NEW DELHI: In a significant ruling, the Supreme Court has laid down guidelines for encashment of bank guarantee or letter of credit. A bench comprising justice Tarun Chatterjee and justice PK Balasubramanyan said, “We find that the following principles should be noted in the matter of injunction to restrain the encashment of a bank guarantee or a letter of credit (LoC).”

First, banks that give such guarantees are duty-bound to honour them as per terms agreed upon between the parties concerned, irrespective of any dispute raised by its customer. In the matter of invocation of a bank guarantee or an LoC, it is not open for the bank to rely upon the terms of the underlying contract entered into between parties concerned, court said.

Second, the existence of any dispute between parties to the contract is not a ground for issuing an order of injunction to restrain enforcement of bank guarantee or a LoC. The apex court said that the bank guarantee or LoC is an independent and a separate contract and absolute in nature.

Third, the beneficiaries are entitled to realise an unconditional bank guarantee or an LoC in terms of the agreement, irrespective of any pending disputes relating to the term of the contract.

Fourth, the courts should be slow in granting an order of injunction to restrain the realisation of a bank guarantee or an LoC.

However, the bench said that courts can pass an order, restraining encashment of the bank guarantee or LoC in two exceptional circumstances. One; where there is fraud of an egregious nature which would vitiate the very foundation of such a bank guarantee or LoC and the beneficiaries seek to take advantage of the situation; and two, when allowing encashment of an unconditional bank guarantee or an LoC would result in irretrievable harm or injustice to one of the parties concerned.

The guidelines pertaining to the issue came up during an appeal by Himadri Chemicals Industries, which entered into an agreement with Iran-based Coal Tar Refining to supply extra hard pitch to the appellant. Accordingly, an irrevocable LoC was opened by the appellant in favour of the Iranian entity.

Later, due to disputes between parties with the appellant, alleging supply of inferior quality goods, the company moved the court with the plea not to release payment under the LoC. It said encashment will result in irreparable loss to it. It alleged fraud by the foreign company. The court while elaborating the guidelines, dismissed the appeal as it failed to prove the allegations.

ICC Uniform Customs and Practice for Documentary Credits (UCP 600)

ICC Publication No. 600, 2006 Edition

UCP 600 came into effect on 1 July 2007. It contains significant changes you will need to know, including:

The new UCP 600 also contains within the text the 12 Articles of the eUCP, ICC’s supplement to the UCP governing presentation of documents in electronic or part-electronic form.

Used by letter of credit practitioners worldwide, the Uniform Customs and Practice for Documentary Credits (UCP) are the most successful private rules for trade ever developed. Bankers, traders, lawyers, transporters, academics and all who deal with letter of credit transactions worldwide, will refer to UCP 600 on a daily basis.