SUPREME COURT OF INDIA

Before:- S.P. Bharucha and M. Jagannadha Rao, JJ.

Civil Appeal Nos. 3052 with 3053 of 1984. D/d. 5.5.1998.

Makharia Brothers - Appellants

Versus

State of Nagaland and others - Respondents

Contract Act, 1872, Section 126 - Contract - Enforcement of claim under Bank guarantee - Bank guarantee has to be read in conjunction with the terms of contract - Bank guarantee to remain in force up to date stated therein and it was to be enforceable for period of six months thereafter - Failure of contractor to extend terms of bank guarantee till all the dues of State under contract had been fully paid - Suit by State asking for decree of specific performance - No bank can be compelled to furnish a bank guarantee without adequate funds to fall back upon should the bank guarantee have to be honoured - When the contractor declined to extend the terms of the bank guarantee, the proper course for State was to terminate contract on grounds of breach of terms thereof.

[Paras 6 and 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 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 the Bank guarantee in the event of earlier termination or rescission of the contract agreement.

(ii) declaration that the bank guarantee executed and furnished shall continue to remain valid and enforceable until the expiration of the period as mentioned in earlier declaration.

(iii) grant of permanent injunction against the defendant restraining them from forfeiting, releasing and discharging the bank guarantee and directing the defendants to continue to hold the bank guarantee as an enforceable and effective bank guarantee to be made available to the plaintiff for enforcement as and when demanded until it is certified by the Government that the terms and conditions of the agreement have been fully and properly discharged by the said defendant No. 1."

5. The trial Court decreed the suit against the contractor and the bank and its decision was confirmed by the judgment and order of the High Court which is under appeal. The High Court took the view that the suit as filed could not be stated to be unconnected with the enforcement of the claim under the bank guarantee. It said that it was apparent that, without extension of the bank guarantee, the amount covered by it would not be available to the State for the purpose for which the security deposit was required. As the contractor and the bank had refused to make the bank guarantee enforceable till all the dues of the State under the contract had been fully paid and its claim satisfied or discharged, the suit filed for extending the period of the bank guarantee as mentioned in the plaint had to be regarded as an action "to enforce claim under the guarantee".

6. The terms of the bank guarantee are explicit. The bank guarantee was to remain in force and effect only up to the date stated therein or any extended date and it was to be enforceable for a period of 6 months thereafter. The bank guarantee stated that unless a suit or action to enforce the claim under it was filed within 6 months from the date of its expiry, all the State's rights under the bank guarantee would stand forfeited and the bank would be released and discharged from all liabilities thereunder. There was, therefore, in our view, no way in law in which it could be declared 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 or an injunction could issue to the bank to so renew the period of the bank guarantee. It is correct, as argued by learned counsel for the State that bank guarantee has to be read in conjunction with the terms of the contract in pursuance of which it is issued, but that is not to say that the rights and obligations of the contractor at whose instance the bank guarantee is issued become the rights and obligation of the bank. It needs to be remembered that a bank guarantee is issued by a bank after the party at whose instance it is issued has put the banks in funds. No bank can be compelled to furnish a bank guarantee without adequate funds to fall back upon should the bank guarantee have to be honoured.

7. The contractor was obliged under the terms of the contract to furnish to the State security in the sum of Rs. 2, 87,800/- for due performance of its obligations. By reason of Clause 5.3 of the contract, the contractor could, in lieu of a cash deposit, furnish a bank guarantee. It was, under the terms of that clause, open to the Chief Engineer of the State to direct extension of the period of the bank guarantee. The State could, therefore, require the contractor to furnish the security deposit in cash or by way of a bank guarantee that would cover the period of the contract. The question is what was its remedy against the contractor when the contractor failed to furnish the security deposit in cash or, in lieu thereof, by a bank guarantee. The State could not have filed a suit requiring the contractor to do these things for it would have been tantamount to asking for a decree of specific performance, a decree 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. When the contractor declined to extend the terms of the bank guarantee, the proper course for the State was to terminate the contract on the ground of breach of the terms thereof as aforestated, make a claim for damages and recover on the bank guarantee, if necessary by filing a suit.

8. The suit that was filed by the State was misconceived, both against the bank and the contractor. The appeals must, therefore, succeed. The judgment and order under appeal is set aside and the suit dismissed.

9. No order as to costs.

Appeal allowed.