Holding

A bank guarantee is an unconditional contract between the bank and the principal; invocation cannot be denied on alleged fraud unless the bank itself proves fraud, and breach of contract does not constitute fraud that vitiates the guarantee.

Summary

Reliance Salt Ltd (appellant) entered into a consignment agreement with Cosmos Enterprises (respondent No.1) which required the latter to furnish a Rs 5 lakh bank guarantee from Bank of India (respondent No.2). The consignment agent failed to settle the appellant's bills within the stipulated 30‑day period, prompting the appellant to invoke the guarantee. Respondent No.1 filed a suit seeking a declaration and injunction that the guarantee could not be invoked, alleging fraud on the part of the appellant. The trial court and the Patna High Court held that the invocation was vitiated by fraud and granted the injunction. On appeal, the Supreme Court examined Sections 126 and 17 of the Indian Contract Act and held that a bank guarantee is an unconditional contract between the bank and the principal, and that any claim of fraud must be pleaded and proved by the bank, not by the principal. The Court further ruled that a breach of contract or non‑settlement of bills does not amount to fraud that can defeat the guarantee, and that discrepancies in accounts are not a ground for the bank to refuse payment. Consequently, the Court set aside the lower courts' orders and allowed the appeal, permitting the appellant to invoke the guarantee.

Issues considered

Whether the invocation of a bank guarantee can be barred on the ground of alleged fraud by the principal or consignment agent.
Whether a breach of contract or failure to settle bills within the agreed period constitutes fraud that vitiates a bank guarantee.
Who bears the burden of proving fraud in the context of a bank guarantee – the bank or the principal.
Whether a bank may refuse payment under an unconditional guarantee on the basis of discrepancies in accounts.

Legislation cited

Code of Civil Procedures. 100
Indian Contract Act, 1872s. 126, s. 17

Subjects

bank guaranteecontract of guaranteefraudinjunctionconsignment agreementSection 126Section 17breach of contractunconditional guaranteeSupreme Court

Judgment

A MIS. RELIANCE SALT LTD.
v.
MIS. COSMOS ENTERPRISES AND ANR.

NOVEMBER 22, 2006

B (S.B. SINHA AND DAL VEER BHANDARI, JJ.]

Contract Act, 1872-ss. 126 and 17-Agreement of consignment-
Bank Guarantee-Invocation of, by Principal company on non-settlement of
C bills by consignment agent within stipulated period-Suit for injunction
restraining Principal Company from invoking Bank Guarantee by
consignment agent, pleading case offraud-Courts below holding invocation
of Bank Guarantee vitiated by fraud-Correctness of-Held: Bank Guarantee
constitutes agreement between Banker and Principal, though, at instance of
promisor-On invocation of bank guarantee, bank is to plead case of fraud
D and not the promisor-consignment agent-In terms of the agreement, Bank
could not refuse invocation-Further, bank did not dispute claim of Principal
Company nor contested the suit nor supported the case of consignment
agent-Thus, order of courts belmv set aside.

Respondent No. I and the appellant company entered into a sale
E agreement and respondent was appointed as consignment agent. Respondent
No. I furnished a Bank Guarantee of Rs. 5 lakhs as required. The appellant
could invoke the Bank Guarantee for any loss or damage suffered by it in
case of breach of contract on non-payment of bills within 30 days. The bills
were not settled within the time stipulated. Appellant invoked the Bank
F Guarantee. Respondent No. I filed suit for declaration that the appellant was
not entitled to invoke the Bank Guarantee and injunction restraining
respondent No. 2 from encashing Bank Guarantee at instance of appellant.
Trial court decreed the suit in favour of respondent no. 1 holding that the
invocation of Bank guarantee was vitiated by fraud. Hence the present appeal.

G Allowing the appeal, the Court

HELD: 1.1. A bare perusal of the contents of the Bank Guarantee, shows
that there is no escape from arriving at a conclusion that the guarantee
furnished was an unconditional one. It not only provided for loss or damage

H 280
RELIANCE SAL TL TD. v. COSMOS ENTERPRISES 281
in case of breach of contract, but also loss or damage by reason of non- A
settlement of bills. Such bills under the agreement of consignment were to
be settled within a period of 30 days. In the event the bills are not settled
within the period stipulated in the agreement, the parties intended, as it appears
from the tenor of the Bank Guarantee, that the same would constitute a breach
of contract. It is not in dispute that some amount was due to the appellant B
from the Respondent. The suit was not a suit for settlement of accounts. The
suit was, inter alia, only for a decree for injunction restraining appellant from
invoking the Bank Guarantee. Respondent No. 2-Bank, did not controvert
allegations contained in the demand of the appellant. It did not contest the
suit. It even did not support respondent No. 1 before the trial judge or before
the High Court. [288-G-H; 289-A-B] C
1.2. A claim which is denied or disputed, in the event of necessity for
determination of the /is. may not be found to be correct. If appellant was to
allege a breach of contract in a properly framed suit, Respondent No. 1 could
also allege the breach of contract on the part of appellant. Breach of contract D
by reason of supply of inferior quality of tea or salt or delay in supply or a
short supply may render a party responsible for damages for commission of
breach of contract, but, breach of contract alone does not lead to the conclusion
that a fraud had been committed thereby. It is contended that commission of
fraud would include any act to deceive but then such act must be confined to
acts committed by a party to a contract with intention to deceive another party E
or his agent or to induce him to enter into a contract. Fraud, which vitiates
the contract, must have a nexus with the acts of the parties prior to entering
into the contract. Subsequent breach of contract on the part of a party would
not vitiate the contract itself. [289-B-E]

1.3. Bank Gu.arantee constitutes an agreement between the Banker and
F
the Principal, albeit, at the instance of the promisor. When a contract of
guarantee is sought to be invoked, it was primarily for the bank to plead a
case of fraud and not for a promisor to set up a case of breach of contract.

1.4. The discrepancies in the bills or non-submission of the detailed G
account in respect of business cannot be a ground for denial of encashment
of Bank Guarantee if it is otherwise invokable. [290-AJ

1.5. Although, the Trial Judge as also the High Court observed that the
Bank Guarantee was invokable after lapse of30 days from date of the bill, as
stipulated therein, on its own terms the Bank was bound to pay the amount in H
282 SUPREME COURT REPORTS (2006] SUPP. 9 S.C.R.

A question on its invocation, subject of course to the fulfillment of the other
conditions laid down therein. It could not have refused to honour its
commitment only because the purported accounts were not settled between
the parties or the accounts furnished to the Court were wrong ones. The other
reasons assigned by the Trial Judge as also the High Court that the conduct
B of Appellant was not clean or it had tried to defraud other customers in other
parts of the State, are of not much significance in view of the nature of the
guarantee furnished by the Bank. Submission of respondent that after the
judgment of the High Court, Respondent no. l has got all documents released,
cannot be a ground to refuse invocation of Bank Guarantee by ·appellant, if it
was otherwise entitled thereto. (290-B-E]
c CIVIL APPELLATE JURISDICTION: Civil Appeal No. 5151 of2006.

From the Judgments and Orders dated 31.7.2000 and 28-10-2003 of the
High Court of Judicature at Patna in F.A. No. 28/1997 and L.P.A. No. 1632 of
2000 respectively.
D
Ranjan Mukherjee for the Appellant.

Sunil Kumar, Ranjit Kumar, Rajiv Shankar Dvivedi, Manish Mohan,
Ashish Thakur, Ajay Choudhary, S.S. Ray and Rakhi Ray for the Respondents.

E The Judgment of the Court was delivered by

S.B. SINHA, J. Leave granted.

The I st Respondent herein was appointed as a Consignment Agent by
an agreement dated 23.12.1993 in regard to the sale of products of the Appellant
F Company-plaintiff, namely, Salt and Tea in South and Central Bihar. In terms
of the said agreement it was required to furnish a Bank Guarantee for a sum
of Rs.5 lakhs. The transactions between the parties started in January, 1994.
Some of the clauses in the said Bank Guarantee are as under :

" ....... We ................................ (hereinafter referred to as the Bank) do
G hereby agree to pay the Principal Co. an amount not exceeding
Rs.6,00,000/- (Rupees Six Lacs only) against any loss or damage
caused to or suffered or would be caused to or suffered by the
Principal Co. by reason or any breach of contract by the consignment
agent as their due pe1formance of their duties as consignment agent
for the Principal Co., the major term being settlement of the Principal
H Co. 's bills by the consignment agent within 30 days from the date of
RELIANCE SALT LTD. v. COSMOS ENTERPRISES [S.B. SINHA, J.] 283

receipt of material. A
(2) We ...................... (Bank) do .............. hereby undertake to pay the
amounts due and '.1ayable under this guarantee without any demur
merely on a demand from the Managing Director or any other
director of the Principal Co. stating that the amount claimed is due
by way of loss or damage caused to suffered by the Principal Co. by B
reason of any breach of contract for non payment of the Principal
Company's bills within 30 days from the date of receipts of materials
by the consignment agent of any of the terms and conditions agreed
upon/to be agreed in performance of their duties of consign·ment
agent on behalf of the Principal Co. Any such demand made on the C
......... (Bank) shall be conclusive as regard the amount due and payable
by the Bank under this guarantee.

(3) We ....................... (Bank) further agree that the guarantee shall
remain in full force and effect for a period of 12 (Twelve) months from
the date of issue of this guarantee or till the period that would be D
taken by the consignment agent for the due performance of their
duties as consignment agent on behalf of the Principal Company on
the terms and conditions mutually agreed upon/to be agreed upon
shall continue to be enforceable till all the dues of the Principal
Company have been fully paid and its claims satisfied or discharged
or till the Managing Director or any other director of the Principal E
Company certified that the due performance of their duties as
consignment agent have been fully and properly carried by the
consignment agent and accordingly discharge the Guarantee, which
ever date is earlier.

(4) We ... :.............. (Bank), further agree with the Principal Company F
that the Principal Company have been fullest liberty without our
consent and without AFFECTING IN ANY MANNER. Our
OBLIGATIONS HEREUNDER to vary any of the terms and conditions
agreed/to be agreed with the consignment agent in the due performance
of their duties as consignment agent or to extent time of performance G
by the consignment agent from time to time any of the power exercisable
by the Principal Company against the consignment agent and to
forbear or enforce any of the terms and conditions agreed upon and
.we shall not be relieved from our liabilities by the reason for any such
variation or extension being granted to the consignment or any
forbearance act or omission on the part of the Principal Company or H
284 SUPREME COURT REPORTS (2006] SUPP. 9 S.C.R.

A any indulgence by the Principal Company or any indulgence by the
Principal Company to the Consignment Agent by any such manner or
thing whatsoever which under the law relating to sureties would but
for this provision have effect of so relieving us."

Pursuant to or in furtherance of the agreement entered into by and
B between the parties herein, the 1st Respondent furnished a Bank Guarantee
ofRs.5 lakhs issued by Respondent No. 2, Bank of India, Muradpur, Chouhatta
Branch, Patna on 12.1.1994.

Indisputably, the business dealings between the parties continued upto
C July, 1994. Appellant's bills allegedly remained unpaid for more than 30 days
after the same had been raised amounting to Rs.5,04,739.92p. The said Bank
Guarantee was invoked by letter dated 4.8.1994 whereabout Respondent No.
2 intimated to 1st Respondent. A Title Suit No. 316/94 was filed by 1st
Respondent herein in the Court of Subordinate Judge at Patna, inter a/ia, for
the following reliefs :
D "(a) declaration that the petitioner is not entitled to invoke the Bank
Guarantee for Rs.5 lakhs.
(b) order of injunction restraining the respondent No. 2 from en cashing
the Bank Guarantee at the instance of the petitioner"

E In the said suit, whereas Appellant filed a written statement, the Bank
did not choose to file any. The suit was decreed on contest against Appellant
and ex parte against Respondent No. 2. An appeal taken therefrom by
Appellant before the Patna High Court being First Appeal No. 2811997 was
dismissed by a learne~ Single Judge by an order dated 31.7.2000. An intra-
court appeal was filed as against by Appellant, which was found to be not
F maintainable, purported to be in view of the amended provisions of Section
I 00-A of the Code of Civil Procedure.

The learned Trial Judge framed several issues, the issue No. 7 being :

"VII. Is the defendant no. I is entitled to invoke the bank guarantee
G in question?"

The learned Trial Judge, inter alia, found that (i) the invocation of Bank
guarantee was vitiated by fraud; and (ii) the 1st Respondent wou Id suffer
irreparable injury in regard to the issue bf fraud.

H It was held :
RELIANCE SALT LTD. v. COSMOS ENTERPRISES [S.B. SINHA. J.] 285
"So, I find that plaintiff has made a specific plea of the case of fraud A
and irreparable harm in his pleading and therefore, the plaintiff is
entitled to establish the fact of fraud and irreparable harm, the
exceptions for granting injunction in case of invoking bank guarantee."

In the very nature of the things fraud is secret in its origin or
inception and in the means adopted for its success. Each circumstances B
of by itself may not mean much, but taking all of them together they
may reveal a fraudulent and dishonest plea.

So, the plaintiff is able to establish that the dealing of the plaintiff
was sincere for the business whereas the defendant No. 1 has not
made sincere dealing which caused irregularity in supply and other C
difficulties for which the plaintiff made complaint to the defendant No.
1 time to time.

Now from the perusal of the Ext. E, the original bank guarantee,
it is clear that the bank guarantee was revocable on the ground of any
loss and damage caused to the defendant No. 1 due to breach of the D
contract by the plaintiff or due to non-settlement of the bills of the
defendant No. 1 within 30 days from the date of those bills.

From the perusal of the letter dated 4.8.94 of Defendant No. 1 to
the Bank of India, Muradpur, Chouhatta Branch, Patna, it is clear that
the ground for invoking the Bank Guarantee as stated in the letter E
dated 4.8.94 is only non payment of the bills within the stipulated
period. Therefore there is no ground of loss or damage caused to the
Defendant No. I due to non performance of work in business by the
plaintiff or due to any breach of contract by the plaintiff."

The learned Trial Judge further opined that the evidence of the plaintiff F
corroborated in the form of contemporary documents as well as the unexplained
failure of the beneficiary to respond thereto would lead to the conclusion that
the only realistic inference to draw would be fraud, holding :

"The defendant No. I has not submitted any document in support of G
the balance amount as given in the written statement whereas the
plaintiff has filed all the relevant documents regarding his accounting
in order to prove that actually up to 31. 7.94 only Rs.32,864.35 paise
was due."

"Besides, the defendant had filed objection petition of the injunction H
286 SUPREME COURT REPORTS [2006] SUPP. 9 S.C.R.

A petition of the plaintiff on 23.8.94 and there has been annexure given
as Annexure A in which detailed account of the dealing of business
has been also given. In this, bill dated 16.7.94 is given as the last bill
amounting to Rs.28,000/-."

"So it appears that up to 16.7.94 the defendant No. I has sent goods
B to the plaintiff and in that case the bill dated 16.7.94 is liable to be
paid up to 16.8.94 i.e. within 30 days as per the terms of the agreement
vide Ext. (I) and defendant No. I is entitled to invoke the bank
guarantee only after the lapse of 30 days from the date of bill as
stipulated in the deed of bank guarantee Ext. E."

C "In this view of the· fact the amount given in Ext. D does not seem
to be correct and the account given in the written statement vide para
9 also does not seem to be correct."

"The absence of these things indicate that the action of defendant no.
I was not clean and honest rather it was fraudulent one and therefore,
D the invocation of bank guarantee was made by way of fraud."

"Therefore, the defendant No. I had difference with the consigning
agent in the State of Utt~r Pradesh and Andhra Pradesh. This
circumstance also leads to show that the action of the defendant No.
I was of a fraudulent nature."
E
In regard to the isst1e of irreparable injury, it was held :

"In the instant case, as discussed above, on the basis of oral and
documentary evidence, I find that the defendant No. I had played
fraud for withdrawing the amount of bank guarantee and it will also
F cause irreparable harm to the plaintiff. Therefore this case comes in
purview of the exception given in the settled law and accordingly,
injunction can be granted and defendant No. 1 can be prevented from
invoking the bank guarantee. Thus, this issue is also decided in
favour of the plaintiff and against the defendant."

G The High Court in its judgment opined that although the bank cannot
be prevented from honouring the Bank Guarantee as and when demanded by
the beneficiaries except in the case of fraud which would vitiate the entire
transaction. It was further opined that the plaintiff in paragraph l l; 16 and 19
of the plaint, specifically and clearly pleaded about the fraud played on the
J;I part of Appellant herein. It was furthermore stated that Appellant ought to
...
RELIANCE SALT LTD. v. COSMOS ENTERPRISES [S.B. SINHA, J.] 287
have produced and proved all its Books of Accounts to show that the A
accounts furnished by the plaintiff were not correct.

Before we embark upon the rival contentions of the parties, it would be
necessary to notice the salient features of the Bank Guarantee. The Bank
Guarantee was limited to the extent of Rs.5 lakhs. It was given only against
any loss or damage caused to or suffered by the Principal Company, by B
reason or any breach of contract by the consignment agent their due
performance of the duties of consignment agent of the Principal Company, the
major terms being settlement of the Principal Company's bills by the
consignment agent within 30 days from the date of those bills. The Bank
undertook to pay the amounts due without any demur and merely on demand C
by the Company. Such payment was merely to be made on the basis of a
statement that the amount claimed, inter alia, is due by way of loss or
damage caused to suffer by the Principal Company by reason of any breach
of contract for non-payment of the Principal Company's bill by the consignm.ent
agent of any of the terms and conditions to be agreed upon in performance
of their duties of Consignment Agent on behalf of the Principal Company. D
Any such demand made on the Bank of India should be conclusive as regards
the amount due and payable by the Bank under the said Bank Guarantee. It
was furthermore stated :

" ...... that the Bank Guarantee shall remain in full force and effect for
a period of 12 (twelve) months from the date of issue of this guarantee E
or till the period that would be taken by the Consignment Agent on
behalf of the Principal Company as the terms and conditions mutually
agreed upon shall continue to be enforceable till all the dues of the
Principal Company have been fully paid and its claim satisfied or
discharged or till the managing director or any other director of the F
Principal Company certified that the due performance of their duties
as Consignment Agent have been fully and properly carried out by
the Consignment Agent and accordingly discharge the guarantee
whichever date is earlier."

In its judgment, the learned Single Judge referring to paragraphs 11, 16 G
and 19 of the plaint, stated :

" ...... .In para 11 it has been stated th.at "they are not ready for settlement
of the account as that would reveal their own fault and misconduct"
and the defendant No. I intent to somehow or other to obtain huge
H
288 SUPREME COURT REPORTS [2006) SUPP. 9 S.C.R.

A amount of the plaintiff and thereafter vex and harassed the plaintiff in
refunding the same." Similarly, in para 16 of the plaint it has been
stated that defendant No. I is guilty of misconduct, irregularity,
deception, misrepresentation and fraud etc. and under the
circumstances, the defendant has no right to invoke the bank
guarantee."
B
Paragraphs 11, 16 and 19 of the pleadings and the evidences adduced
on behalf of I st Respondent, thus, were confined to the issue of inferior
quality of supply, late supply and short supply of consignments.

"Fra•Jd" is defined in Section 17 of the Indian Contract Act, 1872 in the
C following terms :

"S.17. "Fraud" defined.-"Fraud" means and includes any of the
following acts committed by a party to a contract, or with his
connivance, or by his agent, with intent to deceive another patty
thereto or his agent, or to induce him to enter into the contract :
D
(I) the suggestion, as a fact, of that which is not true, by one who
does not believe it to be true;
(2) the active concealment of a fact by one having knowledge or
belief of th~ fact;
E (3) a promise made without any intention of perfonning it;

(4) any other act fitted to deceive;
(5) any such act or omission as the law specifically declares to be
fraudulent.
F Explanation.-Mere silence as to facts likely to affect the willingness
of a person to enter into a contract is not fraud, unless the
circumstances of the ca~e are such that, regard being had to them, it
is the duty of the person keeping silence to speak, or unless his
silence is, in itself, equivalent to speech."
G A bare perusal of the contents of the Bank Guarantee, as noticed
hereinbefore, shows that there is no escape from arriving at a conclusion that
the guarantee furnished was an unconditional one. It not only provided for
loss or damage in case of breach of contract, but also loss or damage by
reason of non-settlement of bills. Such bills under the agreement of
H consignment were to .be settled within a period of 30 days. In the event the
RELIANCE SALT LTD. v. COSMOS ENTERPRISES [S. B. SINHA, 1.] 289

bills are not settled within the period stipulated in the agreement, the parties A
intended, as it appears from the tenor of the Bank Guarantee, that the same
would constitute a breach of contract. It is not in dispute that some amount
was due to the Appellant from the Respondent. The suit was not a suit for
settlement of accounts. The suit was, inter alia, only for a decree for injunction
restraining Appellant from invoking the Bank Guarantee. Respondent No. 2-
Bank, indisputably, did not controvert allegations contained in the demand of B
the appellant. It did not contest the suit. It even did not support Plaintiff-
Respondent No. 1 before the learned Trial Judge or before the High Court.

A claim which is denied or disputed, in the event of necessity for
determination of the /is, may not be found to be correct. If Appellant was to C
allege a breach of contract in a properly framed suit, Respondent No. 1 could
also allege the breach of contract on the part of Appellant herein. Breach of
contract by reason of supply of inferior quality of tea or salt or delay in
supply or a short supply may render a party responsible for damages for
commission of breach of contract, but, breach of contract alone does not lead
to the conclusion that a fraud had been committed thereby. It is contended D
that commission of fraud would include any act to deceive but then such act
must be confined to acts committed by a party to a contract with intention
to decei~e another party or his agent or to induce him to enter into a contract.
Fraud, which vitiates the contract, must have a nexus with the acts of the
parties prior to entering into the contract. Subsequent breach of contract on E
the part of a party would not vitiate the contract itself.

"Contract of guarantee" is defined under Section 126 of the Indian
Contract Act in the following terms :

"126. 'Contract of guarantee', 'surety', 'principal debtor' and F
'creditor '-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." G
Bank Guarantee constitutes an agreement between the Banker and the
Principal, albeit, at the instance of the promisor. When a contract of
guarantee is sought to be invoked, it was primarily for the bank to
plead a case of fraud and not for a promisor to set up a case of breach
of contract. H
290 SUPREME COURT REPORTS [2006) SUPP. 9 S.C.R.

A The discrepancies in the bills _or non-submission of the detailed account
in respect of business cannot be a ground for denial of encashment of Bank
Guarantee if it is otherwise invokable.

B Although, the learned Trial Judge as also the High Court observed that
the Bank Guarantee was invokable after lapse of 30 days from date of the bill,
as stipulated therein, on its own terms the Bank was bound to pay the amount
in question on its invokation, subject of course to the fulfillment of the other
conditions laid down therein. It could not have refused to honour its
C commitment only because the purported accounts were not settled b~tween
the parties or the accounts furnished to the Court were wrong ones. The other
reasons assigned by the learned Trial Judge as also the High Court that the
conduct of Appellant was not clean or it had tried to defraud other customers
in other parts of the State, in our considered opinion, are of not much
D significance in view of the nature of the guarantee furnished by the Bank.

Submission of Mr. Ranjit Kumar that after the judgment of the High
Court the I st Respondent has got all documents released, cannot be a ground
to refuse invokation of Bank Guarantee by Appellant, if it was otherwise
entitled thereto.
E
We, therefore, are of the opinion that the impugned judgments cannot
be sustained. They are set aside accordingly. The appeal is allowed. This
order shall not, however, come in the way of Respondents to file a suit for
accounts or take other measures which are available to them in law. Respondent
No. I shall pay and bear the costs of Appellant in the appeal. Counsel fee
F assessed at Rs. I 0,000/-.

NJ. Appeal allowed.