices.

16
 CONCLUSION

Bank guarantee is a very important financial tool that promotes the execution of trade
and instills trust in business houses and individuals. The same is considered a comfort
mechanism for parties involved, as ensuring adequate performance of contractual
obligations will be ensured. A bank guarantee is the binding commitment of a banking
institution to make good in case the borrower fails to meet its obligations under the
contract. This, therefore acts as an assurance and a form that the bank would step in to
meet the obligation of the debtor when it is needed-thus ensuring business credibility
and the risk of non-performance, especially in large commercial transactions of such
infrastructure, exports, and government contracts.
Where the letter of credit is so much in close relation with the delivery of goods, bank
guarantees provide for better forms of protection such as performance financial and bid
guarantees, and so on. This chapter attempts to do a full analysis of the types of bank
guarantees into other chapters and discuss how such instruments helped ensure stability
in the financial and commercial spheres.
A guarantee contract is a three-party law of contracts that, by definition, has the
following parties: the guarantor, the debtor, and the creditor. It enables a guarantor who
agrees to take up the obligations of the debtor in case he fails to fulfill those obligations.
That tenet underlies many finance contracts and assures the creditor whenever a debtor
fails. It is a type of collateral planned with the intention of instilling confidence and
reducing the risk involved for a creditor.
We also explored the preconditions in law for such a contract of guarantee, namely at
least three parties involved, some objective definition of the principal debt, and some
consideration; which brought us to a discussion of whether bank guarantees are
contracts of guarantee.
While both mechanisms involve a third-party assuming liabilities of the primary party,
some significant differences exist between them. A bank guarantee is an independent
agreement between the banker and the beneficiary. It is an agreement by which the
banker undertakes to pay a stated sum on default by the principal debtor, entirely
irrespective of any original contract between the debtor and the creditor. On the other
hand, the agreement of guarantee involves a contingent liability, for it comes into play
only after default has been ascertained.
Though both have protections for the interests of the creditor, a bank guarantee is more
independent than in the conventional agreements of guarantee.
Cases such as United Commercial Bank v. Bank of India (1981), where the judgment
categorically held that a bank guarantee, esp. an unconditional one has to be complied
with on demand with or without any disputes arising in the contract to which it is

17
ancillary. The Supreme Court of India in Ltd. v. State of Bihar (1999), "for a bank
guarantee, there is a fiduciary relationship between the banker and the beneficiary,
which cannot be easily set aside unless fraud is proved or irretrievable loss is shown.".
These and other landmark decisions laid down a basic legal framework to interpret the
enforceability of bank guarantees. Different judicial decisions on various issues of
public interest have classified bank guarantees to be an independent one and have also
acknowledged the necessity of the guarantee under business transactions about
confidence by eliminating unnecessary legal barriers from the beneficiaries while
exercising guarantees. The paper argues that though bank guarantees exhibit principal
characteristics with the contract of guarantee, they still are a completely different legal
and financial tool essential to the modern world economics.

18