Bank Guarantee is the kind of surety that is obtained from the Borrowing organization’s bank. It is a Guarantee that when a debtor would fail to pay the amount due at the time of performance, then the Bank would intervene and would cover up the liability. This is done so that the lending party does not suffer any financial loss in case the Borrowing party fails to arrange for the funds at the right time. Here, the guarantee means that the bank would be ensuring the party that all the liabilities would be covered by the bank. If all the essentials are followed then, it can be a popular option from the Creditor’s point of view as well as the buyer’s since it secures the transaction to a great extent.

The bank guarantees are unconditional which means that it is nowhere dependent on the relationship between the beneficiary, the guarantee holder, and the debtor.

The Bank Guarantee can be only restrained when there is a fraud discovered or there is any irreversible injustice caused to parties to the contract or there has been a special equity in any case.

In case, the invocation is valid and there is no court that prohibits the payment, the bank is formally liable to disburse the claim towards the lender. The bank also, as and when it is supposed to disburse the claim, it notifies the borrower that it is about to pay on his behalf so he should start the arrangement for the funds and prepare to reimburse the payment to the bank.

There are mainly two types of Bank Guarantee: –

  • Advance Payment Guarantee
  • Deferred Payment Guarantee

What are Bank Guarantees? How and when can it be Restrained by the Courts?

They are a type of financial tool offered by a lending institute, generally a bank that ensures the lender that in any case the debtors liabilities would be met.

The Hon’ble Indian courts have interpreted that the bank guarantee, which is unconditional can be easily invoked by the beneficiary, which is the lender disregarding the fact that there are any disputes amongst the beneficiary and the borrower, also known as the Principal Obligation.

It can be said that invocation of Bank Guarantee, which is unconditional cannot be stayed by the court. It is possible in only those cases where, there is a component of fraud involved which ultimately defeats the purpose of the contract.

Also, where in the exercise of the disbursement of the promise would lead to a irreparable harm or injustice to any one of the parties concerned, then it should be considered to be an invocation of the contract.

Letter of Credit

Letter of credit similar to a Bank Guarantee is a Financial tool, that is provided by a financial institution like a Bank, where the bank assures that the payment would be received by the lender on time and that too of the proper amount. Since the nature of the Letter of Credit is negotiable, the bank, which issues it have an option of paying the beneficiary directly or to any other entity, since it transferable.

The key difference between LOC and Bank Guarantee is that the latter is commonly used by contractors while the other is primarily used in the field of Exports and Imports.

In certain case like the Larsen And Toubro Limited And Anr. vs Punjab National Bank And Anr[1]. It can be seen that how the parties to the contracts, just unanimously, with just a conflict, disagreed and since the option of interference of the court was absent, the defendant, took the heavier side and removed the guarantee from the obligation.

In this case, an illegal contract was about to get rendered with the accent of both the parties. Here, S.28 of the Indian Contract Act was referred where the contractual agreement regarding grace period was taking place and the validity of Digital Signature was in a Bank Guarantee was taken into consideration.


According to Meghna Mishra’s article, “India: Bank Guarantees in India”, it distinguishes bank as an entity from the beneficiary, it also holds Bank Guarantee as an independent contract, which is not subordinated from any other.

Currently, there are various types of Bank Guarantees, depending on the type of issuance, types of conditions specified in it, and also on the type of performance.

According to S. 20 of the Banking Regulation Act, it is the prohibiting factor, which restricts any bank to restrain from proving loans to any individual or any Directors of any company,  who has given the Guarantee to receive any loan amount. This is done in order to avoid the company’s directors to escape their liability from the contract and to restrain the bank being the ultimate sufferer.

The S.126, clearly states the definitions of Bank Guarantee and the penalties relating to the default and the breach of the contract. It can be seen that the number of breach of contracts relating to guarantee has arisen substantially.

Coming to the challenges faced by the parties to fulfil their contractual obligation is at the position, which is very difficult to get out of the cycle. It is not sure that once a party has entered into the contract the surety will be free of complete liability and since the courts do avoid intervention in these cases, the parties tend to develop a tendency of fear of exploitation from the other party. Keeping an improper perspective and a fear in mind usually leads to perform fraudulent activities and thus, it can be stated that despite being a well-established financial tool, the laws relating to the Bank Guarantee can be amended, so that the viscous nature of the parties gets curbed.



Oil and Natural Gas Company (ONGC) entered into a contract with Italy’s M/s Saipem in order to build a system of Gas pipeline for the lift.

The scope of the contract included surveying, designing, installing, testing, wrapping, and all other work related to installation of the system at the plant. The pipeline approximately measured a length of 182 km.

The contractual price was fixed at $63,875,000 plus an additional INR 8,06,00,000. The contract stated that under normal circumstances, the date of competition was 30th day of April, 1991.

The contract, also provided scope for liquidated damages in case, the contractor failed to complete his obligation, a penalty of 3% per month with a cap of maximum of 10% of the contract price for delay not more than 4 months.

To cover up the same M/s Saipem was required to furnish a Bank Guarantee of 10% of the contract price. In order to contend with the terms and conditions, entered into a bank guarantee contract with SBI. The Bank Guarantee had been obtained for a sum of $6,387,500 including an additional sum of INR 8,060,000.


On March 17th, 1993, which marked the 306th day of delay, the company, took a survey and analysed a damage of $4,320,432 plus INR 5,515,959.

The company catered the contractor with several option to have the bank guarantee continued. It gave an option to extend the Guarantee till the first day of October, 1993. The contractor, willing to accept this option send a letter to the bank

Gradually, the contractor and the bank did not honour the terms and conditions of the guarantee and then the Bank dishonoured the cover and removed it guarantee.

The bank responded with the contradictory argument of the Italian court and also challenged the validity of the contract between the appellant and the contractor.


It was held that, the bank can abstain from processing any payment to the Company, by the High Court. But when appealed in the Supreme Court, it gave a verdict in favour of ONGC because the terms of the contract clearly stated unrestricted Guarantee and the Bank had no Prima Facie Good defence to the suit, so, the decision of the Supreme Court ruled in favour of ONGC and ultimately the Bank was liable to enforce the contract.


The suggestion lies as in, there should be uniform Civil or a Criminal code when dealing with the contracts made in and around Bank Guarantee since, the courts do not tend to intervene and resolve the matter related to the disputes arising from the bank guarantee, it can be very difficult for the parties to match up the level of authenticity, therefore, it is suggested that the courts, must try to intervene and intercept the matters, so that the collaboration amongst the parties to the contract would remain at a reliable level and none of the party would try to find ways to restrain the contract.

The government should design a portal where every individual and company’s database shall be stored and would contain credits, which would reduce whenever a guarantee would be issued and would increase whenever the Guarantee is discharged. The credit rating would improve constantly whenever the Guarantee is fulfilled legitimately and would decrease vice-versa. The advantage to this would be it would restrain the company’s from over applying.  


This article therefore covers some concept of Bank Guarantee and its Restrain brought by the Courts in detail. It is also centric towards the facts and some recent developments in fraudulent activities and how Contract of Guarantee takes shape when the regulated and monitored guidelines of the RBI is circulated timely.

The article also helps in proving how the role of Bank Guarantee is important in the Business Platform, where there is no pre-existing trust relationship between the parties to the contract. We have also got to know that why does the Court do not intervene within the conflicts arising out of the disputes.

Contributed by Tejas Sikka (Intern)

Student at OP Jindal Global University


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