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Delhi High Court

JUDGMENT
Badar Durrez Ahmed, J.

Page 359

1. Initially, the application [IA No. 11121/2003] under Order 39 Rules 1 & 2 of CPC was argued on
30.11.2005 and orders were reserved. The counsel also sought time to take instructions as to whether
the suit itself could be disposed of at this stage. On 05.12.2005 the counsel responded by saying that it
could. The following issues were framed:-

1. Whether any contract/agreement came into existence between the plaintiff and the defendant No. 1?

2. Whether the defendant No. 1 is entitled to invoke the Bank Guarantee?

3. Relief.

And, it was submitted that the arguments advanced at the hearing of the said application be treated as
arguments in the suit and the same be disposed of. It is so being disposed of by this judgment.

Page 360

2. The plaintiff has filed the present suit seeking a declaratory decree as well as a decree for permanent
injunction. The declaration that is sought by the plaintiff is that no agreement / contract has come into
being between the plaintiff and the defendant No. 1 for the construction of Semi-Merry Go Round
System for Tenughat Thermal Power Station, Lalpania, Jharkhand pursuant to the letter inviting
tenders dated 17.02.2003 issued by the defendant No. 1. The relief of permanent injunction that is
sought by the plaintiff is for restraining the defendant No. 1 from invoking / negotiating the bank
guarantee No. LKB/4692/22050 of 22.03.2003 for a sum of Rs. 15.00 lakhs issued by the defendant
No. 2 (bank) at the request of the plaintiff to the defendant No. 1. An injunction is also sought against
the defendant No. 2, restraining it from making any payment under the said bank guarantee to the
defendant No. 1. The application [IA No. 11121/2003] under Order 39 Rules 1 and 2 read with Section
151 of the Code of Civil Procedure, 1908 (hereinafter referred to as the 'CPC') was filed by the plaintiff
seeking the interim relief of restraining the defendant No. 1 from invoking / negotiating the said bank
guarantee as also restraining the defendant No. 2 from making payment to the defendant No. 1 under
the said guarantee.

3. On 25.11.2003, the plaint was registered as a suit and this court directed the issuance of summons to
the defendants. Notice was also issued to the defendants in the said application (IA No. 11121/2003)
and ex parte interim orders were passed restraining the defendant No. 1 from invoking the said bank
guarantee subject to the condition that the validity of the bank guarantee was extended for a further
period of three months from the date of its expiration. The defendant No. 2 was also restrained from
releasing the bank guarantee and from making payment till further orders from this court. This ex parte
order has continued till date. The bank guarantee has, however, been kept alive by extending its
validity from time to time.

4. The admitted facts in brief are that the defendant No. 1 issued a letter inviting tender (hereinafter
referred to as the 'LIT') on 17.02.2003 (Annexure-'A' to the plaint), inter alia, to the plaintiff in respect
of the construction of Semi-Merry Go Round System for Tenughat Thermal Power Station, Lalpania,
Jharkhand. It was a condition of the LIT that the bids must be accompanied by Earnest Money Deposit
of Rs. 15.00 lakhs. Clause 7.0 of the Instructions to Tenderers related to Earnest Money. While the said
clause specifically provided for the deposit of Earnest Money of Rs. 15.00 lakhs by crossed bank draft
or pay order, it is an admitted position between the parties that subsequently instead of the requirement
of depositing the Earnest Money by crossed bank draft or pay order, the tenderers could give a bank
guarantee for the said amount in favor of the defendant No. 1. Clause 7.5 of the Instructions to
Tenderers prescribed that the Earnest Money of the unsuccessful tenderers would be discharged /
returned on the award of contract to the successful tenderer. It was also provided that in the case of the
successful tenderer, the Earnest Money would be retained by the defendant No. 1 as part of the security
deposit in accordance with clause 16.0 of the General Conditions of the Contract. Clauses 8.0, 8.1, 8.2
are crucial for Page 361 determination of the issues at hand and, therefore, the same are reproduced in
their entirety:-

8.0 Validity
8.1 Tenders shall remain valid and open for acceptance / award for a period of 6 months
from the date of opening of tenders. Should the tenderer fail to keep the tender open for acceptance /
award as stated above or if the tenderer withdraws his tender before the expiry of the said period or
makes any modifications in the terms and conditions of the tender which are not acceptable then
RITES without prejudice to any other right or remedy shall be at liberty to forfeit his Earnest Money.

8.2 In exceptional circumstances, prior to expiry of the original validity period, RITES may request the
tenderers for a specified extension in the period validity. The request and the responses thereto shall be
made in writing or by cable or telex. A tenderer may refuse the request without forfeiting his Earnest
Money. A tenderer agreeing to the request will not be required nor be permitted to modify his tender
but will be required to extend the validity of his Earnest Money correspondingly.

5. It is in the background of these provisions that the factual position has to be understood. The tender
was submitted by the plaintiff on 24.03.2003. The bids were opened on the same day, i.e., on
24.03.2003. By virtue of clause 8.1 referred to above, the tenders were to remain valid and open for
acceptance / award for a period of six months from 24.03.2003, i.e., up to 23.09.2003. On 09.09.2003,
the defendant No. 1 sent a letter to the plaintiff informing the plaintiff that the finalisation of the
subject tender would take some more time and, therefore, requested the plaintiff to extend the validity
of the same unconditionally up to 30.11.2003 . The plaintiff by a letter dated 22.09.2003 responded to
the aforesaid request of the defendant No. 1 by indicating that in the quotation submitted by it on
24.03.2003, the plaintiff had offered a rebate of 18%, but in the intervening period, the prices specially
of steel had seen a steep rise and therefore, the rates quoted in the original bid were no longer
workable. The plaintiff, however, to maintain its relations with the defendant No. 1 and the Tenughat
Thermal Power Project, agreed to extend the validity of the offer up to 30.11.2003 in the following
words:-

However to maintain our relations with RITES and Tenughat Thermal Power Project, we extend the
validity of our offer up to 30th November, 2003 subject to rebate in our bid being reduced from 18%
offered on 24/03/2003 to 5%.

5. By a letter dated 28.10.2003 (Annexure-'G' to the plaint), the defendant, with reference to the
plaintiff's said letter of 22.09.2003, informed the plaintiff, inter alia, as under:-

Please refer your letter No. DSC/2K3/1329 dated 22.09.2003. Your conditional extension of validity of
the subject tender is unacceptable under Clause No. 8.2 of Instructions to Tenderer Vol.-I. However,
your offer of extension of validity has been accepted unconditionally.

Page 362
It also informed the plaintiff that the defendant No. 1 was pleased to issue this letter of award
for the said work on acceptance of the plaintiffs bid at a total contract price of Rs. 15,13,67,385.35.
The defendant No. 1 by the same letter also informed the plaintiff that the Earnest Money submitted by
it in the form of a bank guarantee for Rs. 15.00 lakhs would be retained as part of the total security
deposit and would be adjusted against the security deposit as per clause 16.1 of the General Conditions
of Contract. Since the plaintiff did not respond to this letter awarding the contract, the defendant No. 1
sent another letter dated 18.11.2003 (Annexure-'H' to the plaint) asking the plaintiff to expedite the
return of two copies of the Letter of Award signed by it as a token of its unconditional acceptance. The
defendant No. 1, by the same letter also indicated that failure to do so would constitute a breach of the
agreement effected by the acceptance / award of the tender and that the Earnest Money accompanying
the tender would be forfeited by the defendant No. 1 as liquidated damages for such default.
Immediately thereupon, the plaintiff instituted the present suit on 24.11.2003 and on 25.11.2003 when
the matter came up for hearing before this court, the aforesaid ex parte interim orders were passed. The
position has continued to remain the same since then.

Plaintiff's Arguments

6. It was argued by Mr Endlaw, who appeared for the plaintiff, that there was no enforceable contract
between the plaintiff and the defendant No. 1 and, therefore, the defendant No. 1 was not entitled to
invoke the bank guarantee and thereby forfeit the Earnest Money. He submitted that the offer that was
made by the plaintiff by submission of its bid on 24.03.2003 was valid up to 23.09.2003. Till that date,
the defendant No. 1 had not awarded the contract to anybody. It is, no doubt, true he contended, that
the defendant No. 1 by its letter of 09.09.2003 requested the plaintiff to extend the validity of its
original bid of 24.03.2003 unconditionally up to 30.11.2003. But, it is also true that the plaintiff agreed
to extend the validity up to 30.11.2003 only conditionally, i.e., subject to the rebate of 18% being
reduced to 5%. According to him, this was a conditional extension of validity and unless the condition
was accepted by the defendant No. 1, the offer made could not be deemed to have been extended
beyond the period of 23.09.2003. He further contended that since the defendant No. 1 by its letter dated
28.10.2003 had indicated that the plaintiff's conditional offer was unacceptable under clause 8.2 of the
Instructions to Tenderers, the defendant No. 1 was not entitled to accept the extension of validity
unconditionally. The defendant No. 1, according to the learned counsel, could either accept the
conditional extension of validity or reject it. It could not convert the conditional extension of validity
of the tender made by the plaintiff into an extension of validity unconditionally. Therefore, according
to the learned counsel for the plaintiff, there was no contract which emerged between the plaintiff and
the defendant No. 1 as there was no consensus ad idem between them. This being the case, he
submitted that the position of the plaintiff would be that of an unsuccessful tenderer and, therefore, by
virtue of clause 7.5 of the Instructions to Tenderers, the Earnest Page 363 Money was liable to be
returned to the plaintiff. Mr Endlaw referred to the decision of the Supreme Court in the case of Zodiac
Electricals Pvt Ltd v. Union of India 1986 SC 1918 and India Meters Ltd., Madras v. Punjab State
Electricity Board and Ors. .

Defendants' Arguments

7. On the other hand, Mr Anil Airi, the learned counsel for the defendant No. 1, submitted that the
defendant No. 1 was entitled to forfeit the Earnest Money and was entitled to invoke the bank
guarantee in view of clauses 8.1 and 8.2 of the Instructions to Tenderers. He submitted that upon a
reading of clause 8.2, it would be apparent that this clause does not permit a conditional acceptance. If
a tenderer accepts the request for extension of the period of validity, then that acceptance must be
without any modifications. The tenderer had every right to refuse the request of the defendant No. 1 to
extend the validity of the offer, but if the tenderer accepts the request for extending the validity period,
then it must be unconditional. According to him, since the plaintiff had accepted the request of
extending the validity period, in terms of clause 8.2, it must be deemed to be an unconditional
acceptance and the conditions sought to be imposed by the plaintiff would have to be ignored. It was
further argued by the learned counsel for the defendant No. 1 that the encashment of a bank guarantee
can be injuncted only under two exceptional circumstances-

1) where there is a fraud in connection with the bank guarantee which would vitiate the very
foundation of such guarantee and this fraud must be an established fraud; and

2) where allowing the encashment of an unconditional bank guarantee would result in irretrievable
harm or injustice to one of the parties concerned and the irretrievable injury must be of such an extent
as would make it impossible for the guarantor to reimburse himself if he ultimately succeeds.
He also submitted that in cases of bank guarantees, it is only the bank guarantee which must be looked
into and not the underlying contract. The two are separate contracts in which different parties are
involved. In support of this proposition, the learned counsel for the defendant No. 1 relied upon the
decisions of the Supreme Court in the case of National Highways Authority of India v. Ganga
Enterprises and Anr. and Dwarikesh Sugar Industries Ltd. v. Prem Heavy Engineering Works (P) Ltd
and Anr. . The learned counsel for the defendant No. 2 (bank) supported the arguments raised by the
counsel for the defendant No. 1.

Page 364
General Discussion

8. After having heard the arguments advanced by the counsel for the parties, it appears to me that the
most vital issue in the present matter is the interpretation which has to be put to clause 8.2 of the
Instructions to Tenderers in the light of the two letters dated 09.09.2003 and 22.09.2003 exchanged
between the plaintiff and the defendant No. 1.

9. Before I examine the meaning of the said clause 8.2, I would like to clear the ground insofar as the
scope of the present suit is concerned. Issue No. 1 pertains to the formation of a contract. And, Issue
No. 2 relates to the right of the parties under the Bank Guarantee. What makes this case interesting are
the special circumstances: (1) the question of existence of a contract between the plaintiff and the
defendant No. 1; and (2) the absence of an invocation letter insofar as the Bank Guarantee is
concerned. What has to be seen is to what extent the existence or otherwise of an 'underlying contract'
between the plaintiff and the Defendant No. 1 affects the enforceability of the Bank Guarantee
extended by the Defendant No. 2 to the Defendant No. 1 at the instance of the Plaintiff. Insofar as the
question of injuncting a bank from encashing the bank guarantee is concerned, there is ample authority
that such a course is only open in the exceptional cases of fraud (and that too an established fraud) or
where, because of special equities, the non-grant of an injunction would lead to irretrievable injustice
to the party seeking the injunction. In this case, although fraud in the classical sense has not been
pleaded some elements of fraud would arise. The argument being, if in the absence of the Defendant
No. 1 being entitled to forfeit the earnest money deposit, the Defendant No. 1 still went ahead and
invoked the Bank Guarantee,--Would it not be a fraudulent invocation ? Moreover, if the plaintiff were
to succeed in Issue No. 1, would it not result in a situation of special equities ?

Issue No. 1:

10. The entire dispute between the plaintiff and the defendant No. 1 falls within the narrow compass of
the interpretation that is to be placed on clause 8.2 of the Instructions to Tenderers. Upon a reading of
the said clause, it becomes clear that if the defendant No. 1 wanted to have the validity of the tender
extended beyond the original period of six months as prescribed under clause 8.1, it was up to the
defendant No. 1 to request the tenderers for a specified extension and this request had to be made prior
to the expiry of the original validity. There is no dispute with regard to this. The request was made by
the defendant No. 1, inter alia, to the plaintiff prior to the expiry of the original validity period. There is
no dispute that the request was made in writing and that the response thereto by the plaintiff was also
in writing. In the event the tenderer refused the request, his Earnest Money would not be forfeited.
Where a tenderer agreed to the request, it was specifically indicated in clause 8.2 that neither could the
defendant No. 1 require the tenderer to modify his tender nor was it permissible for the tenderer to
modify his tender. To my mind, the correct interpretation of clause 8.2, therefore, entails that either the
tenderer acceded to the request for extending the period of validity Page 365 unconditionally or his
response would be treated as a refusal. The tenderer was not permitted to agree to the request of
keeping his offer valid and also modify his offer. If he did so, then it would amount to a refusal. And, if
it amounted to a refusal, then he did not incur the liability of forfeiture of his Earnest Money. The case
cited by the learned counsel for the plaintiff [Zodiac Electricals (supra)] would certainly help the
plaintiff's cause. In that case, under similar circumstances, a conditional offer was made. However, the
other party did not unconditionally accept such offer and insisted on another condition which was
contrary to the stipulation made in the offer by the first party. In these circumstances, the Supreme
Court was of the view that the addition of the condition by the second party did not amount to an
unconditional acceptance of the offer made by the first party and, therefore, it could not possibly be
contended that a concluded contract had been arrived at between the parties. The court held that the
additional condition imposed by the second party was really in the nature of a counter-offer. It appears
that a similar logic would be applicable in the facts of the present case. The request for extension made
by the defendant No. 1 was an offer or a proposal extended by it to the plaintiff. This offer or proposal
was not met by the plaintiff in the shape of an acceptance simpliciter but by a counter-offer. This
counter-offer which specified a condition of reduction in rebate from 18% to 5% was not accepted in
its entirety by the defendant No. 1. Therefore, it cannot be said that an offer was met with an
acceptance of that offer resulting in a concluded contract. The counter-offer or counter-proposal made
by the plaintiff was with a condition. The defendant No. 1 rejected the condition and purported to
accept the proposal thereby claiming that a concluded contract had been struck and since the plaintiff
thought otherwise, the defendant No. 1 was entitled to forfeit the Earnest Money by invoking the Bank
Guarantee. I am unable to subscribe to this view. The offer or proposal had to be accepted in its
entirety with the condition or not at all and, if the offer was not accepted in its entirety, then it would be
a deemed refusal on the part of the plaintiff and, therefore, the defendant No. 1 would not be entitled to
forfeit the Earnest Money. There is no other clause which has been pointed out under which the
defendant No. 1 could forfeit the Earnest Money in the circumstances obtaining in this case.

11. To elucidate, let me refer to the first principles as set out in The Indian Contract Act, 1872
(hereinafter referred to as the Contract Act). When one person signifies to another his willingness to do
or to abstain from doing anything, with a view to obtaining the assent of that other to such act or
abstinence, he is said to make a proposal1. When the person to whom the proposal is made signifies his
assent thereto, the proposal is said to be accepted. A proposal, when accepted, becomes a promise2.
The person making the proposal is called the Promisor, and the person accepting the proposal is called
the promise 3. When, at the desire of the promisor, the promiseor any other person has done or
abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing
something, such act or abstinence or promise is called a consideration for the promise4. Every promise
and every set of promises, forming the consideration for each other, is an agreement5. An agreement
not enforceable by law is said to be void6. An agreement enforceable by law is a contract7.

Page 366

12. In this context, the question that arises is whether the relationship between the plaintiff and the
Defendant No. 1 can be said to be governed by an agreement enforceable by law " viz. a contract ? It
must be made clear that the matter involves two stages. The first stage commencing with the
defendant's LIT (which was merely an invitation for proposals) and culminating upon the expiration of
the initial validity period of the plaintiff offer or proposal (i.e., the tender). The second stage
commenced upon the defendant No. 1's request to the plaintiff to extend the validity of its tender and
relates to the events subsequent thereto. Insofar as the first stage is concerned there does not seem to be
any difficulty. The defendant No. 1 invited proposals / offers by virtue of its LIT of 17.02.2003. The
plaintiff, amongst others responded to this invitation and submitted its proposal / offer (the tender) on
24.03.2003 Along with the earnest money deposit (in the shape of the said Bank Guarantee). The
defendant No. 1 did not accept this proposal / offer throughout the validity period of six months, i.e.,
up to 23.09.2003. Therefore, if the events of the second stage are kept aside for the time being, the
proposal / offer made by the plaintiff on 24.03.2003 lapsed on 23.09.2003 by virtue of clause 8.1 read
with Section 6 of the Contract Act8. Obviously, no agreement came into being, much less a contract.

13. Now, do the events of stage two indicated above change the position ? To examine this aspect it
must be kept in mind that before an agreement is said to result from the communications of parties
there must be a meeting of minds, there must be consensus ad idem. This principle is codified in India
in Section 7 of the Contract Act which, inter alia, provides that in order to convert a proposal into a
promise, the acceptance must be absolute and unqualified. The defendant No. 1, by its letter of
09.09.2003 proposed to the plaintiff to extend the validity of the original offer of the plaintiff up to
31.11.2003 unconditionally . The plaintiff did not agree to extend the validity up to 31.11.2003
unconditionally . The plaintiff made a counter-proposal. It agreed to extend the validity of its offer but
only upon different terms " viz. the rebate of 18 % be reduced to 5%. But, the defendant No. 1 did not
accept this counter-proposal absolutely or unconditionally. What it did was to split up the plaintiff's
counter-proposal into two components--(a) agreement to extend the validity and (b) the condition of
reduction in rebate from 18% to 5%. Having done so, the defendant No. 1 accepted Part (a) and
discarded Part (b) of the plaintiff's counter-proposal. Thereby claiming to bind the plaintiff down to
accepting the extension of validity of the initial offer unconditionally up to 30.11.2003. Keeping in
mind the express provisions of the Contract Act, it is clear that what the defendant No. 1 purports to do
is impermissible in law. The proposal made by the defendant No. 1 to the plaintiff to extend the
validity up to 30.11.2003 unconditionally was not accepted by the plaintiff. The counter-proposal made
by the plaintiff was also not accepted by the defendant No. 1. As such, no agreement was reached by
and between the plaintiff and the defendant No. 1 to extend the validity of the initial offer of
24.03.2003 up to 30.11.2003 unconditionally .

Page 367

14. In the case of the General Assurance Society Ltd v. The Life Insurance Corporation of India AIR
1964 SC 892, the Supreme Court in the context of a question as to the extent of the dispute which was
referred to arbitration in the backdrop of an offer of settlement made in that case observed:-

When one party makes a composite offer, each part thereof being dependent on the other, the other
party cannot by accepting a part of the offer compel the other to confine its disputes only to that part
not accepted, unless the party offering the composite offer agrees to that course.

It follows, therefore, that a composite offer such as the one made by the plaintiff in response to the
defendant No. 1's request of 09.09.2003 cannot be accepted in part unless the plaintiff agrees to that
course. No such agreement is discernible from the conduct of the plaintiff. It was, therefore, not open
to the defendant No. 1 to accept only a part of the plaintiffs counter-proposal and unilaterally style it as
an 'unconditional' acceptance. The only course open was to reject the plaintiffs conditional counter-
proposal. Which would amount to the plaintiff having refused to accede to the defendant No. 1's
request for extending the validity of the original offer of 24.03.2003. In such a situation, in view of the
said clause 8.2 itself, the earnest money was not liable to forfeiture at the hands of the defendant No. 1.
Issue No. 1 is decided accordingly in favor of the plaintiff.

15. Is the defendant No. 1 entitled to invoke the Bank Guarantee even though there is no contract
between the plaintiff and the defendant No. 1 and even though the defendant No. 1 is not entitled to
forfeit the earnest money ? The plaintiff's counsel submitted that the defendant No. 1 would not be so
entitled. And, as mentioned above, the counsel for the defendant No. 1 urged that the bank guarantee
was an entirely separate contract, independent of the underlying contract. The bank guarantee was
unconditional and, therefore, neither its invocation nor its encashment could be injuncted except in
cases of fraud or irretrievable injustice.

16. To appreciate the arguments of counsel, it would be necessary to state the law on the subject. One
must keep this in mind that while the law of contracts in England is largely uncodified and it is court
made law based upon established commercial practices and principles of contract law which are
essentially common law principles except in modern times where some specialised laws have been
enacted. The same is the position with American law. In India, however, much of the principles of
contract as was then a part of the common law of England has been codified in the form of the Indian
Contract Act, 1872. Contracts, and that includes bank guarantees, would, therefore, be governed by the
statutory provisions. The common law principles as applicable in England or in the USA which have
been imported into the Indian legal system after the Indian Contract Act, 1872 would only supplement
it and not supplant it. This, I am afraid, is often lost sight of when considering the question of
injunction of Bank Guarantees.

Page 368
17. I shall now examine the relevant provisions of the Contract Act. Section 126 of the said Act, which
defines the terms 'contract of guarantee', 'surety', 'principal-debtor' and 'creditor,' provides that 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. In the context of
the present case, the bank guarantee is a contract of guarantee. The bank (defendant No. 2) is the surety
inasmuch as it has extended the guarantee and the plaintiff and the defendant No. 1 are the principal-
debtor and creditor respectively. The transaction between the aforesaid three parties is essentially a
matter of three separate contracts. The first and main being the underlying contract between the
principal-debtor and the creditor, i.e., between the plaintiff and the defendant No. 1. The second being
the contract of guarantee or the bank guarantee which is between the surety and the creditor, i.e., the
defendant No. 2 and the defendant No. 1. The third is the contract between the principal-debtor and the
surety, i.e., between the plaintiff and the defendant No. 2. Although, the three contracts are independent
in one sense, they are also inter-related in another sense and are founded upon the underlying contract.
Section 128 of the Contract Act stipulates that the liability of the surety is co-extensive with that of the
principal-debtor, unless it is otherwise provided by the contract 9. Section 133 makes it clear that any
variance made without the surety's consent in the terms of the contract between the principal-debtor
and the creditor, discharges the surety as to transactions subsequent to the variance. Section 134
stipulates that the surety is discharged by any contract between the creditor and the principal-debtor, by
which the principal-debtor is released, or by any act or omission of the creditor, the legal consequence
of which is the discharge of the principal-debtor. However, certain kinds of discharge of the principal-
debtor which may operate by operation of law may not ensure to the benefit of the Surety. Such
instances being the bankruptcy of the principal-debtor or liquidation in the case the principal-debtor is
a company10. Construing the aforesaid provisions, it is apparent that although there are three separate
relationships and contracts between the three parties, the contract of guarantee does, to a large extent,
depend upon the relationship between the creditor and the principal-debtor under the underlying
contract. This is so because firstly, the liability of the surety under a contract of guarantee is co-
extensive with that of the principal-debtor unless, of course, otherwise provided by the contract.
Secondly, any variation brought about by the principal-debtor and the creditor in the terms of the
contract between them, without the surety's consent, would discharge the surety as regards all
transactions subsequent to the variance. Thirdly, if the principal-debtor and the creditor enter into an
arrangement whereby the principal-debtor is released or because of any act or omission on the part of
the creditor the legal consequence of which is the discharge of the principal-debtor, the surety is also
automatically discharged. Therefore, under the scheme of the provisions under the Contract Act itself,
the contract of guarantee is not entirely independent of the underlying contract between the principal-
debtor and the creditor and/or of their acts Page 369 of omission or commission resulting in any
variation or modification or discharge of the principal-debtor. Going strictly by these provisions, it
would be seen that when a principal-debtor is discharged or released of its liability, then, the surety is
also so discharged. In the context of the present case, it would mean that if the plaintiff is discharged of
its liability, then, the surety (defendant No. 2) would also stand discharged under the contract of
guarantee. As I have held while discussing Issue No. 1 that there was no contract between the plaintiff
and the defendant No. 1 and the period of validity of the offer had also expired on 23.09.2003, the
defendant No. 1 (creditor) could not forfeit the earnest money amount and, therefore, could not insist
upon the defendant No. 2 (surety) to discharge its liability under the bank guarantee. Clearly, therefore,
the defendant No. 1 would not be entitled to invoke the bank guarantee and seek payment there under
when by its own act and omission the principal-debtor has been discharged.

18. Coming now to the aspect of injuncting the invocation or encashment of a bank guarantee, it is
seen that the Common law principles with regard to this appears to be quite well-settled inasmuch as
the invocation / encashment of a bank guarantee ought not to be injuncted except where there is fraud
or special equities or where the non-grant of an injunction would lead to irretrievable injustice to the
parties seeking injunction. Courts have also stressed the aspect of a bank guarantee being independent
from the underlying contract. The case law in this regard is plentiful. A survey of the same would be
instructive.

19. In Elian v. Matsas (1966) 2 L 1 L Rep 495 Lord Denning, M.R., while refusing to grant an
injunction observed:-

...a bank guarantee is very much like a letter of credit. The courts will do their utmost to enforce it
according to its terms. They will not, in the ordinary course of things, interfere by way of injunction to
prevent its due implementation. Thus they refused in Malas v. British Imex Industries Ltd. (1958) 2 QB
127. But that is not an absolute rule. Circumstances may arise such as to warrant interference by
injunction.

In R.D. Harbottle (Mercantile) Ltd v. National Westminster Bank Ltd. 1977 (3) WLR 752, Kerr, J.
observed as under (at page 761):-

It is only in exceptional cases that the courts will interfere with the machinery of irrevocable
obligations assumed by banks. They are the life-blood of international commerce. Such obligations are
regarded as collateral to the underlying rights and obligations between the merchants at either end of
the banking chain. Except possibly in clear cases of fraud of which the banks have notice, the courts
will leave the merchants to settle their disputes under the contracts by litigation or arbitration as
available to them or stipulated in the contracts. The courts are not concerned with their difficulties to
enforce such claims; these are risks which the merchants take. In this case the plaintiffs took the risk of
the unconditional wording of the guarantees. The machinery and commitments of banks are on a
different level. They must be allowed to be honoured, free from interference by the courts. Otherwise,
trust in international commerce could be irreparably damaged.

Page 370

20. In United City Merchants (Investments) Ltd. and Ors. v. Royal Bank of Canada: [1983] A.C. 168
(H.L.), the court was considering the question of fraud and as to whether the do were fraudulent
although accurate would still have to be accepted by the bank and the bank was thus obliged to make
payment under a letter of credit. The court observed as under:-

A large number of English and American authorities were considered by the Court of Appeal. But, as
all three members of the Court of Appeal concluded, there is no English or American authority directly
deciding the point now being considered, since it was never an issue. It is very important to bear this in
mind since dicta in certain cases state the fraud exception in terms of the fraud of the beneficiary,
commonly the seller, and the buyers placed much reliance upon them: see, for example, Edward Owen
Engineering Ltd. v. Barclays Bank International Ltd. [1978] Q.B. 159 and Sztein v. J. Henry Schroder
Banking Corporation (1941) 31 N.Y.S. 2D 631. But Stephenson L.J. Observed [1982] Q.B. 208, 234A,
fraud on the part of the beneficiary was all that the court was concerned with in both of those cases; it
never directed its mind in either case to the question of the effect of fraud of a third party.

It further held as under:-

As to the authorities, Hamzeh Malas & Sons v. British Imex Industries Ltd. [1958] 2 Q.B. 127 merely
emphasises the separate nature of the contract. It is nowhere concerned with the issues raised in the
present case, R.D. Harbottle (Mercantile) Ltd v. National Westminster Bank Ltd. [1978] Q.B. 146;
Edward Owen Engineering Ltd. v. Barclays Bank International Ltd. [1975] 1 W.L.R. 315 all relate to
the granting of interlocutory relief. In the above cases, the bank was desirous of paying, but the courts
held to the contrary. It would, therefore, be surprising that where there is fraud and the bank does not
wish to pay, the court in those circumstances should compel it to pay. Neither Power Curber
International Ltd. v. National Bank of Kuwait S.A.K. [1981] 1 W.L.R. 1233 nor Gian Singh & Co. Ltd.
v. Banque de l'Indochine [1974] 1 W.L.R. 1234 assist on the present point.

The appellants contend that it is axiomatic that an issuing or confirming bank deals in documents not in
goods and that the letter of credit contract is, and must remain, independent of any dispute under the
primary contract of sale. It follows, therefore, they contend, that with two possible exceptions, the bank
is bound to pay if the documents are in order on their face and entitled to refuse to pay only if the
documents do not support the appellants proposition.

21. In Bolivinter Oil SA v. Chase Manhattan Bank and Others: [1984] 1 All ELR 351, Sir John
Donaldson MR and Griffiths LJ, speaking for the court of appeal said as under:-

...we should like to add a word about the circumstances in which an ex parte injunction should be
issued which prohibits a bank from paying under an irrevocable letter of credit or a performance bond
or guarantee. The unique value of such a letter, bond or guarantee is that the beneficiary can be
completely satisfied that, whatever disputes may thereafter arise between him and the bank's customer
in relation to the performance or indeed Page 371 existence of the underlying contract, the bank is
personally undertaking to pay him provided that the specified conditions are met. In requesting his
bank to issue such a letter, bond or guarantee, the customer is seeking to take advantage of this unique
characteristic. If, save in the most exceptional cases, he is to be allowed to derogate from the bank's
personal and irrevocable undertaking, given be it again noted at his request, by obtaining an injunction
restraining the bank from honouring that undertaking, he will undermine what is the bank's greatest
asset, however large and rich it may be, namely its reputation for financial and contractual probity.
Furthermore, if this happens at all frequently, the value of all irrevocable letters of credit and
performance bonds and guarantees will be undermined.

He further cautioned the judges who deal with cases where such injunctions are sought in the following
words:-

Judges who are asked, often at short notice and ex parte, to issue an injunction restraining payment by
a bank under an irrevocable letter of credit or performance bond or guarantee should ask whether there
is any challenge to the validity of the letter, bond or guarantee itself. If there is not or if the challenge is
not substantial, prima facie no injunction should be granted and the bank should be left free to honour
its contractual obligation, although restrictions may well be imposed on the freedom of the beneficiary
to deal with the money after he has received it. 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 thereafter 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, for irreparable damage can be done to a bank's credit
in the relatively brief time which must elapse between the granting of such an injunction and an
application by the bank to have it discharged.

22. In U.P. Cooperative Federation Ltd v. Singh Consultants and Engineers (P) Ltd: , the Supreme
Court (Per Sabyasachi Mukherjee, J) held as under:-

In order to restrain the operation either of irrevocable letter of credit or of confirmed letter of credit or
of bank guarantee, there should be serious dispute and there should be good prima facie case of fraud
and special equities in the form of preventing irretrievable injustice between the parties. Otherwise the
very purpose of bank guarantees would be negatived and the fabric of trading operation will get
jeopardised.

23. In General Electric Services Company Inc v. Punj Sons (P) Ltd and Anr. , the Supreme Court held:-

Page 372
If the documentary credits are irrevocable and independent, the Bank must pay when demand
is made. Since the Bank pledges its own credit involving its reputation, it has no defense except in the
case of fraud. The Bank's obligations of course should not be extended to protect the unscrupulous
party, that is, the party who is responsible for the fraud. The nature of the fraud that the courts talk
about is fraud of an egregious nature as to vitiate the entire underlying transaction . It is fraud of the
beneficiary, not the fraud of somebody else.

24. In Syndicate Bank v. Vijay Kumar and Others: 1992 (2) SCC 330 in paragraph 14 thereof, the
Supreme Court held as under:-
14. From the above discussion it can be gathered that the Bank guarantees are on different level and
they must be allowed to be honoured free from interference by the courts and a Bank which gives a
guarantee must honour the same according to its terms and it is only in exceptional cases that the court
will interfere with the machinery of irrevocable obligations assumed by the banks. A fortiori the same
principle applies in respect of Bank guarantees which are discharged. When once the Bank guarantee is
discharged the obligation of the Bank ends and there is no question of going behind such discharged
Bank guarantee. The courts should refrain from probing into the nature of the transactions between the
Bank and the customer which led to the furnishing of the Bank guarantee.

25. In Svenska Handelsbanken v. M/s Indian Charge Chrome and Others: , the Supreme Court
emphasised that (see paragraph 60):-

..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.

In the said case, while considering the decision in Handerson v. Canadian Imperial Bank of Commerce
and Peat Marwick Ltd: 40 British Columbia LR 318, the Supreme Court observed that that was a case
where the facts were peculiar. The plaintiff had arranged an irrevocable letter of credit to fulfilll his
obligation to purchase 20 episodes of two television shows from a production company. The shows
were never produced and the production company went into bankruptcy, yet the receiver of the seller
made a demand upon the bank for payment under the letter of credit. Upon an application brought
about by the plaintiff, the court granted interim injunction and held that the letter of credit is
independent of the contract of sale between the buyer and the seller. The issuing bank agreed to pay
upon presentation of documents, not goods. It was held that there is an exception to this rule which is
that the bank should not pay under the credit where it knows that the request for payment is made
fraudulently in circumstances when there is no right to payment. The case in Handerson (supra) fell
within that exception Page 373 inasmuch as the bank had been put in knowledge of the fact that the
shows had not been produced and, therefore, the receiver was not entitled to the proceeds. After
discussing the entire case law on the subject and upon examination of the facts before it, the Supreme
Court in Svenska Handelsbanken (supra) refused to grant injunction in view of the finding that the
contracts between the lender and the borrower were not vitiated by any fraud and there was no question
of irrevocable injury. It was again reiterated that:-

In law relating to bank guarantees, a party seeking injunction from encashing of bank guarantees by the
suppliers has to show prima facie case of established fraud and an irrevocable injury.

26. In State Trading Corporation of India Ltd v. Jainsons Clothing Corporation and Another: , the
Supreme Court was of the view that in case of bank guarantees:-

it is only in exceptional case, that is to say, in case of fraud or in case of irretrievable injustice, the
court would interfere.

In State Trading Corporation (supra), the Supreme Court further held as under:-

8. The grant of injunction is a discretionary power in equity jurisdiction. The contract of guarantee is a
trilateral contract which the bank has undertaken to unconditionally and unequivocally abide by the
terms of the contract. It is an act of trust with full faith to facilitate free flow of trade and commerce in
internal or international trade or business. It creates an irrevocable obligation to perform the contract in
terms thereof. On the occurrence of the events mentioned therein the bank guarantee becomes
enforceable. The subsequent disputes in the performance of the contract does not give rise to a cause
nor is the court justified on that basis, to issue an injunction from enforcing the contract, i.e., bank
guarantee. The parties are not left with no remedy. In the event of the dispute in the main contract ends
in the party's favor, he/it is entitled to damages or other consequential reliefs.

9. It is settled law that the court, before issuing the injunction under Order 39, Rules 1 and 2, CPC
should prima facie be satisfied that there is friable issue strong prima facie case of fraud or irretrievable
injury and balance of convenience is in favor of issuing injunction to prevent irremedial injury. The
court should normally insist upon enforcement of the bank guarantee and the court should not interfere
with the enforcement of the contract of guarantee unless there is a specific plea of fraud or special
equities in favor of the plaintiff. He must necessarily plead and produce all the necessary evidence in
proof of the fraud in execution of the contract of the guarantee, but not the contract either of the
original contract or any of the subsequent events that may happen as a ground for fraud.

Page 374

27. In Ansal Engineering Project Ltd v.Tehri Hydro Devlopment Corporation Ltd and Another: , the
Supreme Court held as under:-

4. It is settled law that bank guarantee is an independent and distinct contract between the bank and the
beneficiary and is not qualified by the underlying transaction and the validity of the primary contract
between the person at whose instance the bank guarantee was given and the beneficiary. Unless fraud
or special equity exists, is pleaded and prima facie established by strong evidence as a friable issue, the
beneficiary cannot be restrained from encashing the bank guarantee even if dispute between the
beneficiary and the person at whose instance the bank guarantee was given by the bank, had arisen in
performance of the contract or execution of the works undertaken in furtherance thereof. ...

It further held as under:-

5. It is equally settled law that in terms of the bank guarantee the beneficiary is entitled to invoke the
bank guarantee and seek encashment of the amount specified in the bank guarantee. It does not depend
upon the result of the decision in the dispute between the parties, in case of the breach. The underlying
object is that an irrevocable commitment either in the form of bank guarantee or letters of credit
solemnly given by the bank must be honoured. The court exercising its power cannot interfere with
enforcement of bank guarantee / letters of credit except only in cases where fraud or special equity is
prima facie made out in the case as friable issue by strong evidence so as to prevent irretrievable
injustice to the parties. The trading operation would not be jettisoned and faith of the people in the
efficacy of banking transactions would not be eroded or brought to disbelief. The question, therefore, is
whether the petitioner had made out any case of irreparable injury by proof of special equity or fraud
so as to invoke the jurisdiction of the Court by way of injunction to restrain the first respondent from
encashing the bank guarantee. ...

28. In Dwarikesh Sugar Industries Ltd v. Prem Heavy Engineering Works (P) Ltd and Another: , the
Supreme Court observed that numerous decisions had been rendered by the court over a span of nearly
two decades with regard to the principles which the courts must apply while considering the question
whether to grant an injunction which has the effect of restraining the effect of bank guarantees. The
court mentioned its earlier decisions in Svenska (supra), Larsen & Toubro Ltd v. Maharashtra SEB: ,
Page 375 Hindustan Steel Workers Construction Ltd v. G.S. Atwal & Co. (Engineers) (P) Ltd: and U.P.
State Sugar Corporation v. Sumac International Ltd: and reiterated the principles set down in those
cases. The Supreme Court pointed out that one exception to the rule of non-interference with a bank
guarantee is fraud and that too established fraud. It further pointed out that the second exception to the
rule of granting injunction is the result of irretrievable injury which has to be such a circumstance
which would make it impossible for the guarantor to reimburse himself if he ultimately succeeds.
While considering the question of fraud, the Supreme Court mentioned that the observations of Sir
John Donaldson MR and Griffiths LJ in Bolivinter Oil SA (supra), were apposite and had also been
approved by the Supreme Court in U.P. Cooperative Federation Ltd v. Singh Consultants and
Engineers (supra). It must be remembered that in Bolivinter Oil SA (supra), it was inter alia held that
an injunction may be granted as an exceptional case where it is proved that the bank knows that any
demand for payment already made or which may be made thereafter will be clearly fraudulent. The
evidence must be clear both as to the fact of the fraud and as to the bank's knowledge.

29. In Hindustan Construction Company Ltd v. State of Bihar and Others: , the Supreme Court
reiterated the principle that courts are reluctant in granting an injunction against the invocation of a
bank guarantee except in the case of fraud, which should be an established fraud or where irretrievable
injury was likely to be caused to the guarantor. In Hindustan Construction Company (supra), however,
the court passed an injunction against encashment of a bank guarantee but on the ground that the
invocation itself was bad. It was held that in that case, the bank guarantee could be invoked by none
except the Chief Engineer and as the invocation had not been done by the Chief Engineer, the same
was wholly wrong and the bank was under no obligation to pay the amount covered by the
performance guarantee to the Executive Engineer. This case added another dimension in the question
of injunctions of a bank guarantee. It provided that where the bank guarantee had been improperly
invoked, then, an injunction could be granted from encashment of the same.

30. In Federal Bank Ltd v. V.M. Jog Engineering Ltd and Others: 2001 (1) SCC 663, the Supreme
Court held as under:-

Page 376

55. In several judgments of this Court, it has been held that courts ought not to grant injunction to
restrain encashment of bank guarantees or letters of credit. Two exceptions have been mentioned " (i)
fraud, and (ii) irretrievable damage.

31. In Industrial Finance Corporation of India Ltd v. Cannanore Spinning and Weaving Mills Ltd and
Others: , the Supreme Court noted that a contract of guarantee, though it is not a contract regarding a
primary transaction, but is an independent transaction containing independent and reciprocal
obligations. It is on principal-to-principal basis and by reason wherefor the statute has provided both
the creditor and the guarantor some relief as specified in Section 130 to 141 of the Indian Contract Act.

32. The principles deducible from the aforesaid decisions is that courts ought not to grant injunction to
restrain encashment / invocation of bank guarantees or letters of credit except in cases of fraud and
irretrievable damage. The fraud must be an established fraud of an egregious nature so as to vitiate the
underlying transaction and it is fraud of the beneficiary, not fraud of somebody else. The bank can
refuse to pay under a bank guarantee or a letter of credit where it is proved that the bank knows that
any demand for payment already made or which may be made thereafter will be clearly fraudulent.

33. Now, in the factual background of the present case, I find that the offer of the plaintiff lapsed on
23.09.2003 and there was no underlying contract between the plaintiff and the defendant No. 1. When
the plaintiff's offer lapsed on 23.09.2003 it became entitled to the return of the earnest money amount
and the defendant No. 1 could not, in law, forfeit the same. Knowing that it is not entitled to forfeit the
amount, if the defendant No. 1 still goes ahead and invokes the bank guarantee it would be doing so
despite the knowledge that it has no right to forfeit the amount. Such an invocation would be clearly
fraudulent. Since the defendant No. 1 is the beneficiary, such fraudulent action on its part would be
liable to be injuncted in view of the well settled legal principles.

34. Thus, whichever way one looks at the problem the answer is the same. If the statutory provisions of
the Indian Contract Act and in particular Section 134 are considered, the Surety (the Bank) stands
discharged because the principal-debtor (the plaintiff) is discharged / released of its liability inasmuch
as I have held that the creditor (defendant No. 1) has no right to forfeit the earnest money deposit. That
being the case, the defendant No. 1 cannot ask the defendant No. 2 (the bank) to pay under the bank
guarantee. If the common law principles as per various decisions of the courts are considered, then,
too, the defendant No. 1 cannot insist on payment under the bank guarantee. This is so because, such
an insistence would be fraudulent in the wake of its knowledge that it has no right in law to forfeit the
earnest money deposit. Hence, this issue also is decided in favor of the plaintiff and against the
defendants.

Page 377
Issue No. 3.

35. Now comes the question of relief. Both issues 1 & 2 have been decided in favor of the plaintiff.
This being the case, the plaintiff is entitled to a declaration that upon the expiry of validity of the initial
offer there subsisted no contractual relationship between the plaintiff and the defendant No. 1 and,
therefore, the defendant No. 1 is not entitled to forfeit the earnest money. The plaintiff is also entitled
to the relief of permanent injunction restraining the defendant No. 1 from invoking the bank guarantee
No. LKB/4692/22050 of 22.03.2003 for a sum of Rs. 15.00 lakhs issued by the defendant No. 2. The
plaintiff is also entitled to an injunction restraining the defendant No. 2 from making any payment
under the said bank guarantee to the defendant No. 1. The plaintiff is also entitled to costs. It is so
decreed.

36. The suit and all pending applications including IA No. 11121/2003 stand disposed of.