Principle of Fair Invocation of Bank Guarantees by State Instrumentalities Pending Arbitration

1. Introduction

This commentary examines the Kerala High Court’s decision in Flemingo (DFS) Private Limited v. Airports Authority of India (WP(C) Nos. 24021/2023 & 7025/2025, dated April 11, 2025), where the court addressed the legality and fairness of encashing bank guarantees furnished under airport duty‑free shop licences while arbitration proceedings were pending. The key parties were:

• Petitioner: Flemingo (DFS) Pvt. Ltd., operator of duty‑free shops at Trivandrum and Calicut airports.
• Respondent: Airports Authority of India (AAI), a statutory instrumentality formed under the Airports Authority of India Act, 1994.

Flemingo had furnished two irrevocable bank guarantees totaling Rs. 3.96 crores in favour of AAI. Disputes arose over licence fees, arbitration was initiated, and interim stays were granted and subsequently lapsed. AAI encashed the guarantees, prompting these writ petitions under Article 226 of the Constitution.

2. Summary of the Judgment

The High Court addressed two threshold issues:

1. Whether Flemingo could maintain a writ petition against the Commercial Court’s closure of its Section 9 application (interim injunction) in arbitration proceedings.
2. Whether AAI was justified in invoking the bank guarantees after interim stays lapsed.

The court held:

• The order closing the Section 9 petition was not an appealable refusal under Section 37 of the Arbitration and Conciliation Act, 1996 (“Act”) and thus could be challenged by way of a writ petition.
• AAI, as a State instrumentality, must act “fairly, justly and reasonably” (per ABL International Ltd.). Although bank guarantees are ordinarily invocable without inquiry into underlying disputes, an exception arises where invocation amounts to unfairness—in this case, because a sole arbitrator had been validly appointed (order of June 21, 2024) and the invocation prejudiced Flemingo’s right to arbitration.

Remedy granted: AAI must deposit the amounts realized on the two guarantees in an interest‑bearing fixed deposit pending the outcome of the arbitration challenge before the Supreme Court.

3. Analysis

3.1. Precedents Cited

• High Court Bar Association, Allahabad v. State of U.P. [(2024) 6 SCC 267]: Courts cannot automatically vacate interim orders on lapse of time without hearing the beneficiary, endorsing the maxim actus curiae neminem gravabit.
• Harihar Collections v. Union of India [(2020) Bom 1622]: Encashment during pendency of stay challenged as unfair where the matter was under judicial consideration.
• U.P. State Sugar Corporation v. Sumac International Ltd.: Interim injunctions against bank guarantee invocation only in cases of fraud or extreme injustice.
• Abl International Ltd. v. Export Credit Guarantee Corporation Of India Ltd. [(2004) 3 SCC 553]: State entities must act fairly and reasonably in contractual dealings.
• Other arbitration appeals jurisprudence: PHR INVENT EDUCATIONAL SOCIETY v. UCO BANK, Himadri Chemicals Industries Ltd., Vinitec Electronics Pvt. Ltd., Gujarat Maritime Board v. Larsen & Toubro, Andhra Pradesh Pollution Control Board v. CCL Products, Standard Chartered Bank v. Heavy Engineering Corporation.

3.2. Legal Reasoning

The court’s reasoning unfolded as follows:

1. Maintainability of Writ: The Commercial Court’s order “closing” the Section 9 petition was neither a grant nor a refusal of an interim measure under Section 9 of the Act and hence not appealable under Section 37. Article 226 jurisdiction was properly invoked.
2. Fairness in Invocation: While bank guarantees are ordinarily invocable without judicial scrutiny of disputes, AAI’s invocation after a valid sole arbitrator was appointed (though stayed by the Supreme Court) created an unfair outcome. The principle from ABL International imposes a heightened duty of fairness on State instrumentalities.
3. Equitable Relief: In exercise of writ jurisdiction, the High Court directed AAI to park the invoked amounts in an interest‑bearing fixed deposit, preserving the status quo until final adjudication.

3.3. Impact on Future Cases

This judgment establishes that:

• State instrumentalities invoking bank guarantees during arbitration must ensure no unfair prejudice to the guarantor, especially where arbitrators have been validly appointed.
• Courts will scrutinize automatic invocation by public bodies to uphold Article 14 fairness.
• Interplay of Section 9 (interim measures) and writ remedies under Article 226 is clarified—orders “closing” Section 9 petitions can be challenged directly in High Courts.

4. Complex Concepts Simplified

• Bank Guarantee: An irrevocable commitment by a bank to pay a beneficiary if the guarantee’s principal fails its contractual obligations.
• Section 9, Arbitration & Conciliation Act: Empowers courts to grant interim reliefs (e.g., injunctions, attachment) before or during arbitration.
• Section 11(6): Procedure for appointing arbitrators by courts when parties cannot agree.
• Section 37: Identifies orders appealable to higher courts—refusals/grants under Section 9 are appealable; mere “closures” are not.
• Article 226: High Courts’ power to issue writs for enforcement of fundamental rights or for any other purpose.
• Actus Curiae Neminem Gravabit: “An act of the court shall prejudice no one.” Courts must not harm litigants by procedural lapses.

5. Conclusion

The Kerala High Court’s decision in Flemingo v. AAI crystallizes a new principle: public bodies must invoke bank guarantees in a manner consistent with fair play, particularly when arbitration mechanisms are in place. By channeling the invoked funds into an interest‑bearing deposit, the court preserved the guarantor’s rights without undermining the beneficiary’s security, striking a balance between contractual certainty and constitutional fairness. This precedent will guide future disputes involving arbitration interim measures and enforcement of financial securities by State entities.