The Madhya Pradesh High Court has clarified that invoking a Performance Bank Guarantee before exhausting the dispute resolution mechanism stipulated in the contract constitutes a breach of contractual obligation and procedural fairness. This judgment reinforces the principle that parties must adhere to agreed-upon contractual remedies before resorting to coercive financial actions.
Background & Facts
The Dispute
The petitioner, M/s Kunal Structure (India) Pvt Ltd, entered into a contract with the respondents, M.P. Audyogik Kendra Vikas Nigam Indore Ltd (now M.P. Industrial Development Corporation), for the construction and commissioning of infrastructure projects, including a Sewage Treatment Plant (STP). The contract included a Performance Bank Guarantee issued by Union Bank of India bearing No. 43510IGL0000617 for an amount of Rs. 12,49,20,000, intended to secure the petitioner’s performance obligations.
Key Facts
- The contract was executed with express terms governing dispute resolution under Clause 12
- The petitioner completed all physical works, including maintenance-related tasks, by 03.11.2024
- On 08.09.2025, the petitioner formally requested release of dues and release of the bank guarantee, citing completion of the 5-year maintenance period
- The petitioner highlighted that the only outstanding issue was the non-availability of electrical power supply to the second STP unit, which delayed final testing and handover
- Despite this, the respondents threatened to invoke the bank guarantee for the full amount of Rs. 12,49,20,000
- The bank guarantee was originally valid until 03.02.2025 and had been extended till 20.10.2025
- No formal dispute had been raised under Clause 12 of the contract prior to the threat of encashment
Procedural History
- 09.10.2025: Writ Petition No. 39606 of 2025 filed before the Madhya Pradesh High Court seeking restraint on encashment of the bank guarantee
- 09.10.2025: Interim order passed by the Court directing that the bank guarantee shall not be encashed pending hearing, subject to renewal by the petitioner
- 17.10.2025: Petitioner informed respondents of renewal of the bank guarantee as directed
- 10.11.2025: Hearing on interim relief and jurisdictional objections
- 17.03.2026: Final hearing and disposal of the writ petition
The Parties' Positions
Petitioner’s Position: The petitioner contended that all contractual obligations had been fulfilled, and the only impediment to final handover was the respondents’ failure to provide electrical power to the second STP unit - a factor beyond the petitioner’s control. The threat of encashment was arbitrary, premature, and in violation of Clause 12 of the contract.
Respondents’ Position: The respondents argued that the petitioner had not yet received final acceptance and that the bank guarantee remained valid until its expiry. They claimed the guarantee was a security instrument and could be invoked at any time before its expiry, irrespective of pending contractual disputes.
Relief Sought
The petitioner sought:
- Immediate release of the Performance Bank Guarantee
- Permanent injunction against its encashment
- Declaration that invocation of the guarantee prior to exhausting contractual dispute resolution mechanisms is invalid
The Legal Issue
The central question was whether the respondents could invoke the Performance Bank Guarantee before the petitioner had exhausted the mandatory dispute resolution mechanism prescribed under Clause 12 of the contract.
Arguments Presented
For the Petitioner
The petitioner relied on the express terms of Clause 12, which mandated a structured, multi-tiered dispute resolution process before any claim could be adjudicated. Counsel argued that the bank guarantee was not an unconditional instrument but a security tied to performance obligations under the contract. Invoking it without following the contractual dispute mechanism violated the principle of pacta sunt servanda and amounted to an abuse of process. The petitioner cited Union of India v. Raman Iron Foundry to support the proposition that contractual dispute resolution clauses must be respected.
For the Respondent
The respondents contended that the bank guarantee was an independent financial instrument, separate from the underlying contract, and could be invoked upon mere demand. They argued that Clause 12 was merely procedural and did not restrict the right to invoke the guarantee. They further claimed that the petitioner’s delay in obtaining power supply was a failure to complete the work, thereby triggering the guarantee.
The Court's Analysis
The Court undertook a detailed examination of Clause 12 of the contract, which established a clear, sequential dispute resolution framework: first, a dispute must be raised in writing before the Competent Authority within 45 days of its occurrence; if unresolved, it may be appealed to the Appellate Authority within 30 days; and only thereafter may it be referred to the Madhya Pradesh Madhyastham Adhikaran under the 1983 Act.
"No dispute can be raised after 45 days of its first occurrence. Any dispute raised after expiry of 45 days of its first occurrence shall not be entertained and the employer shall not be liable for claims arising out of such dispute."
The Court observed that the petitioner had not raised any dispute under Clause 12, but neither had the respondents. The threat of encashment was not a dispute resolution step - it was a coercive financial action taken in the absence of any formal dispute being raised or adjudicated. The Court held that such an action would effectively nullify the entire dispute resolution mechanism agreed upon by the parties.
The Court emphasized that the bank guarantee was not an unconditional guarantee but a performance-linked security. To permit its invocation without exhausting the contractual remedy would render Clause 12 otiose and undermine the parties’ autonomy to structure their dispute resolution process.
The Court further noted that the petitioner had demonstrated a prima facie case of completion of works, with only a minor external impediment (lack of power supply) preventing final handover. The respondents had not demonstrated any breach by the petitioner that would justify the invocation of the full guarantee amount.
The Verdict
The writ petition was disposed of with directions. The interim order dated 09.10.2025 restraining encashment of the Performance Bank Guarantee shall continue until final adjudication under Clause 12. The petitioner is directed to raise a formal dispute under Clause 12 within 15 days. The Competent Authority shall decide the dispute within 45 days, the Appellate Authority within 45 days of appeal, and the Madhya Pradesh Madhyastham Adhikaran within 2 months if the matter is referred there. No party shall seek unnecessary adjournments. In case of non-cooperation, either party may approach this Court for modification. The bank guarantee shall not be encashed during this process.
What This Means For Similar Cases
Contractual Dispute Clauses Override Unilateral Encashment
- Practitioners must now argue that any invocation of a bank guarantee must be preceded by compliance with the contract’s dispute resolution mechanism
- Courts will not permit parties to bypass agreed-upon adjudication processes through financial coercion
- The guarantee’s purpose is to secure performance, not to circumvent contractual remedies
Prima Facie Completion Triggers Burden on Respondent
- If a contractor demonstrates substantial completion of works, the burden shifts to the employer to prove a valid, timely dispute under the contract
- Minor external impediments (e.g., utility delays) do not constitute contractor default
- Failure to raise a dispute within the stipulated 45-day window bars future claims
Procedural Compliance Is Non-Negotiable
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Parties must strictly adhere to timelines under contractual dispute clauses
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Failure to raise a dispute within 45 days extinguishes the right to claim
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Courts will enforce these timelines as mandatory conditions precedent to any remedy
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Any party seeking adjournments before the Competent Authority, Appellate Authority, or Tribunal must justify them; repeated delays may trigger court intervention
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The judgment establishes a clear roadmap for enforcing contractual dispute resolution in infrastructure and public works contracts
