Can force majeure apply against enforcement of bank guarantees? The Delhi High Court’s analysis
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Akil Hirani
Majmudar & Partners, Mumbai
Dhruv Somayajula
Majmudar & Partners, Mumbai
Background
Halliburton Offshore Services Incorporated (Petitioner) and Vedanta Limited (Respondent) had entered into a contract for the development of three oilfields. The Petitioner had undertaken to complete the drilling of the oil wells by 31 March 2020. However, on 22 March 2020, the Petitioner sought an extension of the timeline, citing the Covid-19 pandemic and the resultant lockdown imposed by the government of Rajasthan from 22 March to 31 March 2020, which was subsequently extended throughout India. The Respondent rejected the Petitioner’s argument and sought to invoke the bank guarantees given by the Petitioner for breach of contract. The Petitioner approached the Delhi High Court (Delhi HC) seeking an injunction against the invocation of the bank guarantees.
Arguments
The Respondent argued:
- that an invocation of a bank guarantee is a separate matter and is not affected by any disputes that may arise out of the non-performance of any obligation by either party;
- that a court can issue an injunction only on the invocation of a bank guarantee in circumstances where the bank fulfilling the guarantee is aware of an egregious fraud being committed on account of paying under the bank guarantee; and
- that the Petitioner was merely using force majeure as an excuse after failing to adhere to the deadlines of the project.
The Petitioner argued:
- that the Respondent had agreed to 31 March 2020 as the deadline for completing the work, and that a very small part of the work was still pending on 22 March 2020;
- that an injunction on the invocation of bank guarantees can be sought on the ground of special equity to prevent irreparable damage to the debtor;
- that the Petitioner would suffer irreparable harm if the bank guarantees were invoked; and
- that the timeframe of the injunction on the invocation of the bank guarantees was very limited (only until one week after the lockdown was lifted by the Rajasthan government).
Indian law on bank guarantees
Section 126 of the Indian Contract Act 1872 defines a contract of guarantee, wherein a third party, or guarantor, promises to the creditor to perform or discharge the liability of the debtor. In a contract of guarantee, the creditor can recover the guaranteed amount from the guarantor immediately upon the debtor failing to perform the contract. An unconditional bank guarantee is a development on this concept where a bank provides an unconditional guarantee of repayment to the creditor to discharge the debtor’s liability. This is a preferred mode of guarantee in commercial contracts as banks are considered reliable guarantors. Further, bank guarantees are generally protected from injunctions by courts, with certain exceptions as explained below.
The Petitioner’s arguments are based on established jurisprudence in India. In the case of UP State Sugar Corporation v Sumac International Limited, India’s Supreme Court ruled that upon the failure to perform a promise, a bank guarantee can be immediately invoked by a party under all circumstances, except in cases of egregious fraud or to provide special equities to parties who would otherwise suffer irreparable harm.
As such, the law on injunctions on bank guarantees is quite settled in India, ie, a court can grant an injunction against the invocation of a bank guarantee or letter of credit only in exceptional circumstances where the debtor may suffer irreparable harm if invoked.
The Delhi HC’s interim order
The Delhi HC, in an interim order dated 20 April 2020, agreed with the Petitioner that an injunction on the invocation of an unconditional bank guarantee can be granted only in cases where the bank observes an egregious fraud or in cases of special equity to prevent irreparable harm.
The Delhi HC cited the case of Itek Corporation v First National Bank of Boston, in which the District Court of Massachusetts issued an injunction on a bank guarantee recognising irreparable harm to the petitioner if the bank guarantee was invoked and the exceptional circumstances involved. Here, the petitioner was unable to fulfil its obligation in a contract on account of the revolution in Iran.
Recognising the exceptional nature of the ongoing Covid-19 pandemic and the country-wide lockdown, the Delhi HC held that a failure to complete the contract in this case was a clear exception to the law on bank guarantees and granted a temporary injunction until one week after the lockdown was lifted.
The Delhi HC’s final judgment
On 29 May, the Delhi HC vacated the interim injunction order dated 20 April, preventing the invocation of bank guarantees in favour of the Petitioner and allowing the Respondent to encash the bank guarantees.
The Delhi HC reviewed the contract and the correspondence between the parties, and the timeline of the services provided by the Petitioner to the Respondent. The Delhi HC noted that the contract between the parties specifically provided for epidemics and plague. Therefore, Covid-19 could be regarded as a potential force majeure event under the contract. However, as the Petitioner had been in breach of the contract since September 2019, the Covid-19 pandemic could not be cited as a ground for non-performance of the contract due to a force majeure event.
Accordingly, the exceptional circumstances calling for special equities towards the Petitioner did not arise, and the Delhi HC held that there were no grounds for continuing the injunction against the invocation of the bank guarantees by the Respondent.
Conclusion
In the Halliburton case, the Delhi HC has clarified the operation of force majeure clauses. Limiting the injunction on bank guarantee enforcement to the minimum period possible, while tracing the connection between the non-performance of a contract and the Covid-19 pandemic, is a reasonable approach taken by the Court. It must be noted that while the circumstances in Halliburton required the Delhi HC to permit the eventual encashment of the bank guarantees, parties to commercial contracts that have genuinely been rendered impossible to perform due to the exceptional circumstances caused by the Covid-19 pandemic can get relief from Indian courts, who are analysing the facts and circumstances of each case.
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