HUMBOLDT WEDAG INDIA PVT. LTD. v. DALMIA CEMENT VENTURES LTD.

Judgment

#1. This Appeal challenges the legality of the Order dated

4.8.2010 passed by the learned Single Judge under Section 9 of the Arbitration & Conciliation Act, 1996 (A&C Act for short) restraining Respondent No.2 from invoking the subject Bank Guarantees, viz. dated 19.3.2008 for ‘ 2,50,00,000/- and

26.3.2008 for ‘ 14,10,80,000/-, aggregating to ‘ 16,60,80,000/-. FAO(OS)536/2010 By Order dated 24.9.2009, the learned Single Judge then seised of the docket, observed that – “the contract awarded to the petitioner was cancelled by the respondent due to recession. The respondent had given advances to the petitioner to the extent the petitioner has executed the bank guarantee in favour of the respondent. There is no doubt that in view of the cancellation of the contract, the petitioner would be liable to recover expenses/liability in terms of the contract from the respondent. Looking into the high cost (around Rs.27 lac) of maintenance of bank guarantee of Rs.16,60,80,000/- and that the petitioner has staked a claim of Rs.28 crores, I consider it would be appropriate that the petitioner instead of giving a bank guarantee of full amount of Rs.16,60,80,000/- gives a bank guarantee of Rs.9 crore so as to reduce the expenses of the petitioner. ….. The respondent shall not encash this bank guarantee till further orders. The interim order passed is conditional on furnishing fresh bank guarantee”. By the impugned Order dated 4.8.2010, the succeeding learned Single Judge has been pleased to “dismiss the present petition and direct the petitioner to provide further bank guarantee in the sum of Rs. 7,60,80,000/- within a period of four weeks from today on the same terms and conditions on which the petitioner‟s earlier bank guarantee were provided. The bank FAO(OS)536/2010 guarantee of Rs.9 crores furnished by the petitioner and the additional bank guarantee shall be kept alive till the passing of further orders by the arbitral tribunal. The restraint against the encashment of the bank guarantee contained in the order dated

24.09.2009 stands vacated”.

#2. At the time of the hearings before us, it was admitted that the Bank Guarantee for ‘ 9,00,00,000/- (nine crores) has been invoked and payment of this amount has been received in the coffers of the Respondent. We are, therefore, now concerned only with the Bank Guarantee for the sum of ‘ 7,60,80,000/- required to be furnished as per the impugned Order.

#3. The facts of the case are that the parties had entered into a contract pertaining to the manufacture and supply of Raw Mill, Pyro Processing, Clinker Mill Systems for 4500 tpd Split located cement project in Belgaum, Gulburga 1, Gulburga 2 & Meghalaya. The Appellant was the supplier and Respondent No.1 was the purchaser. The contract for both design and engineering as well as equipment supply was ‘ 166.08 crores; after amendment on 15.9.2008, the price was reduced to ‘ 159.08 crores. Simultaneous with the Appellant furnishing Bank Guarantees for the aforementioned ‘ 16,60,80,000/-, Respondent No.1 paid ‘ 96,93,100/- on

23.5.2008 and ‘ 62,14,900/- on 24.9.2008. The subject FAO(OS)536/2010 Contract contains a Clause which sets out that neither party shall be considered to be in default with respect to its obligations under the Contract to the extent that the default is due to any event of force majeure. However, no event of force majeure was to relieve either party from liability for an obligation which had arisen before its occurrence. Clause 26 of the contract protects the rights of the Respondent to terminate it by thirty days‟ notice in which contingency “a reasonable amount in respect of loss of profit not exceeding 10% of the total amount due under the Contract to the extent that such profit has not already been paid” is provided for. We are not concerned with the claim for damages. It bears repetition that the Appellant has furnished Bank Guarantee for the total sum of ‘ 16,60,80,000/- and, in return, has received this very sum in cash from the Respondent as an advance.

#4. The salient stipulation in the two Bank Guarantees read thus:- We, Deutsche Bank AG, having its Registered Office at 222, Kodak House, Dr. D.N. Road, Fort, Mumbai – 400 001 (hereinafter referred to as the „Bank‟, which expression shall unless repugnant to the context or meaning thereof mean and include its successors in interest, executors, administrators and permitted assigns), at the request of the Supplier, hereby irrevocably and unconditionally guarantee and FAO(OS)536/2010 undertake to pay you, Dalmia Cement Ventures Ltd., the Purchaser, without demur, dispute or delay, on

your first written demand, an amount or amounts not exceeding a total sum of Rs.14,10,80,000/- (INR Fourteen Crores Ten Lacs and Eighty Thousands only), provided that you confirm to us at the same time in writing, that the Supplier has not fulfilled all or any of his Contractual Obligations as stipulated in the Contract including but not limited to delivery of the agreed quantity and/or the shipment of the Product on the date agreed upon with the Purchaser. The liability of the Bank as contained herein shall automatically get reduced proportionately to the value of such parts of the Product (including all machinery and equipment) that may have been successfully delivered as certified by the Purchaser based on which the advance or on account amount paid by the Purchaser have been adjusted in the corresponding invoices of the Supplier raised with respect to the Contract. This Bank Guarantee shall expire latest on 04th July, 2009 (Guarantee Expiry Date), unless the Purchaser discharges the Guarantee earlier. (emphasis supplied)

#5. By letter dated 17.11.2008, Respondent No.1 informed the Appellant that – “Due to the unforeseen financial crisis across the world, leading to difficulties in financial closures of Projects, we are canceling our Order for Raw Mill, Cement Mill for Plant 3 and Pyro for Plant 4. ….. The Raw Mill, Cement Mill and Pyro of Plant 1 and the Raw Mill, Cement Mill of Plant 2 are being FAO(OS)536/2010 presently put on “Hold” due to the uncertainties in the economy”. Thereafter, there have been several exchanges of correspondence. This constrained the Appellant to file the aforementioned Petition under Section 9 of the A&C Act on

3.7.2009. We have already narrated the substance of the Orders dated 24.9.2009 as well as the impugned Order dated 4.8.2010.

#6. Eventually, by letter dated 20.8.2010, Respondent No.1 informed its Banker/Respondent No.2 that the contract between the parties had been terminated. A brief summation of Court proceedings in OMP No.343/2009 was given. The Bank Guarantee for the sum of ‘ 9,00,00,000/- was invoked, stating – “we confirm that the Supplier has not fulfilled its contractual obligations”. The sum of ‘ 9,00,00,000/- has been paid by Respondent No.2 to Respondent No.1. The Bank Guarantee for the sum of ‘ 7,60,80,000/- furnishable by the Appellant in favour of Respondent No.1 in compliance with the impugned Order is not yet furnished.

#7. The law regarding invocation/encashment of Letters of Credit and Bank Guarantees has been crystallized as far back as in 1970 in Tarapore and Co., Madras –vs- V.O Tractors Export Moscow, AIR 1970 SC 891. Their Lordships elaborately and perspicuously explained the scope and ambit of judicial interference in such matters in these words-- FAO(OS)536/2010 The scope of an irrevocable letter of credit is explained thus in Halsbury’s Laws of England (Vol.34, Paragraph 319 at page 185): “It is often made a condition of a mercantile contract that the buyer shall pay for the goods by means of a confirmed credit, and it is then the duty of the buyer to procure his bank, known as the issuing or originating bank, to issue an irrevocable credit in favour of the seller by which the bank undertakes to the seller, either directly or through another bank in the seller’s country known as the correspondent or negotiating bank, to accept drafts drawn upon it for the price of the goods, against tender by the seller of shipping documents. The contractual relationship between the issuing bank and the buyer is defined by the terms of the agreement between them under which the letter opening the credit is issued; and as between the seller and the bank, the issue of the credit duly notified to the seller creates a new contractual nexus and renders the bank directly liable to the seller to pay the purchase price or to accept the bill of exchange upon tender of the documents. The contract thus created between the seller and the bank is separate from, although ancillary to, original contract between the buyer and the seller, by reason of the bank’s undertaking to the seller, which is absolute. Thus the bank is not entitled to rely upon terms of the contract FAO(OS)536/2010 between the buyer and the seller which might permit the buyer to reject the goods and to refuse payment therefor; and, conversely, the buyer is not entitled to an injunction restraining the seller from dealing with the letter of credit if the goods are defective.” Chalmers on “Bills of Exchange” explains the legal position in these words “The modern commercial credit serves to interpose between a buyer and seller a third person of un-questioned solvency, almost invariably a banker of international repute; the banker on the instructions of the buyer issues the letter of credit and thereby undertakes to act as paymaster upon the seller performing the conditions set out in it. A letter of credit may be in any one of a number of specialised forms and contains the undertaking of the banker to honour all bills of exchange drawn thereunder. It can hardly be over-emphasised that the banker is not bound or entitled to honour such bills of exchange unless they, and such accompanying documents as may be required thereunder, are in exact compliance with the terms of the credit. Such documents must be scrutanised with meticulous care, the maxim de minimis non curat lex cannot be invoked where payment is made by the letter of credit. If the seller has complied with the terms of the letter of credit, however, there is an absolute obligation upon the banker to pay irrespective FAO(OS)536/2010 of any disputes there may be between the buyer and the seller as to whether the goods are up to contract or not” Similar are the views expressed in ‘Practice and Law of Banking' by H.B. Sheldon, “the Law of Bankers Commercial Credits” by H.C. Gutteridge,“the Law relating to Commercial Letters of Credit” by A.G. Devis' “the Law Relating to Bankers' Letters of Credit” by B.C. Mitra and in several other text books read to us by Mr. Mohan Kumaramangalam, learned Counsel Russian Firm. The legal position as set out above was not controverted by Mr. M.C. Satalvad, learned Counsel for the Indian Firm. So far as the Bank of India is concerned it admitted its liability to honour the letter of credit and expressed its willingness to abide by its terms. It took the same position before the High Court. ........

#10. A case somewhat similar to the one before us came up for consideration before the Queens Bench Division in England in Hamzeh Walas and Sons v. British Imex Industries Ltd., 1958-2 QB

#127. Therein the plaintiffs, a Jordanian firm contracted to purchase from the defendants, a British firm, a large quantity of reinforced steel rods, to be delivered in two instalments. Payment was to be effected by opening in favour of the defendants of two confirmed letters of credit with the Midland Bank Ltd., in London, one in respect of each instalment. The letters of credit were duly FAO(OS)536/2010 opened and the first was realised by the defendants on the delivery of the first instalment. The plaintiffs complained that that instalment was defective and sought an injunction to bar the defendants from realizing the second letter of credit. Donovan, J., the Trial Judge refused the application. In appeal Jenkins, Sellers and Pearce L., JJ. Confirmed the decision of the Trial Judge. In the course of his judgment Jenkins, L.J., who spoke for the Court observed thus: “We have been referred to a number of authorities, and it seems to be plain enough that the opening of a confirmed letter of credit constitutes a bargain between the banker and the vendor of the goods, which imposes upon the banker absolute obligation to pay, irrespective of any dispute there may be between the parties as to whether the goods are up to contract or not. An elaborate commercial system has been built up on the footing that bankers’ confirmed credits are of that character, and, in my judgment, it would be wrong for this Court in the present case to interfere with that established practice. There is this to be remembered, too. A vendor of goods selling against a confirmed letter of credit is selling under the assurance that nothing will prevent him from receiving the price. That is of no mean advantage when goods manufactured in one country are being sold in another. It is, furthermore, to be observed that vendors are FAO(OS)536/2010 often reselling goods bought from third parties. When they are doing that, and when they are being paid by a confirmed letter of credit, their practice is - and I think it was followed by the defendants in this case--to finance the payments necessary to be made to their suppliers against the letter of credit. That system of financing these operations, as I see it, would break down completely if a dispute as between the vendor and the purchaser was to have the effect of “freezing” if I may use that expression the sum in respect of which the letter of credit was opened.” In Urquhart Lindsay and Co. Ltd. v. Eastern Bank Ltd., 1922-1 KB 318 the King’s Bench held that the refusal of the defendants bank to take and pay for the particular bills on presentation of the proper documents constituted a repudiation of the contract as a whole and that the plaintiffs were entitled to damages arising from such a breach. It may be noted that in that case the price quoted in the invoices was objected to by the buyer and he had notified his objection to the bank. But under the terms of the letter of credit the bank was required to make payments on the basis of the invoices tendered by the seller. The court held that if the buyers had an enforceable claim that adjustment must be made by way of refund by the seller and not by the way of retention by the buyer. FAO(OS)536/2010

#11. Similar opinions have been expressed by the American Courts. The leading American case on the subject is Dulien Steel Products Inc., of Washington v. Bankers Trust Co., Federal Reporter 2nd Series, 298 p.836. The facts of that case are as follows: The plaintiffs, Dulien Steel Products Inc., of Washington, contracted to sell steel scrap to the European Iron and Steel Company. The transaction was put through M/s. Marco Polo Group Project, Ltd. who were entitled commission for arranging the transaction. For the payment of the the commission to Marco Polo, plaintiffs procured an irrevocable letter of credit from Seattle First National Bank. As desired by Marco Polo this letter of credit was opened in favour of one Sica. The defendant-bankers confirmed that letter of credit. The credit stipulated for payment against (1) a receipt of Sica for the amount of the credit and (2) a notification of Seattle Bank to the defendants that plaintiffs negotiated documents evidencing the shipment of the goods. Sica tendered the stipulated receipt and Seattle Bank informed the defendants that the Dulien had negotiated documentary drafts. Meanwhile after further negotiations between the plaintiffs and the vendees the price of the goods sold was reduced and consequently the commission payable to Marco Polo stood reduced but the defendants were not informed of this fact. Only after notifying the defendants about FAO(OS)536/2010 negotiation of the drafts drawn under the contract of sale, the Seattle Bank informed the defendants about the changes underlying the transaction and asked them not to pay Sica the full amount of the credit. The defendants were also informed that Sica was merely a nominee of Marco Polo and has no rights of his own to the sum of the credit. Sica, however, claimed payment of the full amount of the credit. The defendants asked further instructions Seattle Bank but despite Seattle Bank’s instructions decided to comply with Sica’s request. After informing Seattle Bank of their intention, they paid Sica the full amount of the credit. Plaintiffs thereupon brought an action in the District Court of New York for the recovery of the moneys paid to Sica. The action was dismissed by the trial Court and that decision was affirmed by the Court of Appeals. That decision establishes the well known principle that the letter of credit is independent of and unqualified by the contract of sale or underlying transaction. The autonomy of an irrevocable letter of credit is entitled to protection. As a rule Courts refrain from interfering with that autonomy.

#8. In United Commercial Bank –vs- Bank of India, (1981) 2 SCC 766 : AIR 1981 SC 1426 the Apex Court has reiterated that Courts ought not to grant injunctions restraining performance of the contractual obligations flowing out of a FAO(OS)536/2010 Letter of Credit or a Bank Guarantee between one Bank and another. It observed that - The opening of a confirmed letter of credit constitutes a bargain between the banker and the vendor of the goods which imposes on the banker an absolute obligation to pay. A banker issuing or confirming an irrevocable credit usually undertakes honour drafts negotiated, or to reimburse in respect of drafts paid, paying negotiating intermediate banker and the credit is thus in the hands of the beneficiary binding against the banker. A letter of credit constitute the sole contract with the banker and a bank issuing or confirming a letter of credit is not concerned with the underlying contract between the buyer an seller. Duties of a bank under a letter of credit are created by the document itself, but in any case it has the power and is subject to the limitations which are given or imposed by it, in the absence of the appropriate provisions in the letter of credit. The banker owes a duty to the buyer to ensure that the documents tendered by the sellers under a credit are complied with those for which the credit calls and which are embodied in terms of paying or negotiating bank The description of the goods in the relative bill of exchange must be the same description in the letter of credit, that it, the FAO(OS)536/2010 goods themselves must in each be described in identical terms, even though the goods differently described in the two documents are, in fact, the same. It is the description of the goods that is all important and if the description is not identical it is the paying bank’s duty to refuse payment.

#9. The Respondent has placed reliance on U.P. Coop. Federation –vs- Singh Consultants & Engineers (P) Ltd., (1988) 1 SCC 174 which also enunciates the law on this subject. The Lordships opined thus:-

#45. The letter of credit has been developed over hundreds of years of international trade. It was most commonly used in conjunction with the sale of goods between geographically distant parties. It was intended to facilitate the transfer of goods between distant and unfamiliar buyer and seller. It was found difficult for the seller to rely upon the credit of an unknown customer. It was also found difficult for a buyer to pay for goods prior to their delivery. The Bank’s letter of credit came into existence to bridge this gap. In such transactions, the seller (beneficiary) received payment from issuing bank when he presents a demand as per terms of the documents. The bank must pay documents are in order and the terms of credit are satisfied. The bank, however, was not allowed to determine whether the seller had FAO(OS)536/2010 actually shipped the goods or whether the goods conformed to the requirements of the contract. Any dispute between the buyer and the seller must be settled between themselves. The courts, however, carved out an exception to this rule of absolute independence. The courts held that if there has been fraud in the transaction dishonour beneficiary’s demand for payment. The courts have generally permitted dishonour only on the fraud of the beneficiary, not the fraud of somebody else.

#46. It was perhaps for the first time the said exception of fraud to the rule of absolute independence of the letter of credit has been applied by Shientag, J. in the American case of Sztejn v. J.Henry Schroder Banking Corporation (31 NYS 2d 631). Mr.Sztejn wanted to buy some bristles from India and so he entered into a deal with an Indian seller to sell him a quantity. The issuing Bank issued a letter of credit to the Indian seller that provided that, upon receipt of appropriate documents, the bank would pay for the shipment. Somehow, Mr.Sztejn discovered that the shipment made was not crates of bristles, but creates of worthless material and rubbish. He went to his bank which probably informed him that the letter of credit was an independent undertaking of the bank and it must pay. ....... FAO(OS)536/2010

#53. Whether it is a traditional letter of credit or a new device like performance bond or performance guarantee, the obligation of banks appears to be the same. If documentary credits are irrevocable and independent, the banks must pay when demand is made. Since the bank pledges its own credit involving its reputation, it has no defence except in the case of fraud. The bank’s obligations of course should not be extended to protect the unscrupulous seller, that is, the seller who is responsible for the fraud. But, the banker must be sure of his ground before declining to pay. The nature of the fraud that the courts talk about is fraud of an egregious nature as to vitiate the entire underlying transaction. It is fraud of the beneficiary, not the fraud of somebody else. If the bank detects with a minimal investigation the fraudulent action of the seller, the payment could be refused. The bank cannot be compelled to honour the credit in such cases. But it may be very difficult for the bank to take a decision on the alleged fraudulent action. In such cases, it would be proper for the bank to ask the buyer to approach the court for an injunction.

#10. In Hindustan Steel Works Construction Ltd. –vs-