Court Refuses to Restrain Encashment of Letter of Credit Due to COVID-19 Lockdown
This article has been written by Mani Gupta and Shelja Pradhan and first appeared on the IndiaCorpLaw Blog (here).
In Standard Retail Private Limited v. G.S. Global Corp (8 April 2020), the High Court of Bombay has pronounced possibly one of the first orders interpreting the impact of force majeure clauses on parties’ contractual obligation due to COVID-19. In this case, the petitioners (who were steel importers) had filed an application under section 9 of the Arbitration and Conciliation Act, 1996, seeking directions restraining the respondent banks from encashing letters of credit. The sellers had already shipped the steel and steel products from South Korea.
The Court rejected the ad interim reliefs as prayed. The High Court noted the terms of the force majeure (“FM”) clause in the agreement between the parties as well as the notifications issued by the Government of India (“GOI”) relating to the lock-down and operations of ports.[i]
The High Court refused to grant the ad interim relief for several reasons. First, the Court reasoned that letters of credit are an independent transaction with the banks, and that the banks are not concerned with the dispute between the buyer and the seller. Secondly, the FM clause in the contract is applicable only to the seller (in this case, the respondents) and the buyer cannot invoke the same. The FM clause has been set out and discussed in detail below. Thirdly, the contracts between the parties were concluded on cost and freight (“CFR”) basis. The respondent-exporter had performed its part of the contract as the goods had already been shipped from South Korea to Mumbai. The inability of the petitioners to perform their obligations under the contract and consequential damages cannot be a matter of concern in directing the banks not to encash the letters of credit. Fourthly, the notification of Director General of Shipping, GOI states that there is no restriction on import and export of steel products and it is included in essential services. Fifthly, the lockdown is for a limited period and the petitioner cannot abandon from its contractual obligations on the basis of this pandemic. Lastly, the Hight Court also held that the reliance on the Supreme Court’s judgments of Energy Watchdog v. CERC (2017) and Satyabrata Ghose v. Mugneeram Bangur & Co. (1954) was misplaced and that those judgments are distinguishable on facts.
By refusing to grant an injunction against a letter of credit (which in some sense is akin to bank guarantees), the High Court has created the right precedent. The law relating to grant of injunction on letters of credit in India is the same as those relating to bank guarantees. The two grounds on which injunction may be granted are: (a) fraud of an egregious nature, which vitiates the agreement between the parties; and (b) special equities.[ii] In judgments relating to bank guarantees, courts have held that financial hardship is not a special equity.[iii]
Further, this order also highlights that neither of the three conditions: (a) presence of a FM clause in the contract, by itself; (b) the lock-down; and (c) COVID-19, by themselves would be sufficient to suspend contractual obligations or to rely on section 56 of the Indian Contract Act, 1872 (if applicable). In this case, the FM clause was as follows:
“Article 11. Force Majeure: In the event of an Act of God (including but not limited to floods, earthquake, typhoons, epidemics and other natural calamities), war or armed conflict or serious threat of the same, government order or regulation, labor dispute or any other similar cause beyond the control of “Seller” or any of its suppliers or sub-contractors which seriously affects the ability of “Seller” or any of its suppliers or sub-contractors to manufacture and deliver the “Goods”, “Seller” may, at its sole discretion and upon written notice to “Buyer” either terminate the Contract or any portion affected thereof by such event(s), or delay performance of the Contract, in whole or in part, for a reasonable period of time. Any such delay of performance by “Seller” shall not preclude “Seller’s” later right to terminate the Contract or any portion affected thereof by such event(s). In no event shall “Seller” be liable to “Buyer” or to any third party for any costs or damages arising indirectly or consequentially from such non-fulfillment of or delay in the performance of all or part of the Contract”
A perusal of the above clause clearly shows that although the contract parties had foreseen epidemics as a force majeure, it was only the seller (in this case, the respondent) who could rely on the same, if such event had a serious effect on the ability of the seller to manufacture and deliver the goods. None of these foreseeable events of force majeure allowed the buyer to terminate or suspend its obligation under the agreement between the parties.
Further, as discussed in an earlier post here, the threshold for invoking the doctrine of frustration is set high under Indian common law and parties would have to demonstrate that it is impossible to perform the contract or that the basis of the contract between the parties has been destroyed. In this case, it would be difficult to prove for the petitioners that (a) it is impossible (and not merely, difficult) for them to pay for the goods imported; and (b) the substance of the contract between the parties has been obliterated – as the goods were already shipped from South Korea. From the reported order, it is difficult to ascertain what the detailed grounds and pleadings for invoking the doctrine of frustration are, but in a situation of this sort it would be difficult to argue that the contract is void on account of frustration particularly from the buyer’s perspective as banking operations in India continue unabated. Further, any difficulty in further resale of an imported good would be the subject matter of an independent contract and, therefore, the doctrine of frustration would not be available to the contract of import of goods.
This order would also comfort international parties dealing with Indian counterparties as it points to upholding settled principles of law instead of domestic protectionism in light of a global pandemic. This order should also caution contract parties from thinking that courts would come to their rescue from an unfavorable bargain on the pretext of COVID-19.
[i] The order does not specifically state which notifications were relied on by the respondents. However, reference maybe made to Ministry of Home Affairs’ Order No. 40-3/2020-DM-I(A) dated 24 March 2020, as amended by Order dated 25 March 2020, as also Guidelines dated 31 March 2020 issued by the Ministry of Shipping, GOI.
[ii] As to the nature of irretrievable injury or special equities, see: Dwarikesh Sugar Industries Limited v. Prem Heavy Engineering Works (P) Limited (1997), para 22.