The Enforceability of Guarantees in Contravention of Indian Foreign Exchange Law

The
choice of a law to govern a contract and a court to resolve disputes arising
out of it is—naturally—fundamental in many ways. One of these is that a defence
otherwise available may be lost, if one law does not contain it and the
conflicts rules of the forum lead to the application of that law in preference
to the law that does. Another is that different jurisdictions take different
views about the extent to which its courts will tolerate the enforcement of a
contract that requires or involves an infringement of the laws of a foreign
country. Both these features have come to light in recent years in several
cases involving Indian defendants. Typically, the contract between the parties provides
that disputes will be resolved by foreign-seated arbitration or by the courts
of a foreign country; the respondent is ordered by that forum to pay the
judgment debt and the respondent alleges that to do so would contravene RBI
regulations or Indian foreign exchange law. Sometimes it is not a judgment-debt
but simply a contractual one: for example, an Indian company guarantees a debt
owed by another Indian company to a foreign company; the borrower defaults and
the guarantee is invoked; the Indian company has reason to believe that paying
the guarantee in foreign currency violates Indian foreign exchange law and sets
this up as a defence before the foreign court or arbitral Tribunal.

The
leading cases on this subject—Foster v
Driscoll
[1929] 1 KB 470 and Ralli Brothers [1920] 2 KB 287—have
been revisited recently in two cases involving foreign exchange laws. The
principle in Ralli Brothers is that no action lies on a
contract which requires an act or omission that is unlawful in the place of performance and the principle in Foster v Driscoll is that a court will
not enforce a contract the real object and intention of which is to infringe
the laws of a friendly foreign State. The difference between the Ralli rule and the Foster rule is that the latter applies even if act which infringes
the foreign law is not required by
the contract. This, of course, is well-established and Teare J recently
described it as “so well-known a
principle of the English conflict of laws that it is unlikely to require
prolonged legal argument
.” The two cases in which it has been recently
invoked are Beijing Jianlong
v Golden Ocean
and Deutsche
Bank v Unitech
.

In
Golden Ocean, a Chinese company,
Beijing Jianlong, executed a guarantee in favour of Golden Ocean with respect
to a charterparty under which Golden Ocean chartered a vessel to a subsidiary
of Beijing Jianlong. The arbitration clause provided for London arbitration and
Beijing Jianlong’s contention before the Tribunal was that the arbitration
clause was itself unenforceable because Chinese foreign exchange law prohibits
Chinese companies from executing guarantees in favour of foreigners without the
prior authorisation of the State; and that should the guarantee be invoked,
funds would need to be transferred from China to pay it, which would also
constitute a contravention of Chinese law. It is important to notice that the
argument was not that the guarantee was
void but that the arbitration clause was
unenforceable, which would then prevent the Tribunal from restraining Beijing
Jianlong from pursuing proceedings in China by way of an anti-suit injunction.
The Tribunal rejected these arguments and the Commercial Court upheld the
award. It was pointed out by counsel for Golden Ocean that a London arbitration
clause cannot violate the rule in Foster when,
if the Tribunal has jurisdiction and applies English law, it will be required
to apply that very rule to test the validity of the guarantee. Beijing
Jianlong’s response was that the Tribunal would consider the validity of the
guarantee under English law (by
applying Foster v Driscoll) whereas a
Chinese court would simply rule that it was void notwithstanding the intentions
of the parties or the applicable law. HHJ Mackie QC accepted the submissions of
the respondents, holding that, once it is accepted that an arbitration clause
is severable, the Foster v Driscoll rule
cannot invalidate it simply because the underlying contract may be contrary to
the substantive law of a foreign country: instead, it would be open to the
respondent in the arbitration to set up Foster
as a defence to the substantive validity of the contract before the
Tribunal and the fact that the Tribunal would analyse this issue through the
prism of English, rather than Chinese, law was irrelevant.

The
second case is more recent and involves an Indian company which, like Beijing
Jianlong, provided a guarantee of $150 million to Deutsche Bank, said to be
payable in New York, under an agreement governed by English law and subject to
the exclusive jurisdiction of the English courts. The validity of the guarantee
is part of a more complex dispute between the parties (involving charges of
interest rate rigging and product mis-selling) that is not material here. In
the case before the Commercial Court, Unitech sought to resist the enforcement
of the guarantee on the basis that, although the guarantee was expressed to be
payable in New York, Unitech would have to transfer money from India to New
York as a first step, and this first step would violate Indian law. Two points
are of interest: (i) it was argued
(and assumed to be true) that a New York
court
would not order Unitech to perform because to do so would expose it
to criminal prosecution in India but performance in New York was not per se unlawful and (ii) although New York was the “place of performance” for the
purpose of Ralli Brothers, it was
said that the rule also applies where an act required to be done in order to perform another act required by the
contract is unlawful in the place of performance of that act.

Teare
J, it is submitted correctly, rejected these arguments, explaining that:

The
decisions in Ralli Brothers and Kleinwort establish that the English law
of conflicts excuses performance of an obligation where performance would be
illegal by the law of the country where the obligation is to be performed but
does not excuse performance where, although performance of the obligation is
not illegal in the country where performance is to take place, steps necessary
to enable a party to perform its obligation would be illegal in the country
where such steps would be taken.

These
cases demonstrate that the choice of forum may often be decisive of this issue,
since the conflicts rules of different jurisdictions deal with infringement of
foreign law differently.

About the author

V. Niranjan

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