Banking Law

The Law of Bank Guarantees: Important Tools of Modern Day Commercial Transactions. [Rangeet Poddar] The author is a 4th year B.A.LLB(Hons.) student of WBNUJS, Kolkata. Introduction According to Section 126 of the Indian Contract Act, a contract of guarantee is a contract to perform the promise, or discharge the liability of a third person in case of his default.[1] A bank guarantee is a contractual assurance that is given by the bank to a third party creditor. By virtue of this commercial instrument, the concerned bank undertakes liability on behalf of the principal debtor to fulfill his contractual obligation in the event of default.  This secures the transaction by ensuring that no detriment is caused to the creditor. The nature of obligations of the principal debtor is primary while the obligations of the bank are secondary. By issuing a guarantee, a bank ordinarily undertakes to pay the amounts specified in the guarantee agreement to the beneficiary on demand made by him in accordance to predetermined terms and conditions.[2] The object of a bank guarantee is to ensure the due performance of certain works contracts. The guarantee can also be towards security deposit for a contract or of any kind.[3] In the case of State Trading Corp. of India Ltd. v. Jainsons Clothing Corp.[4], the Supreme Court held that the bank guarantee is a trilateral contract in which the bank has undertaken to unconditionally and unequivocally abide by the terms of the contract. It is an act of trust with full faith to facilitate free flow of trade and commerce in domestic or international trade or business. It creates an irrevocable obligation to perform the contract in terms thereof. On the occurrence of events mentioned in the guarantee contract, the bank guarantee becomes enforceable.[5] There are two types of guarantees: A conditional performance guarantee is one where the surety becomes liable to the party, claiming under the guarantee upon proof of breach of terms of the underlying contract, or on proof of both breach as well as the loss occurring from the breach. Under unconditional guarantee, the guarantor becomes liable to pay the beneficiary the stated amount whenever the demand is made in the manner provided for in the guarantee, without the need for that beneficiary to prove any breach or loss; the guarantor is bound to immediately perform the contract of guarantee without further requirements. The object of unconditional bank guarantees or on demand bank guarantees are to secure hassle-free commercial transactions. Where the bank unconditionally and irrevocably promises to pay on demand, the amount of liability undertaken in the guarantee without ‘demur or dispute’ under the terms of the guarantee, the liability of the bank is considered to be absolute and unequivocal.[6] An on-demand bank guarantee consists of three separate and substantially independent but formally accessory agreements, namely: The underlying transaction or main agreement The indemnity agreement between the account party or principal and the guarantor The on-demand instrument between the guarantor and the beneficiary[7] The question whether the guarantee is a conditional or an unconditional one payable on demand, is a matter of construction in each case from the terms of the bond.[8] Independent nature and encashment of the bank guarantee In Ansal Engineering Projects v Tehri Hydro Development Corporation[9], it was held by the Supreme Court of India that the bank guarantee is an independent and distinct contract between the bank and the beneficiary and is not qualified by the underlying transaction and the validity of the primary contract between the person at whose instance the bank guarantee was given and the beneficiary.[10] The question whether the express terms of the guarantee give rise to the contract of guarantee to be enforced will be the limited enquiry for deciding the rights and obligations flowing from such a guarantee. Bank guarantees are independent in nature.[11] It is a separate autonomous contract between the bank and the beneficiary and is not qualified by the underlying transaction and the primary contract between the beneficiary and the person at whose instance the bank guarantee is given.[12] In a bank guarantee it is not necessary to go beyond the guarantee contract between the creditor and the surety bank and one must not look at any other contract including the underlying or primary one. However the underlying contract comes into the picture only if the guarantee itself makes its encashment, subject to proof of performance of underlying contract as it happened in the Hindustan Construction case[13]. In that case, the bank guarantee was for securing mobilization advance given by State of Bihar and it was provided in the terms of the guarantee that the beneficiary would not have the unfettered right to invoke the guarantee in the event the obligations expressed in the clause of the original contract were not fulfilled by the contractor. In such exceptional scenarios, the bank guarantee loses its autonomous character and depends upon the result of inquiry to the underlying contract. [14] Besides such cases, the court does not interfere with the enforcement of bank guarantees and guarantee contracts are not qualified by underlying transactions.[15]Where the bank guarantee is unconditional and payable on demand or demur, the liability of the bank is absolute and does not depend on the ultimate decision of a pending case in a court or tribunal. The bank only has to ascertain the amount claimed within the terms of the guarantee.[16]The question of encashment of the bank guarantee is entirely upto the beneficiary to invoke the guarantee at any time as he deems to be proper.[17] The National Highways Authority v Ganga Enterprises and Another[18] case laid down that that bank guarantees furnished in the form of security for not withdrawing a bid is fundamentally different from withdrawal of offer before acceptance as per the statutory provisions of the Indian Contract act. In such cases, when a person withdraws his offer within a stipulated time, he has no right to claim the earnest money that he has given in the form of a bank guarantee.

Bail-In Clause in the FRDI Bill: Is the Hysteria Justified? [Ayushi Singh] The author is a third-year student at National Law University, Jodhpur. “I can assure you, my friends, that it is safer to keep your money in a reopened bank than it is to keep it under a mattress.” – Franklin D. Roosevelt (March 12, 1933) The Financial Resolution and Deposit Insurance Bill, 2017, approved by the Cabinet, has been in the ring of fire, drawing protests from the opposition, regulatory bodies and citizens. Mamata Banerjee has vociferously asked for the withdrawal of the Bill, currently under consideration by the Joint Parliamentary Committee, calling it “the biggest assault on the financial security of the poor and middle class of the country.” The point of contention is the bail-in clause under section 52 of the Bill. The said provision is aimed at rescuing a financial institution on the brink of failure by making its creditors and depositors take a loss on their holdings.[1] The Finance Minister, Arun Jaitley, has tried to allay the fears of the public and has hinted that review and correction of the Bill will take place post-release of the Parliamentary Report. The implications of this clause on the deposits made by citizens added with the lack of clarifications from the Government have inflamed the fears of the people as majority of their savings are deposited in banks. ASSOCHAM Secretary General DS Rawat has also asked for withdrawal of this clause due to chances of the trust in the banking system being eroded. He opined that the clause may induce citizens into making bank-runs or scare them into withdrawing their deposits and protecting them in unproductive avenues like real estate, gold, jewellery and even in the unorganised and informal financial markets run by unscrupulous persons.[2] The bail-in clause is not a new concept; in fact, it may have been introduced with a view to keep up with the trends in the World Bank’s financial resolution policies. The Financial Stability Board, which acts as a regulatory body for banking systems globally, have endorsed the bail-in clause as a tool for resolution of financial bodies.[3] In 2014, the EU introduced the bail-in clause in its Bank Recovery and Resolution Directive under which 8% of an institution’s liabilities must be wiped out before any taxpayer support can be provided. This wipe-out has to be done via bail-in of deposits according to a fixed hierarchy as given in article 34 of the Directive.[4] The objective behind introduction of the bail-in clause was to prevent the colossal failure of the bail-out resolution process used during the 2008 financial crisis. The bail-out of “too-big-to-lose” financial corporations shifted the burden of their failure on the taxpayers; this is what these bodies are trying to avoid through the bail-in clause. The drive to accommodate the bail-in clause was validated when it was used successfully during the 2011 economic crisis in Denmark. The resolution was successfully accomplished through a well-formulated bank-package such that the resolution was completed over a weekend with no negative effect on ordinary customers.[5] Failures of the Bail-In Clause However, the implementation of bail-in has not always been rosy. During the 2013 crisis in Cyprus, the insured deposits of citizens were transferred for resolution while the deposits of financial institutions and government entities were fully repaid back. Depositors lost almost 50 per cent of their savings when a bail-in was implemented.[6] Post introduction of bail-in clause in the EU Directive with the hierarchy of deposits, Portugal’s bail-in package for Banco Espirito Santo in 2016 used five of the 52 senior bonds for resolution of its liabilities. Investors who had to suffer losses had threatened lawsuits, accusing the country of discriminating against holders of the same level of bonds and violating the pari passu principle of equal treatment to protect domestic bondholders.[7] In May 2017, the Economy Minister of Italy Pier Carlo Padoan ruled out the recourse of bail-in tool, in spite of the Directive, for the rescue of its two ailing regional banks. This is to safeguard citizens’ confidence in other banks which are already suffering from bad loans caused during recession.[8] Implementation and Procedural Transparency The stark contrast in the above headings display a major difference in the nature of implementation of bail-in clause. Denmark implemented the bail-in clause within the framework of a bank-package wherein the cap of insured amount deposited in banks was increased and a safety net was set up.[9] In Cyprus, the bank holiday was declared and ATMs were shut down, cutting complete access of money to the citizens.[10] Even with the Directive, it is difficult to ensure that the hierarchy of deposits defined is upheld by countries during use of bail-in tool. The International Monetary Fund, which has endorsed the bail-in tool, has also pointed out the need to implement it in an orderly and clear manner-[11] “The legal framework needs to be designed to establish an appropriate balance between the rights of private stakeholders and the public policy interest in preserving financial stability. Debt restructuring ideally would not be subject to creditor consent, but a “no creditor worse off” test may be introduced to safeguard creditors’ and shareholders’ interests.” The RBI in its Report of the Working Group on Resolution Regime for Financial Institutions has suggested that the bail-in tool be used with due care, only as an interim measure which works along with a plan for permanent resolution like sale, merger, etc.[12] Therefore, it is reiterated that if the bail-in clause is to be used, its implementation must be clarified by a fixed set of rules and regulations which would include a system of hierarchy defining the order of volatility of deposits. Another concern is with respect to the insurance cover for the deposits that has remained at Rs. 1 lakh for over two decades. A revision and increase in insurance cover for deposits could help deter financial failure of weaker banks, as once the health of banks becomes well-defined and public, existing depositors may be induced to make bank-runs to protect their savings and pensions in safer banks. The All India Reserve