Independent Agreement of Bank Guarantee Separate from Primary Agreements: Verdict by Delhi High Court
Delhi High Court Reinforces Banks' Obligations in Unconditional Bank Guarantees
In a significant ruling, the Delhi High Court has reaffirmed that banks cannot avoid their payment obligations on unconditional and irrevocable bank guarantees (BGs) by relying on extraneous agreements. The Court's decision, made in the case Kotak Mahindra Bank vs Union of India, sets a precedent that protects the beneficiary's rights and ensures certainty in financial guarantees.
The case revolved around a dispute arising from Engineering, Procurement, and Construction (EPC) contracts awarded by the Union Ministry of Road Transport and Highways (MoRTH) for highway work in Bihar. Sunil Hitech Engineers Ltd (Defendant No. 3) arranged five BGs through Kotak Bank to secure mobilization advances from the ministry. However, when the contractor defaulted, Kotak Mahindra Bank paid ₹48.77 crore under the BGs.
Later, the bank sought recovery from the Union Ministry of Road Transport and Highways, arguing breach of side arrangements in underlying contracts which would discharge the bank from liability. The Court dismissed this claim, stressing that the bank’s obligation is strictly limited to the BG’s terms and cannot be discharged by conditions outside the document.
Justice Jyoti Singh, who was part of the Bench that made the ruling, cited the Supreme Court's decision in Himadri Chemicals v. Coal Tar Refining Co (2007) to reaffirm limited court intervention in the invocation of unconditional bank guarantees. The Court held that if the bank's argument was accepted, an unconditional bank guarantee would be converted into a conditional one, which is impermissible in law.
The Court also highlighted that the bank guarantee’s independence means any disputes underlying the main contract or side agreements do not affect the BG’s validity or enforceability. Enforcement of BGs is immediate and prima facie, i.e., the bank must honour the invocation first before contesting related disputes elsewhere.
The ruling aligns with established Indian law holding that banks cannot condition payment on alleged breaches in separate agreements. Kotak Mahindra Bank was represented by Senior Advocate Sandeep Sethi and others, while the Union of India was represented by Senior Advocate Ravi Prakash and others.
The Court did not order a refund for Kotak but granted it liberty to pursue its claims in the liquidation proceedings of the contractor. Moreover, the Court reserved the right to pursue legal remedies against Defendant No.3. The Court also rejected Kotak's arguments regarding the escrow account and NOC condition, as the bank guarantees were explicitly unconditional.
In summary, the Delhi High Court's judgment reinforces that banks’ obligations under unconditional and irrevocable bank guarantees are strict and absolute, and refusal based on outside side arrangements is impermissible. This decision underscores the importance of adhering to the terms of BGs and upholding the rights of the beneficiaries.
Banks' obligations in unconditional and irrevocable bank guarantees are binding, as the Delhi High Court ruled, laying a precedent that banks cannot avoid their payment obligations by relying on extraneous agreements. Financial institutions must honor bank guarantee invocations immediately, irrespective of disputes arising from underlying main contracts or side agreements.
