Author name: CBCL

[By Rishabh Shivani] The author is a student of National Law School of India University, Bengaluru.   Introduction Bank guarantees are special contracts where a bank guarantees performance by one party in a separate, underlying contract and agrees to furnish payment unconditionally on the demand of the beneficiary. However, egregious fraud and special equities are two exceptions based on which injunctions restraining the  encashment of a guarantee can be granted. While egregious fraud  necessitates fraud by the beneficiary in the underlying contract, special equities conventionally demand exceptional circumstances leading to irretrievable injustice or financial harm to the party claiming the injunction, if such injunction is not granted. Irretrievable injustice has, therefore, been considered a necessary consequence of establishing special equities. In Standard Chartered Bank v Heavy Engineering Corporation Ltd (“Standard Chartered”), the Supreme Court deviated from this rule and recognised special equities as a distinct circumstance from irretrievable injustice, thereby increasing the number of exceptions from two to three. However, the scope of special equities is still unclear, with no single principle laid down to determine when special equities can be claimed. In this piece, I attempt to clarify the meaning of “special equities” after the Standard Chartered ruling and lay down a test of prima facie breach now being used by Courts to establish special equities. Firstly, I provide a brief evolution of the law on special equities, and the changes brought by Standard Chartered. I then look at cases post-Standard Chartered and argue that the single guiding principle for Courts to establish special equities now is when no prima facie breach is attributable to the party claiming the injunction. I conclude by arguing that this changed meaning of special equities was much needed and does not affect the unconditional nature of bank guarantees. Evolution of Special Equities as a Ground for Injunctions The phrase “special equities” neither originates from English common law nor is statutorily defined. It is merely a product of judicial creation and was mentioned for the first time in Texmaco Ltd v State Bank of India, where the Calcutta High Court recognised “special equities” as a second exception where injunctions could be awarded. However, the Court did not elaborate upon what it meant by special equities. It was only after the ruling in Itek Corporation v First National Bank of Boston that there was some clarity. Here, a US District Court held that injunctions may be granted when the encashment would cause irretrievable injustice, such that the party would not be able to reimburse itself later. This dictum has been uniformly applied by Indian Courts. For example, in UP Cooperation Federation v Singh Consultants, the Supreme Court held that parties claiming injunctions will have to prove special equities, the consequence of which is irretrievable injustice, to successfully claim injunctions. In subsequent cases such as UP State Sugar Corporation v Sumac International and Svenska Handelsbanken v Indian Charge Chrome Ltd, courts have focused only on the irretrievability of damages for establishing special equities. Hence, special equities were established only in cases of irretrievable injustice, not otherwise. In fact, in Indu Projects v Union of India, the Delhi High Court went to the lengths of holding that special equities are interchangeably used with irretrievable injustice and are not larger in scope than the latter. Special equities were, therefore, practically ignored by Indian courts as an independent ground for awarding injunctions. However, this position was entirely changed in Standard Chartered. Here, the Supreme Court deviated from its rulings and held that injunctions can be granted when there is fraud, irretrievable injustice and special equities. It recognised special equities as a distinct circumstance from irretrievable injustice and hence, as a third exception. Establishing Special Equities Post Standard Chartered While Standard Chartered has transformed special equities by recognising it as a third exception, the extent of such transformation is, solely by the judgement, unclear as the Court did not define what it meant by special equities and how it was different from irretrievable injustice. Hence, it must be understood by analysing relevant case law post-Standard Chartered’s ruling. Standard Chartered was first applied by the Delhi High Court in Halliburton Offshore Services Inc Limited v Vedanta Limited and Others (“Halliburton”). Here, the imposition of the COVID-19 lockdown made it impossible for Halliburton to perform the contract. Consequently, Vedanta claimed breach and sought to encash the bank guarantees, and in response, Halliburton approached the Court seeking an injunction. Now, as per the pre-Standard Chartered position, the injunction would not have been granted as the damages were not irretrievable. However, the Court here recognised the distinction created in Standard Chartered and held that as Halliburton was willing to perform the contract but was genuinely disabled from doing so due to the lockdown, the encashment of bank guarantees would have caused unfair prejudice to it, and hence there were special equities in its favour. The injunction was, therefore, granted on the ground of special equities. However, the mere existence of COVID-19 is not sufficient to establish special equities. In Shaarc Projects Limited v Indian Oil Corporation (“Shaarc”), there were bank guarantees furnished by Shaarc in favour of Indian Oil. When several breaches were flagged by Indian Oil, Shaarc sought an injunction against the invocation of the bank guarantee, claiming that the performance became burdensome due to COVID-19. The Court rejected this plea holding that the increased burden does not make out a case of special equities. Why did the Court hold differently in these cases, given that both were marred by COVID-19? The differentiating factor was the existence of a prima facie breach. In Halliburton, the breach allegations were unfounded because Halliburton was genuinely disabled from performing the contract due to COVID-19. However, in Shaarc, the pandemic – did not disable Shaarc from performing the contract. The breach allegations were reasonable and well-founded. This prima facie breach principle has also been used in cases where there are arbitral awards in favour of the claimant. In Technimont Pvt Ltd v ONGC Petro Additions, the Delhi High Court

[By Tanya Verma] The author is a student of Dr. Ram Manohar Lohiya National Law University.   Introduction In Digital Lending (DL) context, individuals can conveniently secure loans through online platforms. These platforms, typically accessible as applications or websites, are managed by entities known as Loan Service Providers (LSPs). The digital lending process necessitates borrowers to furnish requisite documentation and request specific financial solutions, including Buy Now Pay Later loans (BNPL), Small Medium Enterprise (SME) loans, Personal loans, Trade loans, and more. These LSPs, duly authorized by Financial Institutions (FIs), evaluate the financial history of applicants along with the submitted documents. Upon thorough assessment, loans are digitally approved through the platform. Following the guidelines established by the Reserve Bank of India (RBI) for Digital Lending, Financial Institutions (FIs) are designated as Regulated Entities (RE). These REs primarily extend loans to entities deemed to have low risk, thereby safeguarding the return of invested funds. However, there are instances where borrowers cannot fulfill their loan obligations, resulting in potential losses for the REs. To mitigate this scenario, LSPs offer a guarantee to REs through an agreement referred to as a Default Loss Guarantee (DLG). The DLG agreement ensures loan protection up to a specified limit. Yet, before August 2022, LSPs introduced a synthetic securitization process involving transferring credit risk for digitally provided loans using credit derivatives or guarantees while retaining the loan portfolio on their own balance sheet. This process included a 100% risk guarantee. In response, the RBI prohibited this approach due to its adverse impact on bank balance sheets and implications for the risk management commitments made by LSPs. This piece attempts to shed light on the broader implications of the same, starting with that of lenders, then loan service providers, and lastly for borrowers, which eventually turn out to be on the brighter side. Before that, a look at the major terms of the guidelines: The LSP providing DLG must be a company incorporated under the Companies Act, 2013. DLG agreements must be legally enforceable contracts between the RE and DLG provider. The DLG arrangement should not exceed 5% of the loan portfolio. The DLG arrangement’s tenor should match the longest tenor of the loan portfolio. DLG can be accepted as cash deposits, fixed deposits, or bank guarantees. REs can invoke DLG within 120 days of overdue. LSPs must publish information about DLG portfolios and amounts on their websites. REs are responsible for identifying loan assets as Non-Performing Assets (NPAs). REs need a board-approved policy before entering any DLG arrangement, covering selection criteria, guarantee scope, monitoring processes, and fees. DLG arrangements are governed by RBI’s Digital Lending Guidelines and other relevant regulations for customer protection and grievance redressal. Implications For brevity of expression, I shall analyze the implications in three parts. First, I shall deal with the implications on lenders, second, for loan service providers, and lastly, for borrowers. For Lenders: We see three major implications for the lenders. First, the RBI’s 5% cap on DLG addresses the issue of high guarantee rates, preventing banks from writing off loans through synthetic securitization. In simpler terms, in a synthetic securitization, a bank buys credit protection on a portfolio of loans from an investor, thereby implying that when a loan in the portfolio defaults, the investor reimburses the bank for the losses incurred on loans in that portfolio up to a maximum, which is the amount invested. This suggests that the RBI’s decision to limit the DLG to 5% of the loan portfolio is a strategic move to curb the practice of offering excessively high guarantee rates by LSPs. By imposing this cap, the RBI aims to prevent banks from taking advantage of synthetic securitization, a process where credit risk is transferred through derivatives or guarantees. The implication is that the RBI seeks to ensure a more controlled and realistic financial environment by discouraging risky lending practices that could lead to potential loan write-offs. Second, it can be seen that the DLG contracts offer security, allowing lenders to enforce terms and impose penalties on breaching LSPs. This highlights the contractual security provided by DLG agreements. Lenders can use these agreements to establish clear terms and conditions with LSPs. In case of any breaches, lenders have the authority to enforce penalties as per the agreement terms. This creates a framework that encourages LSPs to adhere to their commitments, ensuring higher accountability and reducing the risk of non-compliance or misconduct. Thirdly, REs must still identify NPAs for asset classification, excluding guaranteed amounts from LSPs. This point emphasizes that while Digital Lending Guarantee (DLG) agreements provide assurance for loan repayment, it’s still the responsibility of the Regulated Entities (REs) to identify Non-Performing Assets (NPAs) for proper asset classification. The guaranteed amounts from LSPs are excluded from this classification process, indicating that the guarantees do not affect the overall assessment of the financial health of the loans. This separation maintains asset quality and risk assessment transparency, regardless of the guarantees provided. Adding onto the above, it can be seen that board-approved policies and auditor-certified disclosures enhance credit standards and reliability. Here, the focus is on robust credit underwriting standards and transparency in the DLG arrangement process. The requirement for board-approved policies ensures that the entire DLG process adheres to specific criteria, from selecting providers to monitoring and review mechanisms. Auditor-certified disclosures add another layer of reliability by ensuring that the financial information provided by the DLG provider is accurate and trustworthy. This enhancement in credit standards and transparency improves the overall credibility and effectiveness of the DLG arrangements. For Loan Service Providers The situation of LSPs is not the same too, for they can no longer offer exorbitant DLG rates, affecting their risk exposure and credit management. This highlights a significant change for LSPs resulting from implementing the RBI’s DLG guidelines. The guidelines impose a maximum cap on the rates at which DLG arrangements can be offered by LSPs. This cap effectively curtails the ability of LSPs to provide excessively high guarantee rates to

[By Yuvraj Sharma & Jatin Patil] The authors are students of School of Law, Narsee Monjee Institute of Management & Studies, Hyderabad.   Introduction On August 18, 2023, the Reserve Bank of India (“RBI”) has recently released fresh directives regarding the imposition of Penal interest rates on loan accounts. These guidelines will affect from January 1, 2024. According to these new guidelines, any penalties incurred by borrowers due to Not adhering to loan terms will be classified as “penal charges” rather than “penal interest”, added to the existing interest rate on the loans. These guidelines, titled “Fair Lending Practice- Penal Charges in Loan Accounts”, also emphasise that penal charges should not be subjected to interest accumulation, effectively preventing additional interest from being calculated on these charges. This blog analyses critically evaluates the benefit and drawbacks of these guidelines and proposed potentials for enhancements for their effectiveness. Background The Reserve Bank of India has issued guidelines to regulated entities to ensure transparency and fairness in disclosing penal interest. The current regulations provide lending institution with the authority to formulate board approved policies governing the application of Penal Interest rates. However, The RBI has observed that a significant number of Real Estate (“RE”) firms levy penal interest rates alongside the regular interest rate for instances of default or non-compliance with credit terms. The purpose of penal interest Is to promote credit discipline among borrowers and ensure equitable compensation for lenders. Not to serve as a revenue enhancement mechanism beyond the contracted interest rate. The Supervisory assessment conducted by the RBI have unveiled a wide range of practices within the real estate sector concerning the imposition of penal charges or interest. This disparity in approaches has given rise to customer grievances and dispute, highlighting the need for standardization and better regulatory oversight. Presently, these rates and charges vary across banks and other lenders. They are applied in scenarios like missed or delayed EMI repayment, check bounces, repayment of loans. The Term “Penal Charges” and “Penal Interest” ‘Penal charges’ represent extra fees imposed by lenders upon borrowers. These charges become applicable when a borrower experience delays in repaying a loan or the equated monthly installment linked to a loan or other financial instruments. These specific of penal charges for payment defaults differ across banks and non-banking financial companies letting standardized guidelines. These charges are usually stipulated in the agreement terms for payment default. Nevertheless, instances have arisen where lenders attempted to impose higher charges than outlined in the agreement as reported by borrowers. ‘Penal Interest’, In the event that the borrower does not receive the installments in accordance with the specified repayment terms by the end of the month, they will incur an additional charge known as Penal Interest on the delayed installments. This practice is designed to ensure timely to ensure repayment and discourage delays in meeting financial obligations. Triggered Reason for RBI Guidelines The Central Bank has issues new regulations due to the discovery that numerous lending institutions it regulates were imposing extra penal interest rates on borrowers who defaulted or failed to comply with the terms of their credit agreements. These regulations state that penal charges should not be compounded, meaning no additional interest should be calculated based on these charges. However, the standard interest compounding procedure for the loan account remains unaffected. The guidelines set by the regulatory authority RBI concerning penal charges for non-compliance with non-contract terms. These guidelines, effective from January 1, 2024, apply to various financial entities under RBI regulation, including commercial banks, cooperative banks and NBFC’s, housing financial companies and board. The guidelines prohibited imposing penal interest as an additional interest rate on top of the loans rate and institute maintained reasonable “penal charges” for breach of loan terms. These charges must be non-discriminatory and proportional to the severity of non-compliance. The instruction requires entities to disclose the nature and amount of penal charges in loan agreements, important terms and their websites. Furthermore, communication of applicable charges and reason is mandatory when notifying borrowers about non-compliance. Existing loans will transition to the new regime. Their next review or renewal date or within six months of the circular effective date. Notably, these rules exclude credit card, external commercial borrowings, trade units and structure obligations which are covered by civil specific product directions. In essence, the RBI mandates that financial entities regulated by it implement guidelines to ensure fair and transparent penal Charges for Loan Non-Compliance while providing clear disclosure to borrowers. The new rules are applicable to various financial institutions under the RBI jurisdiction except for specific financial product outlines in the text. Fostering Equitable Borrowing Practice: Promoting Uniformity and Fairness through new lending guidelines The new guidelines have been introduced with the intention of covering divergent practice among lending institutions and ensuring that borrowers are not burdened with excessive charges for defaults or non-compliance. This progressive step aims to establish uniformity in the penalties being charged, thus preventing the abuse of process. While instances of process abuse have been noted in the past, these guidelines seek to comprehensively address the issue. As stated, the RBI intention in implementing these guidelines is not to employ them as a tool for revenue enhancement beyond the contracted interest rate. The primary objective of achieving uniformity is a crucial step, although it is important to note that these guidelines do not extend to areas such as credit cards external, commercial borrowings, trade credit, etc. This approach is distinctly centered around individual borrowers aiming to safeguard their interest. These guidelines also mandate that both the rational and the quantum of charges must be transparently disclosed to the borrower within the loan agreement. This major ensures the overall well-being of the borrower and is warmly welcomed. Moreover, these guidelines are the purpose of installing senses of credit discipline among borrowers, emphasizing fairness and the paramount factor, these guidelines have been introduced to uphold the principle of fairness Conclusion In conclusion, The Reserve Bank of India has introduced vital guidelines with the