On-Demand Bank Guarantees: When Can Encashment Be Restrained?

A supplier may believe that the employer has wrongfully terminated a contract. A contractor may have substantial claims for unpaid milestones and extensions of time. Yet the beneficiary may still be entitled to demand payment under an unconditional bank guarantee before those underlying claims are determined.

The apparent harshness of that result reflects a deliberate feature of commercial security: the issuing bank's obligation is normally independent of the dispute between the parties to the principal contract.

Begin with the guarantee, not the underlying dispute

A performance guarantee and the principal construction or supply contract are different legal instruments. The guarantee should be examined on its own terms: the named beneficiary, issuing bank, demand conditions, amount, expiry, required documents and whether the undertaking is conditional or unconditional.

If an instrument obliges the bank to pay on demand without proof of breach, it may not be possible to resist payment by arguing that the employer is at fault or that an extension of time should have been granted. Those allegations may support a separate contractual claim, but they do not necessarily affect the bank's promise.

The form of the instrument matters. A conditional guarantee requiring proof or certification of defined events is different from an autonomous undertaking payable against a conforming demand. A legal opinion that treats all guarantees as identical is unlikely to be reliable.

The Supreme Court's autonomy principle

In *Shipyard K. Damen International v Karachi Shipyard and Engineering*, PLD 2003 SC 191, the Supreme Court considered applications to restrain encashment of performance bank guarantees arising from supply contracts. It affirmed the independent and autonomous character of unconditional guarantees and the limited grounds on which courts should interfere.

The fact that the underlying contract was disputed, or that arbitration was contemplated or pending, did not of itself justify restraining the beneficiary's call.

The Court recognised the exceptional relevance of fraud and circumstances amounting to irretrievable injustice or special equities. Those expressions describe a narrow jurisdiction; they should not be presented as routine alternatives whenever a contractor alleges a wrongful call.

Fraud must be directed at the relevant demand

A general assertion that the employer has acted unfairly does not establish the kind of fraud capable of affecting an independent bank obligation. The evidence should identify the alleged misrepresentation or dishonest act, its connection with the demand and the knowledge or notice relevant to the issuing bank.

The burden cannot be met through allegations alone. A disagreement over whether work was completed, whether defects exist or whether liquidated damages are payable remains, ordinarily, an underlying contractual controversy.

Similarly, irretrievable injustice should not be equated with serious financial inconvenience. Paying under a guarantee may cause a contractor immediate strain. That consequence is inherent in the commercial instrument. The exceptional ground demands substantially more than the possibility that later recovery may be difficult.

The specific wording and factual basis must therefore be assessed before seeking urgent relief.

A demand can still fail to comply with the guarantee

Autonomy does not authorise a beneficiary to ignore the terms of the instrument. A demand may be defective because it is made after expiry, exceeds the available amount, is addressed or executed incorrectly, omits a required declaration or concerns an instrument that was validly discharged.

For this reason, one of the first steps is to obtain the complete guarantee, extensions, amendments and the actual demand notice. Correspondence about whether the underlying contract has been performed should be considered separately.

The issuing bank's examination of documents differs from the project owner's determination of breach. Conflating these processes can lead to a misdirected injunction application.

Taking-over and expiry of defects periods

Construction disputes often arise because a beneficiary continues to hold security after taking-over of the works or after a contract milestone has been achieved. The contractor may say that the security should have been reduced or returned; the employer may rely on pending defects or unresolved payment claims.

The legal position depends on the executed contract and the guarantee. Taking-over is not necessarily the same as final completion, and neither event automatically determines the bank's obligations under an independently drafted security instrument.

If the contract required reduction or release of security, failure to comply may produce an enforceable claim against the employer. But a claim for return of security is distinct from a ground capable of restraining a conforming demand to the issuing bank.

The chronology of taking-over certificates, defects notices, completion certificates, release obligations and extensions to the guarantee should be examined closely.

The relationship with injunction law

An urgent application may invoke Order XXXIX of the Code of Civil Procedure, 1908 and the appropriate substantive relief. Even where ordinary considerations concerning a prima facie case, balance of convenience and irreparable harm are put forward, the special jurisprudence governing unconditional bank guarantees must be confronted.

The Supreme Court's decision in *M/s Sazco (Pvt) Ltd v Askari Commercial Bank Ltd*, reported as 2021 SCMR 558, concerns documentary letters of credit rather than performance guarantees. It reinforces the importance of the autonomy principle and the strict evidentiary burden where documentary fraud is alleged. It should not be described as a decision on every type of guarantee.

An applicant who relies only on the merits of the underlying arbitration may therefore fail to address the decisive legal issue.

Contract drafting before the dispute

The most reliable protection often lies in negotiating appropriate security terms before the project begins. Parties should consider whether the amount is proportionate, when it is reduced, what event triggers release, whether demand must contain a specified certification and how the expiry aligns with the contract programme.

An employer seeking genuine security may not accept a conditional instrument. That is a commercial negotiation. A contractor who accepts an unconditional demand guarantee should understand that it has exchanged some immediate control over its funds for access to the underlying transaction.

The remedy after payment

Payment by a bank does not finally decide responsibility under the principal contract. The contractor may still pursue damages, repayment or other contractual relief through arbitration or litigation, as applicable. The case will require proof of the employer's breach and the amount recoverable, regardless of the bank's obligation to honour the demand.

In assessing the commercial choice, the company should compare the realistic prospects of stopping the demand with the evidence needed for a subsequent recovery claim.

The key question is not whether the call is perceived to be unjust. It is whether the instrument is conditional, whether the demand conforms to it, and whether the exceptional legal basis for court interference is properly established.