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Author: Atrijo Banerjee, II year of B.A.,LL.B. from The West Bengal National University of Juridical Sciences


A Bank guarantee is a popular mode of securing payment in commercial transactions. A Bank guarantee is an assurance to the intended beneficiary that the bank will clear the payments in case the applicant and counterparty to the contract fail to do so[i]. Bank guarantees facilitate business in situations that otherwise would be risky for the intended beneficiary to engage. It guarantees both financial transactions like repayment of debts and performance of contracts for services[ii]. A Bank guarantee represents a separate contract between the bank and the beneficiary. It is separate from the contract between the beneficiary and the applicant. The bank is bound to pay by the terms of the contract[iii].

Types of Bank Guarantees

There are two kinds of bank guarantees:

  1. Unconditional Bank Guarantees

  2. Conditional Bank Guarantees

In an irrevocable or unconditional bank guarantee, the bank has to pay the beneficiary unconditionally and unilaterally upon the demand of the beneficiary. Conditional bank guarantees require certain conditions to be fulfilled before they can be invoked. Whether a bank guarantee is conditional or unconditional can be determined from the terms of the contract.[iv]

Liability under a Bank Guarantee

The bank is unequivocally liable to pay to the beneficiary of a bank guarantee if all the conditions for the invocation of the bank guarantee are fulfilled. In a normal contract of guarantee liability of the guarantor is co-extensive with that of the principal debtor. But in a contract of bank guarantee, the bank is liable to pay to the beneficiary if all conditions have been fulfilled irrespective of the transaction between the beneficiary and the other party. The bank has to pay the required amount to the beneficiary without investigating the transaction between the applicant and the beneficiary or examining any breach by the beneficiary. Also, variation in terms of the contract by the parties does not extinguish a bank guarantee. The beneficiaries can thus encash the bank guarantee even if a dispute is pending[v]. Thus, the contracts related to the bank guarantee are independent of each other though related in some aspects. This is called the Principle of Autonomy.[vi]

Exceptions to the enforcement of Bank Guarantees

The banks usually have an absolute obligation to pay the beneficiaries of bank guarantees. This position is well settled in India and has been upheld by the Supreme Court of India in several verdicts like U.P. Co-op. Federation Ltd. v. Singh Consultants and Engineers (P) Ltd[vii]. In this case, the court held that the bank was obliged to pay to the beneficiary upon demand without any contestation irrespective of the relationship between the beneficiary and the customer of the bank. Otherwise, the purpose of bank guarantees would be defeated and the entire framework of commercial transactions would be disrupted. But there are some exceptions where the beneficiaries cannot encash the guarantees. Courts have held that there were two narrow exceptions where injunctions can be granted against the enforcement of bank guarantees.

They were:

a) Fraud

b) On equitable grounds to prevent gross injustice to the person purchasing the guarantee.[viii]

The Fraud Exception

A bank guarantee cannot be encashed when there is a fundamental fraud on the part of the beneficiary which has been brought under the notice of the bank. The fraud must be so fundamental that it impairs the entire transaction.[ix] This exception developed through judicial decisions and has been recognised by the Supreme Court of India.

The fraud exception is based on the principle of "ex turpi causa non-obiter actio" meaning “truth unravels all”[x]. It is also based on the maxim of“fraus omnia corrumpit” meaning “fraud vitiates everything”[xi]. This exception thus does away with the principle of autonomy. It helps in the public policy of limiting fraud and maintaining the commercial importance of bank guarantees by minimizing the adverse effects of fraud[xii]. The scope of the fraud exception has not been clearly specified by courts. This continues to be a grey area of law.[xiii]

Comparison of the fraud exception in various jurisdictions

United Kingdom

One of the earliest English cases dealing with bank guarantees was Pillars & Rose v Van Mierop & Hopkins.[xiv] In this case Pillans were merchant bankers. They accepted bills from a businessman named White. Mierop & Hopkins, a London firm was the guarantor. White later went insolvent. Mierop & Hopkins refused to honour the contract when the plaintiffs demanded the money from them. In this case, Lord Mansfield observed that Mierop & Hopkins were bound to honour the transaction unless they could prove that some fraud had been committed. Upon hearing this the defendants pleaded that the transaction was concealed from them and they had been defrauded. But Lord Mansfield refused to accept this argument. He held that fraud was not evident in the papers which the defendants had accepted and duly signed[xv]. In this case, the fraud exception was not properly analysed and defined. But it was one of the first cases which laid down the rule that a guarantee can be dishonoured by a financial institution due to fraud.

In the 20th century, the English courts have mostly upheld the principle of non-interference and have granted injunction only in exceptional cases. In the case, Hamzeh Malas & Sons v British Imex Industries Ltd[xvi] the plaintiffs contracted to buy iron rods from the defendants. The shipment of the rods was found to be defective upon delivery. The plaintiffs approached the court demanding an injunction on the enforcement of the letter of credit. The court referred to the fraud rule and the landmark American case, Sztejn v. J. Henry Schroder Banking Corporation[xvii] and held that the dispute related to the quality of iron delivered did not constitute fraud and the bank had an obligation to pay irrespective of any dispute. Another important English case on this subject is United City Merchants (Investments) Ltd v Royal Bank of Canada[xviii] a there was fraud made in the document by a third party. The seller/beneficiary was not aware of it. In the House of Lords, Lord Diplock affirmed the fraud exception but refused to grant an injunction over the enforcement of the bank guarantee because the fraud was done by the third party and the seller was not aware of it. the seller was not aware of it. Following this case, courts in England have tended to determine if the beneficiary was aware of the fraud and look into his mens rea (state of mind)[xix]. Also, in this case, Lord Diplock suggested that fraud would be material with respect to encashment of guarantee only if it affects the ability of the bank to get the money back by selling the goods if the buyer fails to reimburse for it[xx].

United States

One of the most important United States cases dealing with bank guarantees is Sztejn v. J. Henry Schroder Banking Corp, decided by the New York Supreme Court. In this case, the plaintiffs had purchased bristles from a firm named Transea and obtained a letter of credit in benefit of them. But the company had shipped rubbish instead of bristles. This fraud had been brought under the notice of the bank. So, the plaintiffs approached the court to seek an injunction on the enforcement of the guarantee. In this Justice Shientagdistinguished between fraud in documents and fraud underlying the contract and reasoned that the sellers had committed fraud underlying the contract. The court held that the autonomy principle cannot protect such dishonest sellers. [xxi] This Sztejn case influenced the fraud rule in many jurisdictions. There has been some confusion regarding the standard of fraud applied to the Sztejn case. The judgement did not elaborate upon the degree of fraud required. Some scholars believe Sztejn spoke of intentional fraud.

Others argue it referred to a narrower standard of egregious or grave fraud[xxii]. The Judgement delivered by Justice Shientag in Asbury Park & Ocean Grove Bank v. National City Bank of New York[xxiii], offer some hint in this regard. Here it was held that the fraud rule would apply only in cases of serious fraud by the seller like failure to deliver the goods.[xxiv] Thus, it can be understood that the fraud rule will apply when a grave fraud is perpetrated by the beneficiary.


In U.P. Coop. Federation Ltd. v. Singh Consultants and Engineers (P) Ltd[xxv] a division bench of the Supreme Court of India held that an irrevocable bank guarantee or a letter of credit can only be interfered with if an egregious fraud had been committed and grave injustice would be done to the buyer of the guarantee if it is allowed to be encashed. Otherwise, the bank has an obligation to pay when the first demand is made. The court referred to the Sztejn case. In U.P. State Sugar Corporation vs M/S. Sumac International Ltd[xxvi] the court reiterated that the fraud committed needs to be of such proportions that it vitiates the entire foundation of the contract.

In M/S. Reliance Salt Ltd vs M/S. Cosmos Enterprises &Anr[xxvii] the respondent was a consignment agent in regard to the sale of salt and tea of the appellant. They were required to furnish a bank guarantee worth five lakhs. The bills of the appellant were not paid for thirty days in 1994. The appellant sought to invoke the guarantee. The respondent approached the court requesting an injunction. The respondent alleged there was an irregularity in supply by the defendants and often the quality supplied was poor. The respondent also alleged fraud. The appellants did not produce details of their accounts in court to counter the irregularities alleged by the respondents. The appellants approached the Supreme Court. The Supreme Court held that the fraud exception in bank guarantee was similar to fraud under section 17 of the Indian Contracts Act. Fraud would be an act done by a party to fraudulently induce the other to make the contract. The fraud had to have some nexus with the prior conduct of the parties before the contract. Mere breach of contract by way of supply of poor-quality materials did not constitute fraud. Also, the suit was not for the settlement of accounts. So, it can’t be assumed that there was fraud just because of the non-disclosure of accounts. So, the court reversed the order of the lower courts and refused to grant the injunction.

Rigoss Exports International Ltd. v Tartan Infomark Ltd[xxviii] was a case settled by the Delhi High Court where fraud was successfully proven. Here the petitioners were engaged in the business of readymade garments. The respondents were agents of garment importers in Singapore. They signed three MoUs for the export of various garments. The respondents were to procure letters of credit from foreign buyers. They gave separate bank guarantees for the second and third MoUs to the respondents. The respondents provided a fake inspection certificate of the goods for the first MoU and the documents were rejected by the buyer’s bank. They were evasive about the inspection certificate under the second MoU. The appellants did not send any intimation to the respondents about the letter of inspection for the third MoU. Instead of refunding the commission which they had received the respondents sought to invoke the bank guarantees. The petitioner approached the court seeking an injunction. Meanwhile, during the investigation, the petitioners found the respondents had got only accommodating letters of credit. The court found that the conduct of the respondents indicated that they were only interested in getting their commission without ensuring the shipment of goods. The petitioner's action proved they took the LC to be genuine as they invested money to ensure the shipment of the goods. Also, the court observed that in the first transaction a fake letter of the inspection was given. This eroded the basis of future transactions. So, the court gave an injunction on the ground of fraud.


The threshold of proving fraud is very high in India. The rule evolved in the Sztejn case has been often referred to by Indian courts. As shown in the M/S. Reliance Salt Ltd vs M/S. Cosmos Enterprises &Anr case mere defects in the quality of the goods in the contract is not sufficient to constitute fraud. That will be considered a breach of contract as this was just a non-conforming performance. But this is not in conflict with the Sztejn case as there no goods promised under the contract was shipped. Instead, rubbish was shipped. So, the sellers did not send what they promised. So, this constituted fraud as the sellers gave misleading information about providing bristles without which the contract would not have been formed. To prove fraud, it has to be shown that a party has been induced to the contract by fraudulent acts of the other and the fraud negates the entire contract. Such fraud cannot be assumed from circumstantial evidence such as the conduct of the party in other contracts, or reluctance to settle the accounts. In the Rigoss Exports International Ltd case, fraud was successfully proved because sufficient evidence in the form of letters among the various parties was presented before the court. The court analysed the evidence to deduce the intent of the parties and concluded there was a fraud. So, there needs to be a grave, intentional fraud by the beneficiary of the guarantee and such fraud needs to be proven by direct evidence in order to get an injunction under the fraud exception. The mere allegation of fraud by the aggrieved party would not suffice. The burden is upon the person alleging the fraud. As discussed earlier the threshold is similar in other common law jurisdictions like the United Kingdom. Such a high threshold is in consonance with the purpose of unconditional bank guarantees, i.e., to facilitate risky commercial transactions. So, it is argued that the courts should continue to grant the fraud exception in the rarest of cases.

[i]Corporate Finance Institute, What is a Bank Guarantee?, available at Visited 26th May 2021).


[iii]Shivani Kumbhojkar, Bank Guarantees and Injunction on their Invocation, available at (Last Visited 26th May 2021).


[v] Arpit Lahoti, Bank Guarantee, available at Visited 26th May 2021).

[vi] Grace Kayembe, The Fraud Exception in Bank Guarantee, August 30, 2014(LLM Dissertation, University of Cape Town), 17 available at (Last Visited 27th May 2021).

[vii]U.P. Co-op. Federation Ltd. v. Singh Consultants and Engineers (P) Ltd, (1988) AIR 2239.

[viii] Shivani Kumbhojkar, Bank Guarantees and Injunction on their Invocation, available at (Last Visited 26th May 2021).

[ix] Akshay Anurag, Bank Guarantee and Judicial Intervention, available at (Last Visited 26th May 2021).


[xi] Grace Kayembe, The Fraud Exception in Bank Guarantee, August 30, 2014(LLM Dissertation, University of Cape Town), 29, available at (Last Visited 27th May 2021).

[xii]Ross Buckley, Xiang Gao, Development of the Fraud Rule in Letter of Credit Law: The Journey So Far and the Road Ahead, 23(4) University of Pennsylvania Journal of International Law 663 (2002),665.

[xiii]Mihir Naniwadekar, Fraud and Bank Guarantees, available at (Last Visited 26th May 2021).

[xiv]Pillans & Rose v Van Mierop & Hopkins, (1765) 3 Burr 1663, 97 ER 1035.

[xv]Supra note 12, 669.

[xvi] Hamzeh Malas & Sons v British Imex Industries Ltd, (1958) 2 Q.B. 127.

[xvii]Sztejn v. J. Henry Schroder Banking Corporation, (1941) 31 N.Y.S. 2d 631.

[xviii] United City Merchants (Investments) Ltd v Royal Bank of Canada, (1983) 1 AC 168.

[xix]Dr Hang Yen Low, Confusion and difficulties surrounding the fraud rule in letters of credit: an English perspective, 17 The Journal of International Maritime Law, 462 (2011), 463.

[xx]Id., 464.

[xxi]Nevin Meral, The Fraud Exception in Documentary Credits: A Global Analysis, 5 Ankara B. Rev., 39(2012), 52.

[xxii] Xiang Gao, Ross Buckley, A Comparative Analysis of the Standard of Fraud Required Under the Fraud Rule in Letter of Credit Law, 13 Duke Journal of Comparative & International Law, 293(2003), 296.

[xxiii] Asbury Park & Ocean Grove Bank v. National City Bank of New York,35 N.Y.S.2d 985 (N.Y. Sup. Ct. 1942).

[xxiv]Supra note 22, 297.

[xxv] U.P. Coop. Federation Ltd. v. Singh Consultants and Engineers (P) Ltd, (1988) SCR Supl. (2) 859.

[xxvi]U.P. State Sugar Corporation vs M/S. Sumac International Ltd, (1997) 1 SCC 568.

[xxvii] M/S. Reliance Salt Ltd vs M/S. Cosmos Enterprises &Anr,(2006) 13 SCC 599.

[xxviii]Rigoss Exports International Ltd. v Tartan Infomark Ltd, AIR 2002 Delhi 285.

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