1. Works contract — Security deposit via bank guarantee — Refusal to extend guarantee — Suit for declaration and injunction to maintain validity. (Para 2 , 3 , 4 )
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1998 Supreme(SC) 583
SUPREME COURT OF INDIA
S.P. BHARUCHA AND M. JAGANNADHA RAO, JJ.
Makharia Brothers, Appellant
Versus
State of Nagaland and others, Respondents.
Civil Appeal Nos. 3052 with 3053 of 1984, D/- 5-5-1998.
Important Points
A bank guarantee is a contract between the bank and the beneficiary, and the rights and obligations of the contractor at whose instance the bank guarantee is issued do not become the rights and obligations of the bank.
Subject
Contract Law - BANK GUARANTEE
Act Referred
Headnote
BANK GUARANTEE - EXTENSION OF PERIOD - CONTRACTOR'S OBLIGATION - REMEDY OF THE STATE - SECTION 30 OF THE LIMITATION ACT, 1963.
Fact of the Case:
The contractor failed to extend the term of the bank guarantee as directed by the Chief Engineer of the State. The State filed a suit seeking a declaration that the bank guarantee would remain effective and enforceable for so long as the work under the contract was successfully commissioned or the amounts due under the bank guarantee were paid, and an injunction to the bank to renew the period of the bank guarantee.
Finding of the Court:
The bank guarantee was valid only up to the date stated therein or any extended date and was enforceable for a period of 6 months thereafter. The State could not have filed a suit requiring the contractor to furnish the security deposit in cash or by way of a bank guarantee as it would have been tantamount to asking for a decree of specific performance, which would have been incapable of enforcement if the contractor was unable or unwilling to pay out the money or put a bank in funds to provide a bank guarantee.
Issues: Whether the suit filed by the State was maintainable?
Ratio Decidendi: The suit was misconceived as the State's remedy against the contractor for failing to furnish the security deposit was to terminate the contract, make a claim for damages, and recover on the bank guarantee, if necessary by filing a suit.
Final Decision: The appeals were allowed, the judgment and order under appeal were set aside, and the suit was dismissed.
Legal Category Hierarchy
Table of Contents
2. State contended that a suit to extend the bank guarantee period constitutes an action to enforce a claim under the guarantee. (Para 5 )
3. Bank guarantees are governed by explicit expiry terms; banks cannot be compelled to renew guarantees or be bound by the contractor's contractual obligations. (Para 6 )
4. Failure to extend a bank guarantee constitutes a breach of contract, remediable by termination and damages, not by a suit for specific performance. (Para 7 )
5. Appeals allowed — Judgment and order of the High Court set aside — Suit dismissed. (Para 8 )
6. Can a bank be compelled to extend a bank guarantee beyond its explicit expiry date?
No. A bank guarantee is governed by its explicit terms regarding validity and expiry. A bank cannot be compelled to renew the period of the guarantee or be forced to keep it enforceable beyond the stated terms. (Para 6 )
7. Does a suit seeking a declaration that a bank guarantee remains valid constitute an action to enforce a claim under the guarantee?
No. Where a guarantee has explicit expiry and claim windows, a suit to force its extension or continued validity is not an action to enforce a claim under the guarantee. (Para 5 , 6 )
8. What is the proper legal remedy when a contractor fails to extend a bank guarantee as required by a works contract?
The proper course is to terminate the contract on the grounds of breach of terms, make a claim for damages, and recover on the existing bank guarantee if still valid. (Para 7 )
JUDGMENT :- These are appeals against the judgment and order of the High Court of Assam, Nagaland, Meghalaya, Manipur and Tripura.
2. Makharia Brothers (the contractor) entered into a works contract with the State of Nagaland (the 1st respondent). The contract stipulated that the contractor should furnish to the State security in the sum of Rs. 2,87,800/- for due performance of the contract. Clause 5.3 of the contract read thus :
"The Security Deposit may also be furnished in the form the Bank guarantee as per prescribed pro forma annexed with the contract. The Bank guarantee against security deposit shall be valid initially for a period of one year from the date not later to 20th day of the signing of contract and will be subsequently extended for any period as directed by the Chief Engineer so as to cover the guarantee period of 90 days of the successful commissioning of the generating sets, equipments and auxiliaries to the satisfaction of the Chief Engineer."
3. Pursuant to the aforesaid, the contractor furnished a bank guarantee dated 12th December, 1977 issued by the Vyasa Bank Ltd. (the bank). It was valid in the first instance up to 5th January, 1979 and was extended up to 5th July, 1979. The relevant part of the bank guarantee read thus :
"We the Vyasa Bank Ltd. do hereby undertake to indemnify the GOVERNMENT to the extent of Rs. 2,87,800/- (Rupees Two Lacs Eighty Seven Thousand Eight Hundred only) against any loss or damage caused to or suffered by the Government by reason of any breach of the said AGREEMENT. We the Vyasa Bank Ltd. undertake and guarantee to pay the GOVERNMENT ON DEMAND NOT EXCEEDING Rs. 2,87,800/- (Rupees Two Lacs Eighty Seven Thousand Eight Hundred only) in the event of the CONTRACTOR not fulfilling the terms and conditions of the said AGREEMENT. We the Vyasa Bank Ltd. ...............further agree that the guarantee herein contained shall remain in full 3467 force and effect up to and inclusive of 8-1-79 or the expiry of the extended period if any and that it shall be continued to be enforceable till all the dues of the Government under or by virtue of the same AGREEMENT have been fully paid and its claim satisfied or discharged or till the GOVERNMENT certifies that the terms and conditions of the said AGREEMENT have been fully and properly discharged out by the said CONTRACTOR and accordingly discharges the Guarantee subject, however, that the GOVERNMENT shall have no right under the bonds after the expiry of six months stated above or extended if any ............ Our liability under the bond is restricted to Rs. 2,87,800/- (Rupees Two Lacs Eighty Seven Thousand Eight Hundred only). Our guarantee will remain in force till 5-1-79 and unless the suit or action to enforce the claims under this guarantee is filed against us within six months from its expiry, all your rights under the guarantee shall be forfeited and we shall be released and discharged from all liabilities thereunder."
4. The Chief Engineer of the State called upon the contractor to extend the term of the bank guarantee. The contractor declined to do so. Thereupon the State filed the suit in the Court of the Chief Judicial Magistrate, Kohima, out of the decision on which these appeals by the contractor and the bank arise. The suit sought the following reliefs against the contractor and the bank :
"(i) Declaration against the defendants that security deposit by way of bank guarantee No. 3008, dated 12-12-77 (correct date being 12-1-78), furnished by the defendant No. 1 and subsequently extended by letter dated 13-3-79 and execution by the defendant No. 1 shall continue to subsist until the expiration of a period of 90 days of the successful commissioning of the generating sets, equipments and auxiliaries to the satisfaction of the Chief Engineer as per terms and conditions of the contract and the Bank guarantee furnished or until the payment of all dues by the defendant No. 1 of all amounts due to the Government from the amount guaranteed by
