ISSUES ARISING OUT OF GUARANTEES IN INDIA

We would like to elaborate the situation prevailing in India at the moment regarding the provision of Guarantees by Indian nationals / entities to foreign persons / entities.

The concerned legislation is the Foreign Exchange Management Act, 1999 (herein after referred to as “FEMA”) that is an Act of Parliament which was enacted to consolidate and amend the law relating to foreign exchange with the objective of facilitating external trade and payments and to promote the orderly development and maintenance of the foreign exchange market in India.

Under the FEMA, the Government has enacted the Foreign Exchange Management (Guarantees) Regulations, 2000 (herein after referred to as the “Regulations”), which deals specifically with the giving of corporate and other guarantees by Indians to overseas citizens / entities.

Clause 3 of the Regulations reads as under:

“3. Save an otherwise provided in these regulations, or with the general or special permission of the Reserve Bank, no person resident in India shall give a guarantee or surety in respect of, or undertake a transaction, by whatever name called, which has the effect of guaranteeing, a debt, obligation or other liability owed by a person resident in India to, or incurred by, a person resident outside India.”

The regulations then go on to state situations where a Bank (also called an Authorised Dealer) can issue guarantees, with which we are not concerned. However, clause 5 of the Regulations is pertinent to our case and the relevant extract is as under:

“Guarantees which may be given by persons other than an authorised dealer.

5. A person other than an authorised dealer may give a guarantee in the following cases, namely:

(a)…

(b)…

(c)…

(d)…

(e) a bank which is an authorised dealer may, subject to the directions issued by the Reserve Bank in this behalf, permit a person resident in India to issue corporate guarantee in favour of an overseas lessor for financing import through operating lease effected in conformity with the Foreign Trade Policy in force and under the provisions of the Foreign Exchange Management (Current Account Transactions) Rules, 2000 framed by Government of India vide Notification No. G.S.R. 381 (E), dated May 3, 2000 and the Directions issued by Reserve Bank under Foreign Exchange Management Act, 1999 from time to time.”

Further, the Reserve Bank of India has issued directions called the “External Commercial Borrowings Policy – Liberalisation Issue of Guarantee for operating lease” which is also pertinent to our case and reads as under:

“Attention of Authorized Dealer Category – I (AD Category –I) banks is invited to A. P. (DIR Series) Circular No. 24 dated March 1, 2002, in terms of which AD Category – I banks have been permitted to allow payment of lease rentals, opening of letters of credit towards security deposit, etc. in respect of import of aircraft / aircraft engine / helicopter on operating lease basis subject to conditions mentioned therein. Further, in terms of A. P. (DIR Series) Circular No.01 dated July 11, 2008, as a measure of rationalization of the existing procedures, AD Category – I banks have been allowed to convey ‘no objection’ under the Foreign Exchange Management Act (FEMA), 1999 for creation of charge on immovable assets, financial securities and issue of corporate or personal guarantees in favour of overseas lender / security trustee, to secure the ECB to be raised by the borrower, subject to compliance of prescribed conditions.

2. As a further measure of rationalization, it has been decided to allow AD Category – I banks to convey ‘no objection’ from the Foreign Exchange Management Act (FEMA), 1999 angle for issue of corporate guarantee in favour of the overseas lessor, for operating lease in respect of import of aircraft / aircraft engine / helicopter.
3. The ‘no objection’ to the Indian importer for issue of corporate guarantee under FEMA, 1999 may be conveyed after obtaining –

 (i) Board Resolution for issue of corporate guarantee from the company issuing such guarantees, specifying names of the officials authorised to execute such guarantees on behalf of the company.


(ii) Ensuring that the period of such corporate guarantee is co-terminus with the lease period.

4. AD Category – I banks may invariably specify that the ‘no objection’ is issued only from the foreign exchange angle under the provisions of FEMA, 1999 and should not be construed as an approval by any other statutory authority or Government or any other laws / regulations. If further approval or permission is required from any other regulatory / statutory authority or Government under the relevant laws / regulations, the applicant should take the approval of the authority concerned before undertaking the transaction. Further, the ‘no objection’ should not be construed as regularizing or validating any irregularities, contravention or other lapses, if any, under the provisions of FEMA or any other laws or regulations.
5. This shall come into force with immediate effect and will be subject to review from time to time.

6. AD Category – I banks may bring the contents of this circular to the notice of their constituents and customers concerned.
7. Necessary amendment to the Notification No. FEMA 8/2000-RB dated May 3, 2000 [Foreign Exchange Management (Guarantees) Regulations, 2000] is being issued separately. 

8. The directions contained in this circular have been issued under Sections 10(4) and 11 (1) of the Foreign Exchange Management Act, 1999 (42 of 1999) and is without prejudice to permissions/approvals, if any, required under any other law.”

Going further, various Courts of law in India have interpreted these Regulations however, not in the context of the leasing of aircraft, however, the same interpretation would apply to us, in case of any dispute reaching a Court of law in India.

The Bombay High Court[1], while dealing with a similar case where the Petitioner was contending that no permission had been sought by it of the Reserve Bank and thus the Guarantees were void, has held:

“151. A perusal of the judgment of the Division Bench in case of Videocon Industries Limited (supra) makes it clear that the Division Bench had considered the similar issue in the said judgment. The appellant before the Division Bench had issued a patronage letter which was in the nature of a deed of guarantee. The respondent in the said proceedings had filed a winding up petition against the appellant based on such deed of guarantee against the appellant. One of the issue raised by the appellant in those proceedings was that the said letter of guarantee patronage letter was issued in breach of the statutory provisions under the Foreign Exchange Management Act, 1999 and the said Foreign Exchange Rules 2000, no such letter of guarantee could have been enforced by the respondent. Considering these arguments and the issue raised by the parties, the Division Bench of this court has after dealing with section (3) of FEMA and also regulation 3 of the Foreign Exchange Management (Guarantees) Regulation, 2000, has categorically held that the word “or with the general or special permission of Reserve Bank” cannot be construed as prior permission of the Reserve Bank. It is held that where the Regulations contemplate that prior permission or prior approval of the Reserve Bank is required to be obtained, it was so specified.

152. The Division Bench considered regulation 3(a) and accordingly held that it could not be said that the said letter of guarantee (patronage letter) could not be issued without prior approval or prior special permission of the Reserve Bank. Division Bench in the said judgment also considered the judgment of Delhi High Court in case of SRM Exploration Pvt. Ltd. (supra) and has held that in matters of commercial transactions involving crores of amount where the company facing winding up proceedings had stood as a guarantor, if any such defence were to be accepted, the court would be giving a wrong signal and dissuading foreign commercial entities from relying on the guarantees given by Indian Companies and which would ultimately undermine the role of India, the world of trade and commerce. This court also considered the conduct of the appellant by holding that the defence now raised by the appellant that the said patronage letter was issued in contravention of provisions of FEMA or in breach of any other requirements was only after receiving statutory notice i.e. after almost four years of issuance of the patronage letter. It is held that even if the appellant therein had committed any wrong in issuing the patronage letter without obtaining permission of the Reserve Bank, as per the settled legal position, it was not open to a party to take advantage of its own wrong. In my view, the judgment of the Division Bench in case of Videocon Industries Ltd. (supra) squarely applies to the facts of this case. Division Bench has already interpreted the regulation of Foreign Exchange Management (Guarantees) Regulation, 2000 and has also considered the conduct of the appellant who had not raised any such objections for several years and has held that no such prior permission of the Reserve Bank was required for issuing such letter of guarantee. In this case also the petitioner did not raise any such objection for several years though had participated in the negotiations for execution of charter party agreement and also themselves had issued letter of guarantee.
153. In so far as submission of Mr.Makhija, learned counsel for the petitioner now raised when this judgment of Division Bench of this court in case of Videocon Industries Limited (supra) is brought to his notice that even such letter of guarantee could not have been executed at all and the same was in violation of the provisions of the said Foreign Exchange Management (Guarantees) Regulation, 2000 is concerned, in my view the petitioner had never raised such issue at any stage earlier. Be that as it may, the petitioner not having raised any such objection for last several years after executing the letter of guarantee in favour of the respondent and was fully aware of the provisions of Indian law and had acted upon such letter of guarantee cannot be allowed to raise such issue at this stage. I am thus not inclined to accept the submission of Mr. Makhija, learned counsel that no such guarantee could have been executed by the petitioner at all under any of the provisions of the said Foreign Exchange Management (Guarantees) Regulation, 2000.
154. In my view since no prior permission of the Reserve Bank or any other authority was required under the provisions of Foreign Exchange Management (Guarantees) Regulation, 2000 or there was no prohibition from issuing such letter of guarantee under the said regulation and the petitioner not having raised such issue prior to the date of filing their objections before the arbitral tribunal from the date of execution of such letter of guarantee, the recognition and enforcement of foreign award in question cannot be denied. In my view even if prior permission of the Reserve Bank would have been required which was admittedly not obtained by the petitioner before execution of such guarantee, the recognition and enforcement of such foreign award based on such guarantee would not be contrary to fundamental policy of Indian Law and would also not be contrary to the interest of India or justice of morality.”

Further, a Division Bench of the Bombay High Court[2] has held that the words if Clause 3 of the Regulation, i.e. “or with the general or special permission of Reserve Bank” cannot be construed as prior permission of the Reserve Bank. The relevant extract reads as under:

“28. Section 3 of the FEMA by itself does not contain any prohibition against issuance of any letter of guarantee without permission of RBI. However, the statutory regulations being Foreign Exchange Management (Guarantees) Regulations, 2000 provide as under:

“Reg. 3 : Save as otherwise provided in these regulations, or with the general or special permission of the Reserve Bank, no person resident in India shall give a guarantee or surety in respect or, or undertake a transaction, by whatever name called, which has the effect of guaranteeing, a debt, obligation or other liability owed by a person resident in India to, or incurred by a person resident outside India.”

While Regulation 4 refers to guarantees which may be given by authorised dealers, Regulation 5 deals with guarantees which may be given by persons other than authorised dealers. A person other than the authorised dealer may give a guarantee in the specified cases. The relevant clause being (b) reads as under:

“5(b) a company in India promoting or setting up outside India, a joint venture company or a wholly owned subsidiary, may give a guarantee to or on behalf of the latter in connection with its business.”

29. It is true that Videocon which is a person resident in India gave such a guarantee for its subsidiary with registered office in Italy which is a person resident outside India. Learned counsel for Videocon vehemently submitted that since no special permission of the Reserve Bank is on record and no general permission was granted at the time of issuance of the letter of guarantee in 2007, it may be held that the Patronage letter was null and void ab initio.
30. It is not possible to accept the above contention for several reasons. In the first place the words “or with the general or special permission of Reserve Bank” cannot be construed as prior permission of the Reserve Bank. Where the Regulations contemplate that prior permission or prior approval of the Reserve Bank is required to be obtained, it is so specified. For instance, Regulation 3.A imposes restriction of obtaining overseas guarantee in the following terms:

“3.A No corporate registered under the Companies Act, 1956 (1 of 1956) shall avail domestic rupee denominated structured obligations by obtaining credit enhancement in the form of guarantee by international Banks, international financial institutions or joint venture partners, except with the prior approval of the Reserve Bank.”

[Emphasis supplied]

Hence, it cannot be said that the Patronage letter issued in 2007 could not be issued without prior approval or prior special permission of the Reserve Bank.”

In the same Videocon case (supra), the Court relied on a plethora of judgments, which hold that a party (read the Guarantors in the present case) cannot take advantage of its own wrong. The relevant part is reproduced as under:

“34. In any view of the matter, it is also necessary to know that Videocon had never contended in any of its correspondence between 2007 till giving reply to the statutory notice that the Patronage Letter was issued in contravention of the provisions of FEMA or in breach of any other legal requirements. The defence is, therefore, raised for the first time only after receiving statutory notice i.e. after almost four years of issuance of the Patronage Letter. Assuming that Videocon have committed any wrong in issuing the Patronage Letter without obtaining permission of the Reserve Bank, as per the settled legal position, it is not open to a party to take advantage of its own wrong. In Eurometal Ltd. v. Aluminium Cables and Conductors (U.P) Pvt. Ltd.)  [(1983) 53 Comp Cas 744 Cal and SRM Exploration Pvt. Ltd. v. N & S & N Consultants S.R.O.  [(2012) 4 Comp L.J. 178 (Del)], Calcutta and Delhi High Courts respectively have frowned upon company facing a winding up petition taking up such dishonest defence. In these decisions High Courts have taken the view that in matters of commercial transactions involving crores of amount where the company facing winding up proceedings had stood a guarantor, if any such defence were to be accepted, we would be giving a wrong signal and dissuading foreign commercial entities from relying on the guarantees given by Indian Companies and which would ultimately undermine the role of India the world of trade and commerce. We could not agree less. We, therefore, do not find any merit in submissions of Dr. Tulzapurkar that the order of admission of the winding up petition was erroneous on any such count.”

Similarly a Division Bench of the Delhi High Court[3] has inter-alia held that under the FEMA, even an Act taken which requires permission of the Reserve Bank does not void the transaction and shall not prevent legal proceedings being brought in India for recovery of a sum. The relevant extracts of the judgments are are follows:

“8. The senior counsel for the appellant Company has contended that the Guarantee Declaration describes Mr. Ravi Chilukuri as holding power of attorney from the appellant Company but no such power of attorney has been produced; that the Board Resolution is not to execute such a Guarantee Declaration; that even otherwise the same authorized Mr. Ravi Chilukuri to act jointly with Mr. Mohinder Verma and not severally; that the Promissory Notes relied upon are unstamped; that neither the Guarantee Declaration nor the Promissory Notes bear the seal of the appellant Company; that the letter aforesaid of Canara Bank does not refer to the transaction in question; attention is invited to Section 35 of the Stamp Act, 1899 and reliance is placed on Avinash Kumar Chauhan v. Vijay Krishna Mishra  (2009) 2 SCC 532 and Mannalal Khetan v. Kedar Nath Khetan  (1977) 2 SCC 424; it is contended that in the absence of the principal debtor before the Court, no evidence of default exists and the appellant being not a party to that transaction cannot be expected to give such evidence.

9. Per contra, the counsel for the respondent with reference to Section13 of FEMA has argued that there was no bar to the appellant executing said Guarantee Declaration and the same is not voided and the appellant for the violation of not obtaining prior permission of the Reserve Bank of India before executing the Guarantee Declaration is only liable for penalty; that in any case the appellant cannot take advantage of its own default in not obtaining the permission; attention is invited to Section47 of the Companies Act to contend that implied authority is sufficient. Reliance is placed on The Oriol Industries Ltd. v. The Bombay Mercantile Bank Ltd.  AIR 1961 SC 993 and Industrial Investment Bank of India Ltd. v. Biswanath Jhunjhunwala  (2009) 9 SCC 478; it is also contended that as per the terms of the Guarantee Declaration the respondent was not required to go to the principal debtor before invoking the claim under the Guarantee.
10. The senior counsel for the appellant in rejoinder has further contended that the imposition of penalty under the FEMA implies the act requiring permission being prohibited without such permission. Qua FEMA, the senior counsel for the appellant Company has relied on para 8 B 1 of the Foreign Exchange Manual titled “Guarantees for non-residents”. The same also provides for approval of the RBI.
11. We have perused the provisions of FEMA, 1999 Section3 thereof prohibits dealing in or transferring of any foreign exchange save as otherwise provided therein or under the Rules & Regulations framed thereunder without general or special permission of RBI. We are unable to find any provision therein voiding the transactions in contravention thereof. We may mention that the predecessor legislation to FEMA namely FERA 1973 vide Section47 prohibited entering into any contract or agreement directly or indirectly evading or avoiding any operation of the said Act or any provision thereof. However Sub Section (3) thereof also provided that such prohibition shall not prevent legal proceedings being brought in India for recovery of a sum which apart from the provision of FERA would be due. However the legislature while re-enacting the law on the subject has chosen to do away with such a provision. We are of the view that the same shows a legislative intent to not void the transaction even if in violation of the said Act. Thus we are of the opinion that the plea of the appellant Company in this regard is without any force.”

[1] POL India Projects Limited and Ors. Vs. Aurelia Reederei Eugen Friederich GmbH Schiffahrtsgesellschaft & Company KG and Ors. Arbitration Petition No. 76 and 12 of 2012 decided by Mr. Justice R.D. Dhanuka on 08.04.2015.

[2] Videocon Industries Limited Vs. Intesa Sanpaolo S.P.A. decided by M.S. Shah, Chief Justice and M.S. Sonak J. on 19.07.2014.

[3] SRM Exploration Pvt. Ltd. Vs. N & S & N Consultants S.R.O. decided by A.K. Sikri, Acting Chief Justice and Rajiv Sahai Endlaw J. on 21.03.2012.