THE GIST of Editorial for UPSC Exams : 03 March 2020 [Sanctity of bank guarantees is sacrosanct (The Hindu)]

Sanctity of bank guarantees is sacrosanct (The Hindu)

Mains Paper 3: Economy
Prelims level: Terms of bank guarantees
Mains level: Violations of the terms of bank guarantee

Context:

• It is reported that the Calcutta High Court had asked the Reserve Bank of India to consider ‘appropriate steps’ against Bank of Baroda, including cancelling its banking licence, for delaying to honour a bank guarantee.

Background:

• The case pertains to a bank guarantee issued to Indian Oil Corporation (IOC) at the request of Simplex Projects Ltd. IOC invoked the bank guarantee.
• It is also reported that Bank of Baroda, after seeking legal advice, decided to exercise its rights available under the law preferring to challenge the aforesaid orders passed by the Calcutta High Court before the Supreme Court of India.
• As full details are not available in public domain, one cannot ascertain whether the bank, while not honouring its commitment under the guarantee, envisages any fraudulent element.

Terms of bank guarantees:

• As per Section 126 of Indian Contract Act, contract of guarantee is a contract to perform the promise or discharge the liability of a third person in case of his default.
• When a bank issues a guarantee at the request of its customer in favour of third parties, the bank is liable to discharge its obligation as per the terms of the guarantee issued.
• Apart from stipulations under Contract Act, the RBI’s instruction will be binding on the bank as the RBI is the banking regulator.

RBI’s direction:

• The guarantee should be for a definite period and definite amount. Maximum period can be 10 years.
• The proposal should be analysed like any other fund-based financing, though the limit is a non-fund based one.
• The guarantee should be issued only for customers and after taking sufficient margin and security.
• Most importantly the guarantee should be honoured whenever invoked without any delay.
• Whenever any claim on guarantee is received, the bank has to just see whether the claim is in order, which means that is it actually invoked by the beneficiary only and is it within the time stipulated, and pay.
• There cannot be any delay on this. Only when there is a suspicion of fraud the bank can become cautious. Or there can be some court injunction directing the bank to withhold. On all other occasions the payment under the invoked guarantee should be forthwith.
• The RBI had also informed that non-compliance of the instructions in regard to honouring commitments under invoked guarantees will be viewed by the RBI seriously and it will be constrained to take deterrent action against the banks.

Supreme Court’s direction:

• In the UP Co-op Federation Private Ltd versus Singh Consultants and Engineers Private Ltd (1988 IC SSC 174) case, the Supreme Court said: “We are, therefore, of the opinion that the correct position of law is that commitment of banks must be honoured free from interference by the courts and it is only in exceptional cases, that is, to say, in case of fraud or any case where irretrievable injustice would be done if bank guarantee is allowed to be encashed, the court should interfere.”

What did Bank of Baroda do?

• The order read, “It is submitted on behalf of IOCL that notwithstanding the bank having no right to stall immediate payment upon the invocation of an unconditional bank guarantee, the bank in this case sought some time.” IOCL asserted that the bank had no right to hamper immediate payment of the unconditional bank guarantee, let alone seek extra time.
• IOCL has also claimed that Bank of Baroda must have informed Simplex about the invocation and the company immediately instituted proceedings under Section 9 of the Arbitration and Conciliation Act, 1996 before the Delhi High Court, by virtue of the arbitration agreement contained in the contract between IOCL and Simplex.
• The order also read, “IOCL submits that despite Simplex failing to obtain any order in such proceedings and the Delhi High Court observing that the bank guarantee was unconditional and payment thereunder could not be avoided once the guarantee was invoked, an appeal was preferred which was withdrawn by or about June 1, 2018,”
• Bank of Baroda still refused to release the payment in terms of the unconditional guarantee on the grounds that the money may not have been made available by Simplex to the bank.
• On 24 June, 2019 through another order the court had directed the bank to pay immediately, in which the regulator had not been required to look into the conduct of the Bank of Baroda.

Way forward:

• Therefore, in the current appeal by IOCL was filed in the form of a cross objection, to consider the conduct of the bank and seeking directions to the RBI to take steps against the bank, since it has behaved in an inappropriate manner despite being a nationalized bank.

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Prelims Questions:

Q1. With reference to the National Science Day (NSD) 2020, consider the following statements:
1. ‘Women In Science’ is the focal theme of the programme.
2. It is celebrated every year on 22 February by the Government of India to commemorate the discovery of the ‘Raman Effect’.

Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2

Answer: A
Mains Questions:
Q1. Define the terms of bank guarantees. If any bank violates the rule what RBI can do regarding this?