Bank Guarantee and interference by Courts: The law revisited

In a recently reported decision the Delhi High Court has seemingly exhaustively discussed the principles and the precedents relating to the situations in which bank guarantees, letter of credits etc. require inference by the Courts and in which matters the courts should abstain from coming in way of the free working of the markets.


Discussing the position of law, the High Court observed as under;

8. Coming to the issue of grant of injunction against invocation of Bank Guarantee, the Hon'ble Supreme Court has crystalized the law regarding invocation/encashment of Letter of Credit and Bank Guarantee in its pronouncements such that it admits of no debate or doubt. As far back as in 1970, the Court had in Tarapore and Co., Madras –vs- V.O Tractors Export Moscow, AIR 1970 SC 891 elaborately and perspicuously explained the scope and ambit of judicial interference in matters concerning Letters of Credit and Bank Guarantees in these words--

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 the 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, the 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 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 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 for the 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 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 an 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 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.

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 to 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 the plaintiffs had 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 the 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 from 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.

9. 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 the performance of the contractual obligations flowing out of a 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 to honour drafts negotiated, or to reimburse in respect of drafts paid, by the paying or 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 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.

10. A study of U.P. Coop. Federation –vs- Singh Consultants & Engineers (P) Ltd., (1988) 1 SCC 174 is extremely instructive. The Hon'ble Supreme Court again spoke in these words-

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 if the documents are in order and the terms of credit are satisfied. The bank, however, was not allowed to determine whether the seller had 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 the bank could 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.

.......

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. 

11. In Hindustan Steel Works Construction Ltd. –vs- Tarapore & Co., AIR 1996 SC2268:(1996) 5 SCC 34, the following observations have been made: 

We are, therefore, of the opinion that the correct position of law is that commitment of banks must be honoured free from interference by the courts and it is only in exceptional cases, that is to say, in case of fraud or in a case where irretrievable injustice would be done if bank guarantee is allowed to be encashed, the court should interfere. In this case fraud has not been pleaded and the relief for injunction was sought by the contractor/Respondent 1 on the ground that special equities or the special circumstances of the case required it. The special circumstances and/or special equities which have been pleaded in this case are that there is a serious dispute on the question as to who has committed breach of the contract, that the contractor has a counter-claim against the appellant, that the disputes between the parties have been referred to the arbitrators and that no amount can be said to be due and payable by the contractor to the appellant till the arbitrators declare their award. In our opinion, these factors are not sufficient to make this case an exceptional case justifying interference by restraining the appellant from enforcing the bank guarantees. The High Court was, therefore, not right in restraining the appellant from enforcing the bank guarantees.

12. In U.P. State Sugar Corporation –vs-. Sumac International Limited, AIR 1997 SC 1644:(1997) 1 SCC 568 the circumstances in which the invocation of a Bank Guarantee or payments made pursuant thereto could be interdicted, had been Restated. While spelling out the essentials of fraud and/or irretrievable injustice in this context, the Apex Court had recorded the following observations:- 

12. The law relating to invocation of such bank guarantees is by now well settled. When in the course of commercial dealings an unconditional bank guarantee is given or accepted, the beneficiary is entitled to realize such a bank guarantee in terms thereof irrespective of any pending disputes. The bank giving such a guarantee is bound to honour it as per its terms irrespective of any dispute raised by its customer. The very purpose of giving such a bank guarantee would otherwise be defeated. The courts should, therefore, be slow in granting an injunction to restrain the realization of such a bank guarantee. The courts have carved out only two exceptions. A fraud in connection with such a bank guarantee would vitiate the very foundation of such a bank guarantee. Hence if there is such a fraud of which the beneficiary seeks to take advantage, he can be restrained from doing so. The second exception relates to cases where allowing the encashment of an unconditional bank guarantee would result in irretrievable harm or injustice to one of the parties concerned. Since in most cases payment of money under such a bank guarantee would adversely affect the bank and its customer at whose instance the guarantee is given, the harm or injustice contemplated under this head must be of such an exceptional and irretrievable nature as would override the terms of the guarantee and the adverse effect of such an injunction on commercial dealings in the country. The two grounds are not necessarily connected, though both may coexist in some cases.

.......

14. On the question of irretrievable injury which is the second exception to the rule against granting of injunctions when unconditional bank guarantees are sought to be realised the court said in the above case that the irretrievable injury must be of the kind which was the subject-matter of the decision in the Itek Corpn. case, 566 Fed Supp 1210. In that case an exporter in USA entered into an agreement with the Imperial Government of Iran and sought an order terminating its liability on stand by letters of credit issued by an American Bank in favour of an Iranian Bank as part of the contract. The relief was sought on account of the situation created after the Iranian revolution when the American Government cancelled the export licences in relation to Iran and the Iranian Government had forcibly taken 52 American citizens as hostages. The US Government had blocked all Iranian assets under the jurisdiction of United States and had cancelled the export contract. The Court upheld the contention of the exporter that any claim for damages against the purchaser if decreed by the American Courts would not be executable in Iran under these circumstances and realisation of the bank guarantee/letters of credit would cause irreparable harm to the plaintiff. This contention was upheld. To avail of this exception, therefore, exceptional circumstances which make it impossible for the guarantor to reimburse himself if he ultimately succeeds, will have to be decisively established. Clearly, a mere apprehension that the other party will not be able to pay, is not enough. In Itek case (supra) there was a certainty on this issue. Secondly, there was good reason, in that case for the Court to be prima facie satisfied that the guarantors i.e. the bank and its customer would be found entitled to receive the amount paid under the guarantee.

15. Our attention was invited to a number of decisions on this issue -- among them, to Larsen & Toubro Ltd. v. Maharashtra SEB, (1995) 6 SCC 68 and Hindustan Steel Workers Construction Ltd. v. G.S. Atwal & Co. (Engineers) (P) Ltd., (1995) 6 SCC 76 as also to National Thermal Power Corpn. Ltd. v. Flowmore (P) Ltd., (1995) 4 SCC 515. The latest decision is in the case of State of Maharashtra v. National Construction Co., (1996) 1 SCC 735 where this Court has summed up the position by stating:

"The rule is well established that a bank issuing a guarantee is not concerned with the underlying contract between the parties to the contract. The duty of the bank under a performance guarantee is created by the document itself. Once the documents are in order the bank giving the guarantee must honour the same and make payment ordinarily unless there is an allegation of fraud or the like. The courts will not interfere directly or indirectly to withhold payment, otherwise trust in commerce internal and international would be irreparably damaged. But that does not mean that the parties to the underlying contract cannot settle the disputes with respect to allegations of breach by resorting to litigation or arbitration as stipulated in the contract. The remedy arising ex contractu is not barred and the cause of action for the same is independent of enforcement of the guarantee."

13. Reference may also be made to the observations of B.N.Kirpal, J. (as his Lordship then was) in Dwarikesh Sugar Industries Ltd. –vs- Prem Heavy Engineering Works (P) Ltd., (1997) 6 Supreme Court Cases 450, and the terse deprecation contained therein to the Courts' interdicting the normal operation of Bank Guarantees and Letters of Credit.

21. Numerous decisions of this Court rendered over a span of nearly two decades have laid down and reiterated the principles which the courts must apply while considering the question whether to grant an injunction which has the effect of restraining the encashment of a bank guarantee. We do not think it necessary to burden this judgment by referring to all of them. Some of the more recent pronouncements on this point where the earlier decisions have been considered and reiterated are Svenska Handelsbanken v. Indian Charge Chrome, Larsen & Toubro Ltd. v. Maharashtra SEB, Hindustan Steel Workers Construction Ltd. v. G.S. Atwal & Co. (Engineers) (P) Ltd. and U.P. State Sugar Corpn. v. Sumac International Ltd. The general principle which has been laid down by this Court has been summarised in the case of U.P. State Sugar Corpn. As follows: (SCC p.574, para 12) ―The law relating to invocation of such bank guarantees is by now well settled. When in the course of commercial dealings an unconditional bank guarantee is given or accepted, the beneficiary is entitled to realize such a bank guarantee in terms thereof irrespective of any pending disputes. The bank giving such a guarantee is bound to honour it as per its terms irrespective of any dispute raised by its customer. The very purpose of giving such a bank guarantee would otherwise be defeated. The courts should, therefore, be slow in granting an injunction to restrain the realization of such a bank guarantee. The courts have carved out only two exceptions. A fraud in connection with such a bank guarantee would vitiate the very foundation of such a bank guarantee. Hence if there is such a fraud of which the beneficiary seeks to take the advantage, he can be restrained from doing so. The second exception relates to cases where allowing the encashment of an unconditional bank guarantee would result in irretrievable harm or injustice to one of the parties concerned. Since in most cases payment of money under such a bank guarantee would adversely affect the bank and its customer at whose instance the guarantee is given, the harm or injustice contemplated under this head must be of such an exceptional and irretrievable nature as would override the terms of the guarantee and the adverse effect of such an injunction on commercial dealings in the country.

Dealing with the question of fraud it has been held that fraud has to be an established fraud. The following observations of Sir John Donaldson, M.R. In Bolivinter Oil SA v. Chase Manhattan Bank are apposite:

―... The wholly exceptional case where an injunction may be granted is where it is proved that the bank knows that any demand for payment already made or which may thereafter be made will clearly be fraudulent. But the evidence must be clear, both as to the fact of fraud and as to the bank's knowledge. It would certainly not normally be sufficient that this rests on the uncorroborated statement of the customer, for irreparable damage can be done to a bank's credit in the relatively brief time which must elapse between the granting of such an injunction and an application by the bank to have it discharged.‖

The aforesaid passage was approved and followed by this Court in U.P. Coop. Federation Ltd. v. Singh Consultants and Engineers (P) Ltd.

22. The second exception to the rule of granting injunction, i.e., the resulting of irretrievable injury, has to be such a circumstance which would make it impossible for the guarantor to reimburse himself, if he ultimately succeeds. This will have to be decisively established and it must be proved to the satisfaction of the court that there would be no possibility whatsoever of the recovery of the amount from the beneficiary, by way of restitution.‖

14. It will be apposite to make a reference of Federal Bank Limited –vs- V.M. Jog Engineering Limited, (2001) 1 SCC 663 the Apex Court had recorded the following enunciation of law --

In several judgments of this Court, it has been held that courts ought not to grant injunction to restrain encashment of bank guarantees or letters of credit. Two exceptions have been mentioned - (i) fraud, and (ii) irretrievable damage. If the plaintiff is prima facie able to establish that the case comes within these two exceptions, temporary injunction under Order 39 Rule 1 CPC can be issued. It has also been held that the contract of the bank guarantee or the letter of credit is independent of the main contract between the seller and the buyer. This is also clear from Articles 3 and 4 of UCP (1983 Revision). In case of an irrevocable bank guarantee or letter of credit the buyer cannot obtain injunction against the banker on the ground that there was a breach of the contract by the seller. The bank is to honour the demand for encashment if the seller prima facie complies with the terms of bank guarantee or the letter of credit, namely, if the seller produces the documents enumerated in the bank guarantee or the letter of credit. If the bank is satisfied on the face of the documents that they are in conformity with the list of documents mentioned in the bank guarantee or the letter of credit and there is no discrepancy, it is bound to honour the demand of the seller for encashment. While doing so it must take reasonable care. It is not permissible for the bank to refuse payment on the ground that the buyer is claiming that there is a breach of contract. Nor can the bank try to decide this question of breach at that stage and refuse payment to the seller. Its obligation under the document having nothing to do with any dispute as to breach of contract between the seller and the buyer.

15. It is evident that despite the clarity and consistency in the decisions of the Hon'ble Supreme Court injunctions for the encashment of Bank Guarantees and Letters of Credit are nevertheless granted. Very recently in National Highways Authority of India –vs- Ganga Enterprises, (2003) 7 Supreme Court Cases 410, the Apex Court again adumbrated the law on this subject in the following passage: 

It is settled law that a contract of guarantee is a complete and separate contract by itself. The law regarding enforcement of an ―on-demand bank guarantee is very clear. If the enforcement is in terms of the guarantee, then courts must not interfere with the enforcement of bank guarantee. The court can only interfere if the invocation is against the terms of the guarantee of if there is any fraud. Courts cannot restrain invocation of an ―on-demand guarantee‖ in accordance with its terms by looking at terms of the underlying contract. The existence or non-existence of an underlying contract becomes irrelevant when the invocation is in terms of the bank guarantee. The bank guarantee stipulated that if the bid was withdrawn within 120 days or if the performance security was not given or if an agreement was not signed, the guarantee could be enforced. The bank guarantee was enforced because the bid was withdrawn within 120 days. Therefore, it could not be said that the invocation of the bank guarantee was against the terms of the bank guarantee. If it was in terms of the bank guarantee, one fails to understand as to how the High Court could say that the guarantee could not have been invoked. If the guarantee was rightly invoked, there was no question of directing refund as has been done by the High Court.

16. From the above discussion, it is manifestly clear that there is no dispute that a Letter of Credit is an independent contract and the Courts are not to interfere with the encashment of the Letter of Credit unless the case falls within the purview of exceptions laid down by the Apex Court. The first exception which has been carved out by the Courts is that the fraud perpetrated must be of egregious nature meaning that the said fraud must be one of gross nature which shakes the conscience of the Court and the said fraud must be known to the parties including the party representing as well as the bank. Under the said circumstances, if the said fraud is established, the Court can interfere with the bank guarantee. In U.P. Cooperation Federation Ltd. (Supra) also it was held that the fraud pleaded must be of an egregious nature so as to vitiate the entire underlying transaction of the Bank Guarantee. It is fraud of the beneficiary and not the fraud of somebody else that would make the Court to grant the Order of injunction as asked for.

Have a look at the decision.

SEBI v. IRDA: Exploring the tussle between regulators over ULIPs

The issue which we cover in this post is an interesting one. Two regulators have taken contrary stands and the issue of Unit Linked Insurance Plans (ULIPs) has in fact brought the Securities and Exchange Board of India (SEBI), the securities market regulator of India and the Insurance Regulatory and Development Authority (IRDA) at logger-heads in much as their respective jurisdiction and exercise of powers of concerned. Since legal issues are involved, we seek leave to bring to the attention of our readers the stakes involved and the potential fallouts of this tussle. 

First the facts: A whole-time member of SEBI, exercising powers under Section 11, 11B  and 12(1B) of the SEBI Act, 1992 has issued an order restraining fourteen (14) insurance companies from issuing "any offer document, advertisement, brochure soliciting money from investors or raise money from investors by way of new and/or additional subscription for any product (including ULIPs) having an investment component in the nature of mutual funds, till they obtain the requisite certificate of registration from SEBI." This order has been passed as in the considered view of SEBI the ULIPs launched by these companies were "found to be akin to the mutual fund schemes and were launched without obtaining registration" from SEBI whereas one of the functions SEBI as a market-regular is required to perform in terms of the SEBI Act is the "registering and regulating the working of collective investment schemes including mutual funds" towards which regard the "Securities and Exchange Board of India (Mutual Funds) Regulations, 1996" and "Securities and Exchange Board of India (Collective Investment Scheme) Regulations, 1999" have been framed in terms of which inter alia "“no person can sponsor or cause to be sponsored a collective investment scheme including a mutual fund unless he has been registered with SEBI under the SEBI Act." Thus according to SEBI these companies were in violation of the SEBI Act and regulations by launching and continuing with the ULIPs without being registered with SEBI and following its Regulations.

So what is the rub? Aren't all companies dealing with securities and mutual funds in India registered with SEBI and following its Regulations? Why are the insurance companies so special that they are not required to follow these Regulations? And most importantly, what brings IRDA in picture?

The answer to these questions lies in another Parliamentary enactment and the role of another market-regulators. The Insurance Regulatory and Development Act, 1999, which has constituted the office of IRDA and prescribes (vide Section 14) the powers, functions and duties of IRDA lays down that the IRDA "shall have the duty to regulate, promote and ensure orderly growth of the insurance business and re-insurance business" and in fact various other specific functions and duties have been prescribed by IRDA in this regard under the Act of 1999. Thus, in as much as IRDA is concerned, the sole dominion over insurance companies vests in IRDA and thus comes the rub when SEBI exercises jurisdiction over the insurance companies. 

IRDA has come on record to state that it had specifically "intimated to SEBI that the ULIPs are insurance products marketed by the companies licensed by the IRDA and each of the ULIPs and the conditions thereto are specifically cleared by the IRDA having regard to the Insurance Act and the Regulations issued thereunder and that consequently, the action of SEBI is wholly misconceived and without jurisdiction." Further, the IRDA is also concerned that if the order of SEBI is given effect to, it shall "cause the stoppage of all renewals of insurance policies already invested by the insuring public, may result in the forced premature surrender of insurance policies causing substantial loss to the policyholder and to the insurers.  The effective stoppage of the sale of the said products will cause a complete drying up of the revenue flows to the insurance companies which could disrupt the payment of benefits on maturity, on death and on other admissible claims, putting the policyholder and the general public to irreparable financial loss.  The financial position of the insurers will be seriously jeopardized thus destabilizing the market and upsetting financial stability."

Thus the IRDA has directed, exercising powers under the IRDA Act has directed all the 14 insurance companies which are mentioned in the order of SEBI "to note that notwithstanding the said Order of the SEBI, they shall continue to carry out insurance business as usual including offering, marketing and servicing ULIPs in accordance with the Insurance Act, 1938, Rules, Regulations and Guidelines issued thereunder by the IRDA" which the market calls as IRDA having overruled SEBI and this is where it props up interesting legal issues.

Issues Summarized: Before we deal with the possible legal outcomes, we thought it wiser to cull out the legal issues which are involved in these orders of the two regulators so as to have a clear understanding of the issues.

(1) What are those 14 insurance companies, in the line of fire, required to do? To follow the SEBI order and stop business or to follow IRDA order and continue business in ULIPs?

(2) What is the recourse available to either SEBI or IRDA if the insurance companies defy either of their orders? Will legal sanctions follow the insurance companies in case of their failure to meet out either of the orders?

(3) What happens to investors in these ULIPs? What is the legal status of the policies purchased/renewed by them after the SEBI order?

Examining the legal position: Here we examine the legal position on all of the three issues independently. However, even before we begin, we would like to put a caveat that in all fairness to both SEBI and IRDA, we will not comment upon the correctness of the orders passed by them. That is a issue which is required to be resolved through Good Offices or whatever legal means the regulators or the stake-holders may desire to choose. Here we are examining only the implications and fall outs over the contradictory stands adopted by the two regulators.

(1) and (2) A quick look at the SEBI Act will tell us that the power of SEBI are indeed very wide. The statement of objects and reasons of the Act tells us that SEBI has been instituted being envisioned as "a Board to protect the interests of investors in securities and to promote the development of, and to regulate, the securities market and for matters connected therewith", a mandate which has actually be restated in Section 11(1) of the Act, thus making it an obligatory duty requiring SEBI to ensure that the interests of the investors are protected. Thus, generally, the SEBI does have power to require the entities dealing in securities and ensure that they meeting out the specifications listed in the Regulations prescribed by SEBI. These aspects have been upheld time and again even by the highest courts of the country. Therefore it is clear that the SEBI, in the preliminary, has the power to examine as to whether the role of entities doing business in India fits within the regulatory set-up administered by it. This logically points to the fact that SEBI, given the wide powers it is conferred with, can take action against defaulters for failing to meet its Regulations, which seems to have been done through the order passed by the Whole-Time member of SEBI.

Further, it is a well settled rule of common law that an order, no matter how perverse and illegal and one even without jurisdiction is binding over the subject unless set-aside in a manner known to law. In the present case, even assuming that the SEBI order is incorrect or as the IRDA puts it, without jurisdiction to begin with. However, given the legal set-up in which the rule of law operates in India, the fourteen insurance companies cannot sit over the order grossly violating its terms without getting it set aside. In the present case the only remedy available to them is to file an appeal against the order before the Securities Appellate Tribunal (SAT) or even a direct petition of special leave before the Supreme Court (under Article 136 of the Constitution) or a writ petition before the High Court challenge the order on grounds of lack of jurisdiction, illegality or otherwise. 

In the event the Insurance Companies violate the order of SEBI, the logical fallouts would be that SEBI will be constrained to take action (being a creature of statute, it is required and bound to follow the mandate of the Act and bring to book the defaulters of its orders) and pass necessary orders against these companies for having failed to carry out its order and continuing business. As far as the IRDA goes, it may have the jurisdiction to regulate and monitor insurance companies. However it does not have the powers to poke its nose and sit over judgment over the orders passed by SEBI. All it can do is represent the insurance companies before appropriate forum and carry their grievances further. It neither has the power nor the authority to over-rule a decision passed by a quasi-judicial authority in exercise of powers conferred by a Parliamentary statute. 

However, in as much as the IRDA has already passed orders directing these companies to continue doing business and in terms of the IRDA Act such powers are indeed vested in the IRDA, this brings the insurance companies in a catch 22 position. They are required by the SEBI order to desist from their business whereas the IRDA order directs them to continue doing the business as usual. So what if these companies decide to follow SEBI order and ignore the one passed by IRDA? Given the IRDA Act, they can be taken action against by IRDA, in which scenario they would be required to approach the appropriate forum to challenge such orders of IRDA. Either way, they are bound to face regulatory action from either SEBI or IRDA, depending upon which order they decide to follow.

Thus, as a matter of advice to these companies, the only optimal solution would seek that they approach the appropriate legal forum against the SEBI order and ventilate their grievances against it to get it diluted or set-aside. In which case, till the time the appeal/petition against the SEBI order is pending, the matter being sub-judice, IRDA would oblige by not taking any action against these companies. However, glossing over the SEBI order without challenging its legality can only cost the company in multitudes given the rule of law in the country that an order becomes final and binding if not appealed against or set-aside by an appropriate forum.

(3) Now let us deal with what the investors in these securities have in the offering. Let us assume that for the time-being the order of SEBI is here to stay (for the procedure for setting it aside will bring the appeal/petition in due course). In this scenario, the companies are legally barred from renewing or offering any ULIPs. Thus the new/renewed scrips are contrary to law (being the order passed in terms of the SEBI Act). The law of contracts entitles the agreements not enforceable by law as 'void'. Thus the ULIPs, which are nothing but agreements between the subscribers and the insurance companies, are void till the time the SEBI order stay. In this scenario, a subscriber cannot bring an action for violation of any of the terms of the ULIP by the company and vice versa. In fact the object of the such agreements, under the law of contracts, is also unlawful as it is forbidden by law and thus no legal rights flow from ULIP. 

This basically means that the subscribers will not be able to ventilate their grievances, for non-performance of its obligation by the insurance company under the ULIP before a court of law. A rule of equity might come to help the subscriber, but then it also another rule that law does not help those who knowingly enter into illegal agreements. Thus even the investors are here for a spin. To that extent one has to admit that the SEBI order is incomplete as it does not state the status of the ULIPs already subscribed to by the investors. It stops by saying that the order passed is "without prejudice to any action that might be taken by SEBI in respect of offer documents or advertisements issued by these entities for products (including ULIPs) having an investment component in the nature of mutual funds launched so far." Thus the status of the existing ULIPs depends upon further orders of SEBI and as to which side the camel will sit is anyone's guess. 

Post-script

The companies which are the subject-matter of the SEBI order are as follows;

a. Aegon Religare Life Insurance Company Limited
b. Aviva Life Insurance Company India Limited
c. Bajaj Allianz Life Insurance Company Limited
d. Bharti AXA Life Insurance Company Limited
e. Birla Sun Life Insurance Company Limited
f. HDFC Standard Life Insurance Company Limited
g. ICICI Prudential Life Insurance Company Limited
h. ING Vyasa Life Insurance Company Limited
i. Kotak Mahindra Old Mutual Life Insurance Limited
j. Max New York Life Insurance Co. Limited
k. Metlife India Insurance Company Limited
l. Reliance Life Insurance Company Limited
m. SBI Life Insurance Company Limited
n. TATA AIG Life Insurance Company Limited 

Latest Update

For further update on the Ordinance to resolve the tussle and our views on the same, have a look at the latest post.

Irregularity in parliamentary proceedings not subject to challenge: Constitutional Bench

Dismissing a writ petition filed before the Supreme Court challenging the proceedings undertaken by the Thirteenth Lok Sabha on the ground that the President has not addressed both Houses of Parliament as envisaged under Article 87 of the Constitution, a Constitutional Bench of five judges of the Supreme Court in a recent decision has declared that while there no such irregularity, in any case the irregularity in a parliamentary proceedings was not subject to review by the Courts.

Examining the constitutional set-up on the issue of address by the Parliament to the new sessions of the Parliament, the Bench made the following observations;

7. In the United Kingdom the Queen and two Houses of Parliament constitutes the Legislature so that the Queen is an integral part of the Legislature. 

8. In India the same model has been adopted. Article 79 of the Constitution provides that there shall be a Parliament for the Union, which consists of the President and the two Houses to be known respectively as the Council of the State and the House of the People. Article 83 (2) provides that the House of the People, unless sooner dissolved, shall continue for five years from the date appointed for its first meeting and no longer and the expiration of the said period of five years shall operate as a dissolution of the House, except during a proclamation of Emergency, the period of five years may be extended for a period not extending one year at a time, and not extending in any case beyond six months after such proclamation cease to operate. Under Article 85 (1), the President has to summon each House of the Legislature at such time and place as he thinks fit, so that six months do not intervene between its last sitting in one Session and its first sitting in the next. ...

9. Article 86 speaks about Right of the President to address and send messages to Houses.
10. The scheme of the Constitution, as is evident from the compendium of Articles referred to hereinabove, reveals that Union Parliament consists of the President and the Council of States and the House of the People unless dissolved earlier, the House of the People continues for five years from the date of its first meeting, and the expiration of five years operates as a dissolution of the House except that during proclamation of Emergency, the period of five years may be extended at a time not exceeding one year and not extending in any case beyond six months after such proclamation has ceased to operate. The President is under constitutional mandate to summon each House of the Parliament from time to time to meet at such time and place as he thinks fit. The President alone is vested with the power to summon the House from time to time and prorogue the House or either House; and to dissolve the House of the People. The President has a right to address either House or both the Houses together and for that purpose require the attendance of Members. He may send messages to either House of Parliament, whether with respect to a Bill then pending in Parliament or otherwise, and the House to which message is sent is required to take the same into consideration. ...

12. A plain reading of Article 87 clearly suggests that (a) the President shall address at the commencement of the first session after each general election to the House of the People; and (b) at the commencement of the first session of each year.

...

15. The words “first session of the year” employed in Article 87 (1) has no reference to resumption of the adjourned session. The session commences with the President’s summoning the House to meet. It is Article 85 which deals with the summoning of Sessions of Parliament, prorogation and dissolution of the House of People. The constitutional provision does not require summoning of every Session of Parliament which was adjourned for its own reasons after commencement of its Session pursuant to the summons of the President. It is only when a House is prorogued and a new Session thereafter summoned under Article 85 (2) of the Constitution, the special address by the President a provided for under Article 87 (1) is required with reference to the new Session so as to inform the Parliament of the cause of its summons. No such special address is needed, if a Sessions is adjourned sine die in the previous year and the sittings of the same Session is resumed in the next year. 

16.Articles 85 and 87 were amended so as to do away with the summoning of Parliament twice a year and the constitutional requirement of the President’s special address at the commencement of each Session. The present constitutional position is that not more than six months are to elapse between the last Session and the first day of the following Session. The House is now prorogued only once a year and the President addresses both Houses of Parliament only at the commencement of the first Session of each year. 

17.Article 87, as it originally stood, provided for the President’s address in ‘every Session of the year’. The first amendment in 1951 substituted the words “every Session” by “first Session of each year”. By the first amendment, Articles 85 and 174 were also amended.

The Bench also explained the difference between "Prorogation" and "Adjournment" in the following terms;

20. An adjournment is an interruption in the course of one and the same Session, whereas a prorogation terminates a Session. The effect of prorogation is to put an end with certain exceptions to all proceedings in Parliament then current. ...

23. It is thus clear that whenever the House resumes after it is adjourned sine die, its resumption for the purpose of continuing its business does not amount to commencement of the session.

Expressing its limitations, the Constitutional Bench further observed that "A plain reading of Article 122 [of the Constitution] makes it abundantly clear that the validity of any proceeding in the Parliament shall not be called in question on the ground of any irregularity of procedure. ... The petitioner is essentially raising a dispute as to the regularity and legality of the proceedings in the House of the People. The dispute raised essentially centers around the question as to whether the Speaker’s direction to resume sittings of the Lok Sabha which was adjourned sine die on 23rd December, 2003 is proper? The Speaker is the guardian of the privileges of the House and its spokesman and representative upon all occasions. He is the interpreter of its rules and procedure, and is invested with the power to control and regulate the course of debate and to maintain order. The powers to regulate Procedure and Conduct of Business of the House of the People vests in the Speaker of the House. ... Whether the resumed sittings on 29th January, 2004 was to be treated as the second part of the 14th session as directed by the Speaker is essentially a matter relating purely to the procedure of Parliament. The validity of the proceedings and business transacted in the House after resumption of its sittings cannot be tested and gone into by this Court in a proceeding under Article 32 of the Constitution of India." "31, 31. Under Article 122 (2), the decision of the Speaker in whom powers are vested to regulate the procedure and the Conduct of Business is final and binding on every Member of the House. ... No decision of the Speaker can be challenged by a member of the House complaining of mere irregularity in procedure in the conduct of the business. Such decisions are not subject to the jurisdiction of any Court and they are immune from challenge as understood and explained in Keshav Singh’s case and further explained in Indira Nehru Gandhi Vs. Raj Narain & Anr. It is a right of each House of Parliament to be the sole judge of the lawfulness of its own proceedings. The Courts cannot go into the lawfulness of the proceedings of the Houses of Parliament. wherein it was observed that “the House is not subject to the control of the courts in the administration of the internal proceedings of the House.” The Constitution aims at maintaining a fine balance between the Legislature, Executive and Judiciary. The object of the constitutional scheme is to ensure that each of the constitutional organs function within their respective assigned sphere. Precisely, that is the constitutional philosophy inbuilt into Article 122 of the Constitution of India."

Have a look at the decision.

No decision without proper assistance by lawyers: Supreme Court

Declaring that there is no obligation of a court to decide a case unless properly assisted by the Bar, the Supreme Court in a recent decision dismissed a writ petition inter alia holding that the counsel was not able to show how it was maintainable or carried merit. In this background, the Bench took opportunity to cull out the legal principles in regard to the Courts being assisted by the lawyers for effective adminstration of the justice delivery system.

The Court observed as under;

11. In Thakur Sukhpal Singh Vs. Thakur Kalyan Singh & Anr., AIR 1963 SC 146, this Court has held that in absence of proper assistance to the Court by the lawyer, there is no obligation on the part of the Court to decide the case, for the simple reason that unless the lawyer renders the proper assistance to the Court, the Court is not able to decide the case. It is not for the Court itself to decide the controversy. The counsel cannot just raise the issues in his petition and leave it to the Court to give its decision on those points after going through the record and determining the correctness thereof. It is not for the Court itself to find out what the points for determination can be and then proceed to give a decision on those points. 

12. While deciding the said case, this Court placed reliance upon the judgment of Privy Council in Mst. Fakrunisa & Ors. Vs. Moulvi Izarus Sadik & Ors., AIR 1921 PC 55 wherein it had been observed as under:–
“In every appeal it is incumbent upon the appellants to show some reason why the judgment appealed from should be disturbed; there must be some balance in their favour when all the circumstances are considered to justify the alteration of the judgment that stands. Their Lordships are unable to find that this duty has been discharged.”
13. In The Bar Council of Maharashtra Vs. M. V. Dabholkar & Ors. AIR 1976 SC 242, this Court had observed as under :- “Be it remembered that the central function of the legal profession is to promote the administration of justice. If the practice of law is thus a public utility of great implications and a monopoly is statutorily granted by the nation, it obligates the lawyer to observe scrupulously those norms which make him worthy of the confidence of the community in him as a vehicle of justice – social justice ... Law is no trade, briefs no merchandise.”
14. In T.C. Mathai & Anr. Vs. District & Sessions Judge, Thiruvananthapuram AIR 1999 SC 1385, this Court observed: “The work in a Court of law is a serious and responsible function. The primary duty of a.......court is to administer.......justice. Any lax or wayward approach, if adopted; towards the issues involved in the case, can cause serious consequences for the parties concerned........In the adversary system which is now being followed in India, both in civil and criminal litigation, it is very necessary that the Court gets proper assistance from both sides……………. Efficacies discharge of judicial process very often depends upon the valuable services rendered by the legal profession” 

15. In D.P. Chadha Vs. Triyugi Narain Mishra & Ors., AIR 2001 SC 457, this Court has observed as under:– “..........Mutual confidence in the discharge of duties and cordial relations between Bench and Bar smoothen the movement of the chariot. As responsible officers of the Court, as they are called ---- and rightly, the counsel have an overall obligation of assisting the Courts in a just and proper manner in the just and proper administration of justice.”
16. Thus, in view of the above, law can be summarised to the effect that, in case, the counsel for the party is not able to render any assistance, the Court may decline to entertain the petition. 

17. There is another aspect of the matter. In case, petitioner’s counsel is not able to raise a factual or legal issue, though such a point may have a good merit, the Court should not decide the same as the opposite counsel does not “have a fair opportunity to answer the line of reasoning adopted” in this behalf. Such a judgment may be violative of principles of natural justice. (vide New Delhi Municipal Committee vs. State of Punjab AIR 1997 SC 2847).
18. While dealing with a similar issue, this Court in Re: Sanjiv Datta (1995) 3 SCC 619 observed as under:- “Of late, we have been coming across several instances which can only be described as unfortunate both for the legal profession and the administration of justice. It becomes, therefore, our duty to bring it to the notice of the  members of the profession that it is in their hands to improve the quality of the service they render both to the litigant-public and to the courts, and to brighten their image in the society. Some members of the profession have been adopting perceptibly casual approach to the practice of the profession as is evident from their absence when the matters are called out, the filing of  incomplete and inaccurate pleadings — many times even illegible and without personal check and verification, the non-payment of court fees and process fees, the failure to remove office objections, the failure to take steps to serve the parties, et al. They do not realise the seriousness of these acts and omissions. They not only amount to the contempt of the court but do positive disservice to the litigants and create embarrassing situation in the court leading to avoidable unpleasantness and delay in the disposal of matters. This augurs ill for the health of our judicial system……. The legal profession is different from other professions in that what the lawyers do, affects not only an individual but the administration of justice which is the foundation of the civilised society.”

Have a look at the decision.

Remedy under Article 32: The law revisited

Dr. Ambedkar, the person who is attributed with the fatherly rights over the Constitution of India, declared at the time of adoption of the Constitution that if there was one most important provision in the Constitution, it was Article 32 thereof. This Article 32 confers the right to every citizen to approach the highest court of the country i.e. the Supreme Court of India, for enforcement of his fundamental rights. The scheme of the Constitution is such that the right to approach to the Supreme Court for such cause is in itself a fundamental right.


Explaining the significance and the ambit of the rights available to the citizens to approach the Supreme Court directly in matters affecting the exercise of fundamental rights guaranteed by the Constitution, the Supreme Court in a recent decision [Poonam v. Sunil Talwar] discussed the scope of Article 32 of the Constitution granting such right.

The Bench explained the provision, inter alia as under;

7. The citizens are entitled to appropriate relief under the provisions of Article 32 of the Constitution, provided it is shown to the satisfaction of the Court that the Fundamental Right of the petitioner had been violated. (Vide Daryao & Ors. Vs. State of U.P. & Ors. AIR 1961 SC 1457). This Court has a constitutional duty to protect the Fundamental Rights of Indian citizens. (Vide M.C. Mehta Vs. Union of India AIR 2006 SC 1325). The distinction in a Writ Petition under Article 226 and Article 32 of the Constitution is that the remedy under Article 32 is available only for enforcement of the Fundamental Rights, while under Article 226 of the Constitution, a Writ Court can grant relief for any other purpose also. (Vide A.K. Gopalan Vs. State of Madras AIR 1950 SC 27; Bhagwandas Gangasahai Vs. Union of India & Ors. AIR 1956 SC 175; Kalyan Singh Vs. State of Uttar Pradesh & Ors. AIR 1962 SC 1183; Fertilizer Corporation Kamagar Union, Sindri & Ors. Vs. Union of India & Ors. AIR 1981 SC 344). Even if it is found that injury caused to the writ petitioner alleging violation of Fundamental Right is too indirect or remote, the discretionary writ jurisdiction may not be exercised as held by this Court in State of Rajasthan & Ors. Vs. Union of India AIR 1977 SC 1361. 

8. More so, a writ lies only against a person if it is a statutory body or performs a public function or discharges a public or a statutory duty, or a “State” within the meaning of Article 12 of the  Constitution. (Vide Anandi Mukta Sadguru Trust Vs. V.R. Rudani AIR 1989 SC 1607; VST Industries Ltd. Vs. VST Industries Workers’ Union & Anr. (2001) 1 SCC 298; and State of Assam Vs. Barak Upatyaka U.D. Karamchari Sanstha AIR 2009 SC 2249).

9. It is settled legal proposition that the remedy of a person aggrieved by the decision of the competent judicial Tribunal is to approach for redress a superior Tribunal, if there is any, and that order cannot be circumvented by resorting to an application for a writ under Article 32 of the Constitution. Relief under Article 32 can be for enforcing a right conferred by Part III of the Constitution and only on the proof of infringement thereof. If by adjudication by a Court of competent jurisdiction, the right claimed has been negatived, a petition under Article 32 of the Constitution is not maintainable. It is not generally assumed that a judicial decision pronounced by a Court may violate the Fundamental Right of a party. Judicial orders passed by the Court in or in relation to proceeding pending before it are not amenable to be corrected by issuing a writ under Article 32 of the Constitution. (Vide Sahibzada Saiyed Muhammed Amirabbas Abbasi & Ors. Vs. the State of Madhya Bharat (now Madhya Pradesh) & Ors. AIR 1960 SC 768; Smt. Ujjam Bai Vs. State of Uttar Pradesh & Anr. AIR 1962 SC 1621; and Naresh Shridhar Mirajkar Vs. State of Maharashtra AIR 1967 SC 1)

Have a look at the decision.