Article

Factual Summary: In connection with a bid on construction of a coal-powered steam power plant, Suppliers/Builders 1-3 recommended Lender 4 as a source of credit. Lender 4 formed a consortium of banks with Lenders 5-11 and they entered into credit agreements with Purchaser. Disbursements were to be made by Lenders directly to Suppliers/Builders on presentation of various documents. As a requirement of the credit agreements, demand guarantees for 100% of the loan amounts as well as interest, costs, and fees were provided to Lenders by Guarantor.

In order to ensure that the guarantor would be liable in all circumstances in the event of the borrower failing to carry out its obligations, the lenders insisted that the guarantees very clearly made express provision to be unconditional first demand guarantees which were insulated from any possible dispute between the borrower and the suppliers and even the borrower and the lenders.

The credit agreement between Purchaser and Lenders specified that any arbitration was to take place in Stockholm under the Rules of Conciliation and Arbitration of the International Chamber of Commerce.

When Purchaser found that the plant had a capacity of 60 MW rather than the 108 MW capacity that had been a term of the building contract, it entered a package deal with Suppliers/Builders for them to correct any defects and extend the defect liability period. Accordingly, Purchaser issued a "taking-over certificate," permitting payment of the last five percent of the loan to the Suppliers/Builders.

Subsequently, alleging fraud on the part of both Suppliers/Builders and Lenders, Purchaser sued to void the taking over certificate, reduce the price of the power plant, void the guarantees, enjoin payment by Guarantor or Affiliate to Lenders, and to enjoin the recall of any of the loans by the Lenders. The trial court entered judgment against Purchaser. On appeal, the High Court of Orissa awarded partial judgment to Purchaser and issued an injunction temporarily barring any further guarantee payments to the Lenders. On appeal, the Supreme Court of India dismissed the injunction. Revisiting the case on separate appeals, the Supreme Court stayed the action, pending arbitration.

Legal Analysis:

1. Injunction; Guarantee; Fraud

The Supreme Court noted that independent guarantees, performance bonds and similar bank obligations must be honored except in cases of fraud of "an egregious nature as to vitiate the entire underlying transaction" with "special equities in the form of preventing irretrievable injustice between the parties" required. The Supreme Court therefore ruled that due to the insufficient evidence of fraud and a lack of irretrievable injury, there was no justification of an injunction barring Guarantor from making payments to Lenders. The Supreme Court also took into consideration the public policy argument that it is in the best interest of both Guarantor and the country itself that Guarantor maintain credibility in the international market. Not honoring a guarantee in an international transaction with major foreign banks would cause irretrievable injury to the reputation of the bank.

2. Arbitration Agreements

Noting the existence of the arbitration agreement, the Supreme Court ruled that under Section 3 of the Foreign Awards Act [of India], a stay of proceedings should be granted when a valid arbitration agreement is found to have been made and remains feasible and operative and a party to a court proceeding applies for such a stay.

The Supreme Court ultimately found that the parties were bound by the arbitration agreements they had made in the credit agreements, which specified that any arbitration among the parties take place in Stockholm, before a panel of the International Chamber of Commerce. Accordingly, the Supreme Court stayed all proceedings of this case for arbitration as per the credit agreements.

Comment:

Arbitration. While the court properly refused to enjoin payment without proof of egregious LC fraud, its decision to stay proceedings pending the outcome of the arbitration is troubling with respect to the independent guarantee. Since the demand guarantee was not subject to arbitration, rights under it were not affected by the decision of the arbitration tribunal as suggested by the opinion.

[JEB/vjm/njd]

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