Conditioning the Unconditional: Analysing Special Equities and the Prima Facie Breach Rule

[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 held that the existence of an arbitral award in favour of the party claiming injunction and the lack of counter-claims filed by the beneficiary, demonstrated special equities in its favour.

Further, in Hindustan Construction Company v National Hydro Electric Power Corporation, the contractual disputes between the parties were decided in the appellant’s favour but the respondent wanted to challenge the award and simultaneously encash the bank guarantees. The Court held that the appeal would not alter the substantive correctness of the Tribunal’s findings, hence the respondent would be responsible for the breach even if its appeal succeeds. Consequently, it established special equities and hence, granted the injunction.

This principle’s application has not been limited to exceptional circumstances such as the COVID-19 pandemic – or Arbitral awards. For example, proportionality has also been recognised as a case of special equity based on the principle of prima facie breach. In Chennai Metro Rail Limited v Transtonnelstroy Afcons (JV) and others, the Court looked at the breach allegations prima facie and held that since a huge difference existed between the amount potentially receivable from the arbitration award and the amount in the bank guarantee, there is no valid reason for allowing the invocation of the bank guarantee at this stage.

Further, in Harji Engineering Works Private Limited v Punjab and Sind Bank and another, the appellant entered into a contract with HSCL, the second respondent, and furnished bank guarantees for them. HSCL later cancelled the contracts and sought invocation of the bank guarantees. The Court held that special equities are established here as there was no prima facie fault, the breach allegations were unfounded, and there is no valid reason for encashing the bank guarantees. The approach of the Court in this case, too, was similar to the ones explained above.

The common principle being used by the Courts to establish special equities is whether the plaintiff would get unfairly prejudiced by the invocation of the bank guarantee even when there is no prima facie fault attributable to it. Even though the damages were recoverable in these cases, the Courts prioritised equity concerns by granting injunctions when the plaintiff had committed no wrong, thereby ensuring that the defendant did not unjustly enrich himself by the invocation.

Hence, post-Standard Chartered, special equities are established based on the prima-facie breach rule, where the Courts determine whether, prima facie, the breach allegations are baseless and no fault is attributable to the claimant.

Is The Prima Facie breach rule Against the Unconditional Nature of Bank Guarantees?

The purpose of a bank guarantee is that if the issuing party breaches the contract, the aggrieved party can encash the bank guarantee to reimburse itself for any loss that has either occurred or may potentially occur. Unconditional bank guarantees further streamline this process by allowing the beneficiary to encash it on demand payment, which must be awarded by the bank irrespective of the merits of the underlying dispute.

The  exceptions of fraud and irretrievable injustice were meant to curb this unconditional power in exceptional circumstances. Regrettably, they have been insufficient to fulfil this purpose. Fraud as a ground for claiming injunction is rarely invoked, and the exception of irretrievable injustice was subjected to such a strict interpretation as shown previously, that it was successfully established only in exceptional circumstances, where it was impossible for the claimant to reimburse himself if the guarantee was encashed.

This restricted application has transformed the bank guarantee from a shield, intended to reimburse the innocent party, to a sword used by it even when there is no breach and hence, no reason to invoke the bank guarantee. For example, in Punj Lloyd Insulations v State Bank of India, Punj Lloyd had performed its promise and had received a completion certificate from the beneficiary. However, the beneficiary still alleged deficient performance and sought to invoke the bank guarantee. Since this was a case from the pre-Standard Chartered era, the Court only focused on the irretrievability of damages and held that since the damages are collectable, the injunction cannot be granted. This ruling demonstrates how the strict interpretation of the exceptions unreasonably favours the beneficiary and disregards the equitable concerns of the plaintiff.

In this context, special equities as a third exception are a welcome step as it allows injunctions when there is no breach and no fault attributable to the plaintiff. This ensures that the beneficiary does not unjustly benefit from the unconditional nature of the guarantee even when it has suffered no loss. Further, by allowing encashment when the prima facie breach allegations are not baseless, it accommodates the beneficiary’s interests as well and does not contravene the very purpose of having an unconditional bank guarantee.

Conclusion And Way Forward

In this article -, I have examined the meaning of special equities before and after  the Standard Chartered case, and have shown how Courts are applying a prima facie breach rule to establish special equities. This change is welcome as it is equitable and balances the interests of both parties.

While this third exception is being recognised and applied by Courts the application is not uniform. For example, the Bombay High Court has still been reluctant to consider special equities as a third exception and equates it to irretrievable injustice in a few rulings. This poses troubling consequences as it continues to make the position of law uncertain, despite the attempt made to clarify it in the Standard Chartered case. –

Thus, Indian courts should recognise and apply the distinction brought about by Standard Chartered more uniformly, to ensure that the intent of widening the scope is implemented and brought to good use.

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