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	England and Wales High Court (Commercial Court) Decisions
You are here: BAILII >> Databases >> England and Wales High Court (Commercial Court) Decisions >> Standard Bank London Ltd. v Canara Bank [2002] EWHC 1032 (Comm) (22 May 2002) URL: http://www.bailii.org/ew/cases/EWHC/Comm/2002/1032.html Cite as: [2002] EWHC 1032 (Comm)

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IN THE HIGH COURT OF JUSTICE
QUEENS BENCH DIVISION
COMMERCIAL COURT

		Royal Courts of Justice Strand, London, WC2A 2LL
		22nd May 2002

Mr Justice Moore-Bick:

1. The action

1. In this action the claimant, Standard Bank London Ltd (“Standard”), as trustee for a syndicate of lending banks, seeks to recover the sum of US$10 million from the defendant, Canara Bank (“Canara”), under a demand performance guarantee issued by Canara in support of a contract for the sale of tin made between Dravya Industrial Chemicals Ltd (“Dravya”) as seller and Solo Industries Ltd (“Solo”) as buyer on 19^th September 1997. In the alternative Standard seeks to recover from Canara on a restitutionary basis the balance of two sums totalling US$30 million which it paid to Canara as Dravya’s banker by way of pre-export payments under the contract of 19^th September 1997 and an earlier contract for the sale of tin by Dravya to Solo made on 2^nd February 1996. Canara says that the contract of 19^th September 1997 was a sham because neither Dravya nor Solo intended it to give rise to legal obligations and that therefore the guarantee was procured by fraud, lacks content and is unenforceable. In these circumstances Canara accepts that the payments made by Standard in respect of the pre-export advances were both made under a mistake of fact, but it says that it is not bound to restore the bulk of the money, either because it had paid that money over to its customer, Dravya, before it received notice of Standard’s claim, or because it has changed its position in reliance on its belief that it was entitled to retain that money for its own purposes.

2. Background

2. Dravya is an Indian company forming part of the Hamco group of companies controlled by a Mr. B. M. Patel. The principal member of the group is Hamco Mining and Smelting Ltd whose business includes the smelting of cassiterite to produce tin ingots. In May 1997 ‘Hamco’ brand tin was listed by the London Metal Exchange as constituting good delivery under LME contracts.
3. Solo is an English company carrying on business as a metal trader. At the time of the events giving rise to this action it was controlled by Mr. Madhav Patel, the son of B. M. Patel. In addition to the English company Madhav Patel also controlled another company called Solo Industries Ltd incorporated in the United Arab Emirates (“Solo UAE”) which carried on business from Sharjah as a producer and trader of various non-ferrous metals.
4. It is common ground in this case that between about 1995 and 1998 various companies in the Hamco group, including Dravya, were engaged in a widespread and systematic fraud by which vast sums of money were obtained from a number of banks throughout India and the Gulf. The discovery of this fraud has naturally had a profound effect on Canara’s approach to its dealings with the Hamco Group. The existence of this huge fraud does not itself provide the basis for Canara’s defence to the present action and for this reason it is unnecessary to describe in detail the methods by which it was carried out. However, it does form an important part of the background to the relationship between Canara, Solo and Dravya and it is therefore necessary to say a little more about it.
5. The fraud was organised in a complex and highly sophisticated manner, involving the production by Solo UAE and other companies working in conjunction with it of substantial numbers of false documents, such as bills of lading, freight invoices, insurance certificates and correspondence purporting to emanate from a variety of commercial concerns. The scheme took a variety of forms, but one of the principal methods adopted was the so-called “import” fraud. Hamco or one of its associated companies would purport to enter into a contract with a foreign company controlled by Madhav Patel or one of his associates for the purchase of goods for import into India on c.i.f. terms. A letter of credit would be opened under a facility negotiated with a commercial bank, but the contract was a sham and no goods were shipped. In order to obtain the funds represented by the letter of credit false documents were created by Solo UAE which were tendered to the bank to obtain payment. Funds representing the face value of the letter of credit thus passed into the hands of Hamco’s accomplices. In some cases funds were obtained by discounting bills of exchange. In order to conceal the fact that no goods existed further documents were created to give the appearance that the goods had been lost in transit and that a claim had been made against the cargo insurers. Funds derived from previous fraudulent transactions were remitted to Hamco under the guise of insurance proceeds. Part of the funds were used by Hamco to discharge its liability to the bank and the remainder for its own purposes. Since this scheme required a constant recycling of funds, ever-increasing amounts of money were required to keep the process going. Another aspect of the fraud, though one which is of less immediate significance to the present action, involved the creation of false export contracts under which goods were sold by Solo UAE and other members of the group to companies controlled by Madhav Patel or his associates. Again, false documents were created to give an appearance of genuine export contracts being performed in the usual way. All this activity called for a sophisticated means of creating false documents and an effective system for controlling the flow of funds in order to keep the operation running. That was provided by Solo UAE from its offices in Sharjah. Eventually the Indian banking authorities became concerned at the extent of Hamco’s apparent failure to file documents evidencing the import of goods as required under Indian legislation. They began to make enquiries and as a result of their investigations the fraud eventually came to light.
6. Having regard to the nature and extent of the frauds perpetrated by the Hamco group and its associates it is not surprising that the two contracts between Dravya and Solo with which I am concerned have fallen under the gravest suspicion. Indeed, it is Canara’s case that they were nothing more than sham transactions designed to obtain further funds from the banks. However, it was not suggested that none of the contracts entered into by the members of the Hamco group during this period were genuine, so it is necessary to look carefully at the evidence surrounding these two transactions to see whether they formed part of the fraud or whether they were examples of the smaller number of transactions that were admittedly genuine.
7. I turn therefore to the contracts between the parties as they appear from the documents. Although I shall refer to them as “contracts”, I do so without in any sense pre-judging the question whether they were intended to create legal relations or whether in truth they were nothing more than sham transactions.

3. The contracts

8. On 2^nd February 1996 Dravya entered into a contract with Solo for the sale of a minimum quantity of 5,880 metric tons of tin ingots of ‘Hamco’ brand for delivery at the rate of 140 metric tons a month over a period of 42 months. This has become known for convenience as “the first Dravya supply contract”. Under the contract Solo agreed to make a “pre-export advance” of US$10 million to Dravya to be repaid at the rate of US$277,777.78 a month by set-off against the price due in respect of the goods. The parties subsequently entered into a formal loan agreement dated 9^th March 1996 in respect of the pre-export advance. The advance was funded by a loan of US$10 million made by Standard to Solo.
9. As security for the performance by Dravya of its obligations under the supply contract Canara provided a demand guarantee to Solo in the sum of US$10 million reducing month by month as the amount of the pre-export advance was repaid. It was an express term of the guarantee that the pre-export advance should be paid to Dravya through Canara and that the guarantee should become effective only when the advance had been made. The advance was not in fact released to Dravya but was converted into rupees and held by Canara as cash collateral for its liability under the guarantee. Deliveries under the contract were due to begin in May 1996.
10. On 19^th September 1997 the contractual arrangements between Dravya and Solo underwent substantial revision. Solo agreed to buy from Dravya 7,200 metric tons of tin ingots of ‘Hamco’ brand on c.i.f. terms for delivery at the rate of 200 tons a month over a period of 36 months. This has become known as “the second Dravya supply contract”. Under this contract Solo agreed to pay US$20 million to Dravya as a pre-payment of part of the purchase price, to be repaid at the rate of US$555,555.55 each month by set-off against the price due in respect of the goods shipped that month. The advance payment of US$20 million was again funded by a loan, this time from a syndicate of banks led by Standard. As security for Dravya’s performance Canara agreed to provide a new demand guarantee to Solo in the sum of US$10 million. In the event, the new guarantee was established in the form of an amendment to the original guarantee. It was addressed to Solo as the buyer, though it clearly contemplated the existence of Standard as the source of the funds that were to be made availabe to Dravya by way of the pre-payment. I shall return to the detailed terms of the guarantee at a later point. It is sufficient for present purposes to say that it was expressed in terms of an irrevocable and unconditional agreement to pay on demand the sum of US$10 million against certification, without the need for any proof, of a breach of contract on the part of Dravya. It was, therefore, a classic demand guarantee and in due course it was assigned to Standard as part of the security for the loan. At the same time as it entered into these new arrangements Solo also entered into an offtake agreement with Sogem N.V., a subsidiary of the Belgian Union Minière group, for the sale of the tin to be supplied by Dravya.
11. The second Dravya supply contract and the amended guarantee issued by Canara in support of it were intended to supersede the original contract and guarantee. By February 1998 when all the arrangements in respect of the second contract had finally been put in place a little under 1,000 metric tons of tin had been supplied under the first Dravya supply contract and as a result Canara was still holding the bulk of the funds representing the pre-export advance of US$10 million paid by Solo under that contract. On 27^th February1998, therefore, Canara remitted the sum of US$8,015,952 to Standard in order to repay the outstanding amount of the original pre-export advance. Under its arrangements with Dravya Canara retained the sum of US$10 million on deposit as cash collateral for its obligation under the new guarantee and the balance of the funds was released to Dravya.

4. Was the second Dravya supply contract a sham?

12. This is the central issue in the case. In Snook v London and West Riding Investments Ltd [1967] 2 Q.B. 786 Diplock L.J. described a sham as something “intended to give the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create”. It is necessary, therefore, to examine the evidence to see what were the real intentions of Solo and Dravya in entering into the second Dravya supply contract. Before doing so, however, it is necessary to say a little more about the way in which the issue has developed during the course of the action.
13. The writ in the present action was issued on 23^rd December 1998. Standard applied for summary judgment which was opposed by Canara on the grounds that the contract of 19^th September 1997 was a sham. The case then being put forward by Canara was that by requesting the issue of the guarantee Dravya, with the concurrence of Solo, had represented that it intended to perform the contract in full in accordance with its terms, whereas in truth it had no such intention. Accordingly, so it was said, Canara had been induced by fraud to enter into the guarantee and on discovering the true position had exercised its right to rescind. Alternatively, if Solo was not a party to Dravya’s misrepresentation, the guarantee was void for mistake. These contentions subsequently appeared in the points of defence served on 5^th February 1999 and remained Canara’s case until Mr. Hunter embarked on his closing speech at the end of the trial.
14. Canara’s case at that stage rested on four main planks. The first was the evidence of the widespread fraudulent activity of the Hamco Group to which I have already referred. This is described in some detail in a statement made by Mr. Timothy Warmington, a vice-president of Citibank, who investigated the affairs of the Hamco Group, the Solo companies, the Patels and their associates for the purposes of proceedings in Switzerland. It is supported by a report made by Mr. Graham Tan of the International Maritime Bureau. This evidence was relied on as showing, as was accepted from the outset to be the case, that B. M. and Madhav Patel were thoroughly dishonest men capable of organising fraudulent activities on an enormous scale over a considerable period of time.
15. The second was the fact that Dravya did not appear to be conducting mining operations in India of a kind that would give it access to the quantities of raw material needed to produce the amount of tin that it had agreed to sell. At the time of entering into the second contract Dravya had entered into a toll smelting agreement with Hamco for the production of ingots from cassiterite to be supplied by Dravya and one can see from the contemporaneous documents that in the course of their negotiations Madhav Patel had told Canara that Dravya had access to substantial quantities of ore from sources in India. By the time the present action was begun, however, there were strong grounds for doubting whether Dravya or Hamco had access to the necessary raw materials otherwise than by means of imports. Cassiterite could, of course, be imported, but there was evidence of fraud in relation to the import of goods into India on such a massive scale that it cast serious doubt on whether there had been a sufficient volume of imports to satisfy Dravya’s requirements.
16. The third plank of the case was the fact that Patels’ fraudulent activities were not confined to import frauds but extended also to export frauds in which consignments of cheap or worthless materials were shipped in containers from India masquerading as valuable goods for which large sums of foreign currency could be remitted to the Hamco Group. It was essential to the success of a scheme of this kind that the purchaser should be party to the fraud and so a number of apparently reputable companies controlled by associates of Madhav Patel acted as buyers under the export contracts, thus ensuring that the scheme was not compromised. This aspect of the Patels’ fraudulent activities, together with the limited evidence relating to exports of tin, provided considerable support for Canara’s case that the second Dravya supply contract was a sham.
17. Finally, there was the matter of the quantity of tin supplied under the contract before it broke down in the summer of 1998. Canara accepted that 672 tons had apparently been shipped during the early weeks of the contract, but contended that it had been supplied, in effect, only to give the appearance of a genuine transaction and that there had never been any intention to perform the contract in full in accordance with its terms. Moreover, in the light of the way in which the export frauds had been perpetrated it cast doubt on whether even those shipments that had apparently been made were genuine. Canara contended that it was by no means impossible that, as in many other cases, the ultimate receivers of the goods had been companies under the control of Madhav Patel.
18. Given the background to this contract and the limited nature of the evidence before him, it is not surprising that David Steel J. dismissed Standard’s application for summary judgment on the grounds that it was at least arguable that the guarantee was vitiated by fraud and that in any event this was a case that should go to trial. He concluded on the evidence before him that Dravya did not operate any tin mines and did not have access to other sources of tin ore in India. He therefore considered that the toll smelting agreement was a sham and that that of itself cast serious doubt on the parties’ intention to perform the supply contract in accordance with its terms. The judge was not impressed by the fact that 672 metric tons of tin had been despatched between February and August 1998. He regarded that as far too small a quantity to demonstrate Dravya’s intention to perform the contract in full, expressing the view that those shipments may have been no more than “genuine plums amongst a pile of duff”. In any event he thought that the sales of tin to Sogem called for further investigation. He expressed the view that Canara had a strong case and dismissed the application. In his opening remarks Mr. Hunter Q.C. naturally drew my attention to the judgment of David Steel J. and to the views he had expressed on the merits of Canara’s defence. However, as he himself accepted, I have now had the benefit of full evidence and argument and while I have read that judgment with interest, I must form my own view of these matters.
19. Mr. Hunter also drew my attention to the judgment of the Court of Appeal in Solo Industries UK Ltd v Canara Bank [2001] 2 Lloyd’s Rep. 578, another case arising out of the Hamco frauds, in which Solo sought to recover under a demand guarantee issued by Canara in support of a contract between Hamco and Solo for the sale of aluminium. Mance L.J., with whom Potter L.J. and Sir Martin Nourse agreed, expressed similar doubts about the parties’ intentions with regard to the performance of the contract for the sale of tin with which I am concerned. However, the second Dravya supply contract was only being considered by the court as part of the evidence relating to the authenticity of the contract for the sale of aluminium and again I do not think it would be right for me to be influenced by the views expressed on that occasion.
20. In the light of all this, however, it is ironic that in his closing speech Mr. Hunter felt obliged to abandon one of the primary planks of the original case and to seek permission to amend the defence to make what he himself accepted was a significant departure from the way in which the case had previously been put. The amendment involved withdrawing the allegation in paragraph 11 of the re-re-amended defence and counterclaim that Dravya had fraudulently misrepresented that it intended to supply to Solo the quantities of tin specified in the contract (which might be understood as involving the implicit acceptance that the contract was intended to give rise to legal relations) and substituting an allegation that the contract was a sham in the more usual sense that neither Solo nor Dravya ever intended it to give rise to legal obligations of any kind. On that basis Canara sought to argue that the guarantee was void by reason of the failure of an implied condition precedent that the contract in support of which it was issued was a genuine and valid contract which the parties intended to perform in accordance with its terms; alternatively, that it had been induced to enter into the guarantee by an implied representation to that effect on the part of Dravya and that since the contract was in fact a sham it was entitled to avoid the guarantee on the grounds of fraud.
21. What led to this last-minute change of direction on the part of Canara? It was the recognition that there was cogent evidence that substantial quantities of ‘Hamco’ brand tin, some 5,670 metric tons in all, had in fact been exported by Dravya from India during the period between the beginning of 1996 and the middle of 1998. This fatally weakened Canara’s original case that Dravya had neither the intention nor the capability to export tin from India in any appreciable quantities.
22. Mr. Higham Q.C. vigorously opposed Canara’s application to amend, but not without some hesitation I thought it right to accede to it for two main reasons. First, because in a case involving complex factual issues I considered that it would be unsatisfactory to prevent Canara from putting forward a credible analysis of the evidence, or for me to be inhibited, if I accepted that analysis, in giving effect to it, unless the effect of allowing the amendment would be to cause irremediable prejudice to Standard. Secondly, although the amendment did involve a significantly different analysis of the existing evidence, it did not seem to me give rise to questions that could not be answered satisfactorily on the basis of the evidence already before the court in the form of the documents and witness statements. Mr. Higham submitted that if Canara’s new case had been advanced at the proper time, he might have wished to call additional evidence, but he found it difficult to identify what that evidence might have been. In these circumstances I concluded that allowing the amendment would cause no significant prejudice to Standard in the conduct of the action.
23. Following the amendment Canara’s case in a nutshell was that the second Dravya supply contract was nothing more than a fraudulent device by which Solo and Dravya procured the payment of US$20 million by Standard to Canara and the consequent payment of about US$10 million by Canara to Dravya. In support of that case Mr. Hunter relied on the evidence of the frauds perpetrated by the Hamco and Solo companies, the statements made by B. M. Patel and a senior executive of Hamco, Mr. Paresh Mehta, to the investigating authorities in India, evidence of the mining and smelting activities of the Hamco group, and the evidence of Mr. De Muyter, the finance manager of Sogem. Each of these calls for separate and detailed consideration.
24. It is appropriate to begin, however, by mentioning two preliminary matters. The allegation in this case is one of fraud and Mr. Higham therefore submitted that the court should be reluctant to find the case proved, even on the balance of probabilities, in the absence of cogent evidence. In principle I would accept that that is right. As Lord Nicholls pointed out in In re H (Minors) [1996] AC 563 at pages 586-587,

“. . . . . . . the court will have in mind as a factor, to whatever extent is appropriate in the particular case, that the more serious the allegation the less likely it is that the event occurred and, hence, the stronger should be the evidence before the court concludes that the allegation is established on the balance of probability”.

However, as Mr. Higham accepted, this is a case in which there is overwhelming evidence of the willingness and ability of those who controlled Solo and Dravya to organise successful frauds of a very sophisticated nature and on a massive scale. This is not a case, therefore, in which the court is dealing with businessmen of unsullied reputation and the reluctance which the court would ordinarily feel in making a finding of fraud can properly be tempered by the knowledge that they have already shown themselves to be thoroughly dishonest.

25. Having said that, however, it is also important that evidence of dishonesty in other transactions, even on the scale demonstrated in this case, should not lead the court to find dishonesty where none in fact exists. If and insofar as Hamco and Dravya were attempting to operate a genuine business, it is likely that at least some of the transactions into which they entered were not tainted by fraud. These are all factors to be taken into account in deciding whether the evidence before the court is sufficient to enable Canara to discharge the burden of proof in relation to the particular transactions with which I am concerned.
26. With these principles in mind I turn to the evidence. Mr. Hunter relied strongly on the evidence of the fraud operated by Madhav Patel from Solo UAE’s offices in Sharjah. This is described in detail in the statement of Mr. Warmington to which I have already referred. In July and August 1999 he was head of a team of investigators assembled by Citibank and two other major banks to investigate the activities of Hamco, Solo and a number of companies associated with them. In the course of their investigations Mr. Warmington and his team interviewed various bank employees, held discussions with law enforcement agencies in the United Kingdom, Dubai, Sharjah and India, and, most importantly, obtained access to the computer records left by Solo at its premises in Sharjah. From the information obtained from these different sources Mr. Warmington discovered that although on paper Solo appeared to have been involved in a large number of import and export transactions, most of those transactions were in fact fictitious, having been constructed simply to enable finance to be obtained from the banks on the basis of false documents. Solo’s principal trading partners were companies linked in one way or another to the Patels and debts owed from one company to another were settled using funds obtained from other banks by similar means. He concluded that Solo was the driving force behind a circle of fictitious transactions and fraudulently overvalued shipments designed to defraud the banks of millions of dollars.
27. Mr. Warmington’s account of the methods by which this elaborate deception was carried out is lengthy and detailed and since its essential accuracy is not in issue it is unnecessary to recount it in detail. I have already given a general description of the nature of the fraud that he uncovered. However, it is necessary to mention some further aspects of Solo’s methods because they are potentially relevant to what went on in the present case.
28. Solo claimed to be trading in high value metals. Not all of the transactions into which it appeared to enter were fictitious, but in those cases in which goods were shipped they rarely consisted of valuable metals. Despite that, buyers never complained of being under-charged, nor did sellers complain about being overpaid. Nor do there appear to have been complaints about the quality of the goods. The reason is simple: Madhav Patel exercised control over both buyer and seller. Low value goods were shipped in containers under false shipping documents issued by companies he controlled and created on Solo’s computers. Mr. Warmington identified as collaborators with Solo a number of European companies including Frobevia S.A. and Soficom whose names also appear in some of the transactions between Dravya and Canara. It is right to point out, however, that among this mass of fictitious and fraudulent transactions Mr. Warmington was able to identify some that were genuine. It is also important to note that the fraudulent transactions included both import and export sales. As I have already mentioned, the investigation carried out by Mr. Tan provided further support for Mr. Warmington’s conclusions.
29. Mr. Higham did not challenge the evidence of Mr. Warmington or Mr. Tan nor did he suggest that their conclusions should not be accepted. Hence it was common ground that the Patels and their associates were heavily engaged in fraudulent transactions of the kind they describe.
30. I turn next to the nature of the Hamco group’s interests in the production of non-ferrous metals. A brief description of Hamco Mining and Smelting Ltd and its business can be found in the report of a techno-economic appraisal carried out by the Bank of India in August 1997 in connection with an application for a loan to fund the establishment of additional mining and smelting facilities in the Malkangiri district of Orissa. The report states that Hamco had a smelting plant at Kherdi, Silvassa, with the capacity to produce 20,000 metric tons of aluminium alloy ingots, 1,800 metric tons of tin-lead solder wire, 5,000 metric tons of tin ingots and 10,000 tons of lead ingots a year. By the time of the transaction with which I am concerned the Hamco group had been a valued customer of Canara for some years. According to Mr. Ambavane, a senior manager at the Nariman Point branch in Bombay where Hamco maintained accounts, the company first approached the bank for credit facilities in 1995. At about that time he and another official from the bank visited the plant at Kherdi which they found running at 95% capacity. They also observed large stocks of raw materials. Mr. De Muyter, the finance director of Sogem, also visited the plant at Kherdi in 1997. He confirmed that the plant was in operation and saw quantities of both raw materials and finished products.
31. The raw materials for the smelter at Kherdi were obtained from elsewhere. As far as tin is concerned, significant deposits of ore (cassiterite) were discovered in India only recently. The bulk of these lie in two areas: one in the Bastar District of Madhya Pradesh and extending into the adjacent area of Koraput District, Orissa; and the other in the Tosham District of Haryana. Only the deposits on the first of these areas has so far been the subject of commercial exploitation. The deposits in the Bastar District have been exploited by the Madhya Pradesh State Mining Corporation which established a smelter at Raipur. Officials of the State Mining Corporation confirmed that Dravya had bought the smelter from the Corporation in 1995 and had carried out some expansion work. Mr. Timothy Clayton of Reincas Ltd who was instructed by Canara to obtain first-hand information about the ability of Hamco and Dravya to produce tin for export interviewed a number of local officials of the State Mining Corporation. He reported that one of those whom he interviewed, Mr. A. P. Sahu, Chief General Manager of the Corporation, was uncertain whether the smelter at Raipur had ever been operational. I find this surprising, both because someone in the position of Mr. Sahu could be expected to know whether the plant had been in operation and because one can find references in other sources to its production. Moreover, it was a condition of the purchase that Dravya should retain the existing 42 employees. I am satisfied that the plant had been operational and that production continued for a period of time after Dravya took it over.
32. A publication by the Geological Society of India entitled Tin in India written by T.M. Babu in which the author refers in detail to the tin deposits in the Bastar District, as well as information obtained by Mr. Clayton from Mr. Sahu, shows that there was a lively cottage industry among the local people of collecting cassiterite for sale to the State Mining Corporation for smelting at Raipur and it appears that much of the raw material processed there was obtained in that way. Although it was illegal for ore to be sold to private companies, I do not think that one can rule out the possibility that Dravya obtained a certain amount from this source. Cassiterite could also be purchased from the State Mining Corporation, but the evidence suggests that Dravya only obtained small quantities in that way. It is also possible that ore could have been obtained from other licensees, but there is little concrete evidence that mining leases had been granted to any other companies.
33. Dravya’s purchase of the Raipur smelter appears to have been followed by steps towards obtaining a mining lease for the production of cassiterite. A letter from the Madhya Pradesh State Mining Corporation to Dravya in July 1998 refers to earlier invitations to tender for the exploration of ore bearing areas in the Bastar District and their subsequent exploitation through mining leases and the establishment of smelting plants. It appears from the letter that Dravya entered into a contract with the State Corporation in October 1996 to establish a joint venture for exploiting the tin reserves in the Bastar District and that ten areas were allotted to it for exploration. It was subsequently discovered, however, that the interest of the State Mining Corporation in the joint venture was too small to enable it to qualify as a government company and thus to avoid the restrictions on purchasing ore from the local people. This may have had the effect of rendering the operation at Raipur uneconomic, or it may simply have made it impossible for Dravya to obtain access to sufficient quantities of locally produced ore. At any rate, by early 2001 when Mr. Clayton visited Raipur the smelter had ceased to function.
34. Hamco had also purchased mining rights from the government in the Malkangiri District of Orissa. Dr. Keith Dymott, a mining engineer employed by Standard, spent some days at the site in April 1997. He described how hand picking and sluicing were being used to separate cassiterite from the surrounding material. He also observed a separation plant under construction which at that time was about three quarters complete. The raw material was retained for smelting on site. At the time of Dr. Dymott’s visit Hamco was still assessing the full extent of the deposits. Dr. Dymott thought it unlikely that deep mining would be necessary to exploit the reserves and that production of ore at the rate of about 200 metric tons a month could continue for some years using simple technology.
35. Two employees of Canara, Mr. Joseph, the manager of the Nariman Point Branch, and Mr. Hosea, the Deputy Manager of the Circle Office, Mumbai, visited the operations at Malkangiri in July 1998. The deposits were still being assessed and Hamco had at that stage obtained a mining lease only in respect of 36 hectares. Their report describes the substantial investment already made in roads and bridges needed to obtain access to the area and Hamco’s plans for installing new plant. Mr. Joseph and Mr. Hosea saw stocks of cassiterite which in their estimate amounted to 800-1,000 tons. They noted that although the company had planned to complete the construction of a beneficiation plant and smelter by the end of 1998, the work had yet to begin. Despite that, they were satisfied that the prospects were encouraging.
36. In the light of this evidence Mr. Hunter was in my view right to accept that the Hamco group, including for this purpose Dravya, was engaged in a genuine mining and smelting business, even if it had been unable to develop its mining activities in the manner or at the speed originally intended.
37. I turn next to the circumstances in which the import fraud first came to light and the investigations that ensued. Towards the end of 1997 evidence began to emerge that Hamco had been engaged in creating fictitious import transactions on a substantial scale, although the true picture was not appreciated at the time. Mr. Joseph, who had only recently become manager of the Nariman Point branch, noticed that Hamco’s accounts would have shown an operating loss were it not for the receipt of income from certain unidentified sources. On enquiry he was told by Mr. Paresh Mehta that goods bought by Hamco on c.i.f. or c.&f. terms for import into India were insured for 110% of their purchase price and that when Hamco made a claim on its insurers in respect of goods that had been lost or damaged in transit the additional 10% was treated in the accounts as “other income”. From the size of this item Mr. Joseph realised that there must have been a very large number of insurance claims and pressed B. M. Patel for further information. Mr. Joseph pursued the matter over the course of some months and eventually during the latter part of 1998 Canara made contact with the insurance company that was apparently paying these claims. At that point the existence of the fraud came to light.
38. In due course B. M. Patel and Paresh Mehta were both interviewed on a number of occasions by investigators from the Directorate of Revenue Intelligence and in the course of those interviews they explained how the fraud was carried out. However, as Mr. Higham pointed out, they both told the investigators that during the period of the fraud bills of entry had been filed with the customs authorities in respect of goods actually imported into India to a value of over US$90 million. This was supported by a summary of transactions given to the investigators by Mr. Mehta which contained a detailed breakdown on an annual basis of the proceeds of the letters of credit obtained by Hamco and how they had been applied. The bogus insurance claims were simply one element in a sophisticated scheme to enable funds to be drawn under letters of credit issued to Hamco and subsequently remitted to India. No goods were imported and no bills of entry could ever be filed under those contracts because the contracts were themselves shams. The insurance device both enabled the funds to be remitted and provided a reason for not filing a bill of entry, but in cases where goods were imported there was no reason for Hamco not to file bills of entry and that appears to have been done.
39. In support of its case that the Hamco group did not import any significant quantities of tin concentrate Canara relied in part on the evidence of Mr. Clayton. In the course of his trip to India he visited the offices of the Central Bureau of Investigation at Mumbai where he had discussions with the Deputy Superintendent of Police, Mr. Naryanan, who was in charge of the investigation into the Hamco import frauds. On the basis of his discussions with Mr. Narayanan Mr. Clayton expressed the view there were no imports of tin concentrate, but it is clear that he had made no independent enquiries of his own and had not been given access to any of the original materials obtained in the course of the investigation. In my view his evidence on this point was of little value, his conclusion being based on little more than Mr. Naryanan’s enthusiasm and his confidence that he would succeed in establishing that the Hamco group had been carrying out massive import frauds.
40. The only other evidence to suggest that none of the import contracts made by Hamco during that time were genuine is to be found in a letter sent by the Enforcement Directorate to the Reserve Bank of India in November 1998 setting out a summary of its findings. This states that in some cases Hamco received no goods at all and that in the others false insurance claims were made, thereby suggesting that all the contracts to import goods were sham. In fact, however, the information given by Mr. Mehta to the investigators had been more detailed. He admitted that goods had not been received under many of the contracts and had provided a figure for the sums involved. He had identified as a separate category those cases where bogus insurance claims had been made and had given separate figures for the value of the letters of credit involved in those cases. Finally he had given a separate figure for the value of the letters of credit relating to those contracts under which goods had been received. The sums mentioned in the Enforcement Directorate’s letter make it clear that the letter itself was based on the information provided by Mr. Mehta, but it is also clear that the writer failed accurately to summarise the information that he had been given. There is nothing to suggest that the account given by Mr. Mehta was not broadly accurate and in the light of that evidence I am satisfied that among the many sham transactions there were a significant number of genuine contracts for the import of goods that were performed in accordance with their terms.
41. The fact that the Hamco group was conducting a genuine business and that a significant proportion of the contracts made for the import of goods into India were genuine seriously undermines the suggestion that Dravya was unable or unwilling to import raw materials in order to satisfy its obligations under its contracts with Solo. Apart from that, however, Dravya was part of the Hamco group and had contracted to supply tin of ‘Hamco’ brand. When considering whether Dravya had access to sufficient quantities of raw materials to meet its obligations, therefore, it is necessary to take account of the resources available to the Hamco group as a whole. I have already described the nature and extent of the group’s operations, including the established smelting plant at Kherdi. I am satisfied that a certain amount of cassiterite was available from the sources in Madhya Pradesh and Orissa and that the group was also capable of sustaining the import of raw materials from abroad. In these circumstances the evidence does not in my view support the conclusion that the group was unable to obtain access to substantial quantities of the raw material needed for the production of refined tin.
42. I turn next to consider the various contracts entered into by Hamco and Dravya for the sale of tin in the form of ‘Hamco’ brand ingots. Between January 1996 and May 1998 a large proportion of the tin produced by the Hamco group was sold directly or indirectly to Sogem. Apart from various spot purchases made by Sogem from Solo in September and December 1996 amounting in all to 359 metric tons, all the tin was supplied under long term contracts.
43. On 18^th September 1995 Sogem entered into a contract with Hamco to purchase 160 metric tons of tin each calendar month for a minimum period of 42 months. The minimum quantity of material to be supplied was therefore 6,720 metric tons. Sogem agreed to make a pre-export advance to Hamco of US$10 million to provide working capital, the advance to be repaid over 36 months by being set off against the price due in respect of deliveries of tin. Sogem duly made the pre-export advance and Hamco began making deliveries under the contract in January 1996.
44. Even as deliveries were commencing under that contract, however, Madhav Patel was making further proposals for the sale of tin by Hamco to Sogem, again to be supported by a substantial pre-export advance. Mr. De Muyter confirmed that Sogem had been involved in discussions for the purchase of additional quantities of tin from Hamco in January 1996, but he was not aware of a formal proposal drawn up at that time by Madhav Patel on the basis of Sogem’s standard form of contract which provided for the purchase by Solo or Sogem from Hamco of 5,880 metric tons of tin over a period of 42 months and for a pre-export advance of US$10 million. In the event these particular discussions between Madhav Patel and Mr. De Muyter appear to have petered out. Mr. De Muyter could not explain why that had happened, but it is now clear that Madhav Patel had decided to pursue a different course altogether. Instead of pursuing the discussions with Sogem he decided to transform the proposal into a contract between Solo and Dravya and to present it to Standard as the basis for a loan to finance the pre-export advance of US$10 million. In due course this became the first Dravya supply contract. From Sogem’s point of view, however, the discussions came to nothing. Mr. De Muyter never became aware of the existence of the first Dravya supply contract or of the relationship between Solo, Standard and Canara relating to it.
45. However, before long Mr. De Muyter was again in discussions with Madhav Patel, this time about a possible contract with Dravya rather than Hamco. These discussions eventually culminated in a contract dated 22^nd July 1996 under which Dravya agreed to sell Sogem a minimum of 6,720 metric tons of ‘Hamco’ brand tin at the rate of 160 tons a month for a period of 42 months. The contract also provided for a pre-export advance of US$10 million to be repaid by monthly instalments out of the amounts due in respect of deliveries. Sogem duly made the pre-export advance to Dravya and deliveries began in December 1996. A total of seven monthly instalments were shipped (although deliveries fell heavily into arrears) until the latter part of 1997 when the contract was finally cancelled at the request of Madhav Patel. The explanation he gave to Mr. De Muyter was that Dravya was running short of raw materials because the funds represented by the pre-export advance were being blocked by the banks and it was being prevented from developing its mining operations. However, the fact remains, as Mr. De Muyter confirmed, that for some months during 1996 and 1997 Sogem was receiving deliveries of tin from Hamco and Dravya at the rate of about 320 metric tons a month. The outstanding balance of the pre-shipment advance was repaid to Sogem, apparently without difficulty.
46. In the spring of 1997 Madhav Patel had told Mr. De Muyter that Solo was seeking to obtain pre-financing for the export of tin under arrangements to which Sogem was not directly a party and that he was involved in negotiations with Standard. He sought to negotiate a contract with Sogem in order to convince the bank that Solo had a reliable means of disposing of the tin delivered to it. In the event, however, no new arrangements were made between Sogem and any member of the Hamco group until 12^th December 1997 when it entered into the so-called offtake agreement with Solo for the purchase of 7,200 metric tons of tin to be delivered at the rate of 200 tons a month over a period of 3 years. It may appear slightly odd that Sogem, which at the time still had a contract running with Hamco and only a few months earlier had accepted the cancellation of a contract with Dravya, should at that point have been willing to enter into a contract to buy tin from Solo, but it is clear from Mr. De Muyter’s evidence that Sogem regarded Hamco, Dravya and Solo as different manifestations of one organisation and was willing to deal with whichever of them was willing to sell. The proposal represented an opportunity to increase the quantity of tin available to Sogem and had the additional attraction that Sogem would not have the burden of providing pre-shipment finance. Mr. De Muyter knew that the Hamco group operated a smelter and could obtain concentrate from sources other than its own mines. He did not concern himself with the source of the raw material but with the Hamco group’s ability to produce tin in ingot form. From Mr. De Muyter’s perspective this contract replaced Sogem’s previous long term contract with Dravya. He was, and remained, unaware of the arrangements that had been made between Solo, Dravya and Standard, although he was aware in general terms that Solo would use this new contract in support of its efforts to obtain finance. From Madhav Patel’s perspective this contract played an important part in supporting the second Dravya supply contract which in turn was the basis for the loan of US$20 million by Standard to Solo.
47. Mr. Hunter submitted that the history of Sogem’s contracts with Hamco and Dravya provides the key to understanding the relationship between Solo, Dravya and Standard which was built around the two Dravya supply contracts. Standard obtained virtually all of its information about the workings of the Hamco group from Madhav Patel. He certainly disclosed the fact that there was already in existence a long term relationship between the Hamco group and Sogem because that is reflected in the original proposal prepared by the Trade Finance department for the Credit Committee, though inasmuch as he said that Hamco had a five year marketing agreement with Sogem he did not describe hat relationship accurately. Mr. Andrew Hall, who was a member of Standard’s Credit Department at the time, recalled that, because ‘Hamco’ brand tin had not then been listed by the London Metal Exchange as good delivery and could not therefore be freely traded, Standard had required Solo to enter into an offtake agreement with Sogem. Although that is not recorded in any of the contemporaneous documents, I accept his evidence which is supported by a later memorandum from the Trade Finance department to the Credit Committee in September 1996 to the effect that Solo’s offtake agreement with Sogem had been extended from six months to three years. Later on, when the syndicated loan was being arranged, the Syndication Department was clearly given to understand that there was an offtake agreement with Sogem underpinning the supply contract.
48. The evidence of Mr. De Muyter together with the documents relating to a number of shipments made by Dravya between September 1996 and September 1997 now enables one to see the true picture more clearly. The first matter that emerges is that although Sogem made a number of spot purchases from Solo during the latter part of 1996, there was no long term contract between Solo and Sogem for the sale of tin at any time during that period. Sogem did, however, have two long term supply contracts in place, one with Hamco and one with Dravya.
49. The second matter of importance is that a significant quantity of tin was shipped by Dravya during that period. This was accepted by Mr. Hunter in the light of Mr. De Muyter’s evidence and in the light of that concession it is unnecessary for me to embark on a discussion of the evidence relating to shipments from the port of Nhava Shiva, the movements of individual vessels and local practices relating to the dating of bills of lading. In July 1997 Dravya wrote to Canara enclosing a schedule of nineteen shipments said to have been made between September 1996 and June 1997 pursuant to the first Dravya supply contract. The documents covering these shipments were in the bundles before the court together with documents relating to a further six shipments made in August and September 1997 taking the total to twenty five. In most cases the documents produced by Dravya and Solo can be linked to records kept by Sogem of its various purchases from Hamco, Dravya and Solo. These show that on eight occasions, two in September and six in December 1996, tin apparently sold by Dravya to Solo under the first Dravya supply contract was sold by Solo to Sogem under one of the spot transactions just mentioned. In four cases there are no documents evidencing the sale of the tin by Solo to a third party and there must therefore be some doubt whether any goods were in fact shipped.
50. The documents relating to the other thirteen shipments are even more interesting, however, because they show how the contract between Dravya and Solo and the two long term supply contracts between Sogem and Hamco and Sogem and Dravya were manipulated by Madhav Patel to enable the same shipment of tin to satisfy two contracts at the same time. Mr. Hall confirmed that Dravya presented shipping documents at Standard’s counters for payment under its contract with Solo. Having paid the documents, Standard attached Solo’s invoice and presented the documents to Sogem. Sogem appear to have regarded Solo as the agent of Hamco and Dravya for all purposes and was therefore content to accept shipping documents including an invoice from Solo under its contracts with Hamco and Dravya. In this way documents tendered in respect of four shipments under the contract between Dravya and Solo were used to satisfy the contract of 18^th September 1995 between Hamco and Sogem and documents tendered in respect of a further nine shipments under the contract between Dravya and Solo were used to satisfy the contract of 22^nd July 1996 between Dravya and Sogem.
51. The contract between Dravya and Solo was entirely constructed by Madhav Patel. I am quite satisfied that its attraction lay not in the opportunity to export additional quantities of tin but in the opportunity it provided to raise an additional US$10 million from Standard without significantly adding to the Hamco group’s obligations in relation to the production and export of tin. Although I am satisfied that the group had the resources to produce quantities of tin for export, there is nothing to suggest that it could easily increase the quantity available from 320 to 460 metric tons a month. Indeed, the commercial arrangements surrounding the second Dravya supply contract suggest that a total of 350-400 tons a month was the most that could be achieved. Moreover, the absence of any arrangements for disposing of the tin Solo had apparently agreed to buy lends further support to the conclusion that this contract was not genuine. However, by inserting Dravya and Solo as hidden parties into the existing commercial relationships established by the contracts of 18^th September 1995 between Hamco and Sogem and 22^nd July 1996 between Dravya and Sogem Madhav Patel was able to deceive Standard into thinking that it was financing a genuine export contract. Despite the fact that 359 metric tons of tin were supplied by Dravya to Solo and sold on by Solo to Sogem under spot sales, I am satisfied that this contract was not in fact intended to create legal rights and obligations between the parties in accordance with its terms. Madhav Patel must have known that Sogem was willing to buy as much tin as Hamco could produce and would be willing to buy it on a spot basis if it became available. It is not entirely clear why the first eight shipments were sold to Sogem in that way, but I am quite satisfied that it was never Madhav Patel’s intention that Dravya should deliver 140 tons of tin to Solo each month in addition to the quantities that the group was already committed to supplying to Sogem. The first Dravya supply contract can therefore properly be described as a sham in the sense described by Diplock L.J. in Snook v London and West Riding Investments Ltd.
52. Mr. Hunter submitted that the second Dravya supply contract was also a sham. Madhav Patel, he submitted, had been denied the fruits of the first scheme because Canara had insisted on retaining the full amount of the advance outstanding from time to time on deposit as security for the counter-indemnity on its guarantee. He therefore decided to obtain a much larger advance, only part of which would be supported by a guarantee, thereby ensuring that substantial sums would become available to the Hamco group.
53. The 1997 loan facility was negotiated over the period between June and December 1997. It was a syndicated loan designed to replace the loan agreement entered into by Standard and Solo in March 1996 and was undoubtedly procured by fraud on the part of Madhav Patel. Those who were responsible for organising the syndicate needed to assure themselves and the other banks concerned that Solo had performed its obligations under the original loan agreement, that Dravya was in a position to perform the supply agreement and that Solo had satisfactory arrangements in place for the disposal of the tin that it had agreed to buy from Dravya. Mr. La Trobe, who had responsibility for establishing the syndicate arrangements, was told by the bank’s Trade Finance Department that Sogem was the ultimate purchaser of the tin supplied under the first contract, that the arrangements had operated satisfactorily and that they were to continue. Unknown to Standard, none of that was true. Both Mr. La Trobe and the Credit Committee would have been interested to know about the long term supply contract of July 1996 between Dravya and Sogem because that might have affected their view of Dravya’s ability to perform its contract with Solo, but they were not informed about it for the simple reason that no one at Standard was aware of the existence of that contract until much later. An internal memorandum dated 16^th July 1997 makes it quite clear that the bank was under the impression at that time that Dravya’s only long term supply contract was the one it had with Solo. In these circumstances Standard assumed that the regular flow of documents demonstrated that the contract between Solo and Dravya was being satisfactorily performed.
54. It is tempting to conclude that if the first Dravya supply contract was a sham, the second Dravya supply contract was a sham as well, but there are in my view some important differences between the circumstances in which the two contracts were made and the manner in which they were performed which call for closer consideration. As I have pointed out, one indication that the first Dravya supply contract was a sham is the fact that at no time were there any established arrangements under which Solo could dispose of the tin that Dravya had apparently agreed to supply. ‘Hamco’ brand tin was not accepted as good delivery by the London Metal Exchange until May 1997 and that would have inhibited Solo’s ability to dispose of it otherwise than to traders such as Sogem who were already familiar with the ‘Hamco’ brand. Viewed as a whole, neither the arrangements between the various parties nor the manner of their dealings were structured in a way that was consistent with the existence of a genuine contract between Solo and Dravya. That was largely the result of the fact that Sogem already had its own long term contracts with Hamco and Dravya for the supply of tin.
55. Although dated 19^th September 1997, the second Dravya supply contract does not appear to have been executed by Dravya until 22^nd December 1997. Deliveries were not due to commence until the second calendar month after the receipt of the advance which was itself to be made within 120 days of signature of the agreement and after receipt of the prescribed guarantees. In the event, the facility agreement was not signed until 18^th December 1997 and the advance was not made until 25^th February 1998. By that time Solo had already entered into the new offtake agreement with Sogem dated 12^th December 1997 which was intended to replace the previous contract between Sogem and Dravya. The provisions of the new offtake agreement governing the delivery of tin corresponded to those of the contract between Dravya and Solo. On this occasion, therefore, the contractual arrangements were structured in such a way that the offtake contract between Solo and Sogem could only be performed if tin was delivered to Solo under its contract with Dravya.
56. Finally it is necessary to mention the toll smelting agreement between Dravya and Hamco dated 19^th September 1997 under which Hamco agreed to produce 200 metric tons a month of ‘Hamco’ brand tin ingots at its smelter at Kherdi from concentrate supplied by Dravya from its mines in the Bastar District of Madhya Pradesh. On the face of it this agreement completes the commercial arrangements by providing the means by which ore from Dravya’s mines was to be converted into ingots for export. David Steel J. expressed the view that this contract was a sham because Dravya had no mines or other access to ore capable of supporting it. For the reasons I have given I am not satisfied that that was the case, but nonetheless I have considerable doubts about this agreement. It contains no provisions dealing with the date of commencement of deliveries of ore, and, more importantly, it provides for the delivery of only 200 metric tons of tin concentrate a month which could not on any view be sufficient to produce 200 metric tons of finished ingots. I think it was probably produced to satisfy the banks that Dravya had a means of access to ‘Hamco’ brand tin and to provide further support for the suggestion that it intended to use the pre-shipment advance to develop its mining operations. None of that matters, however, if the Hamco group intended to make tin available to Dravya for sale to Solo so that Solo could in turn satisfy its obligations to Sogem under the offtake agreement. Ultimately this comes back to whether the Hamco group expected to continue its tin smelting operations at Kherdi and elsewhere.
57. Having regard to the way in which the arrangements were structured and to the evidence of the resources available to the Hamco group, I am not persuaded that the second Dravya supply contract was a sham. The offtake agreement between Solo and Sogem was clearly intended to be an effective contract and could not be performed unless Dravya delivered the tin it had agreed to supply under its contract with Solo. Unless Madhav Patel realised that it was impossible for Dravya to make those deliveries, there is no reason to regard the second Dravya supply contract as a sham, and the evidence does not persuade me that he did. No doubt at the time the arrangements were being put in place in the latter part of 1997 and early 1998 the difficulties of keeping the business running in the face of mounting financial pressures were becoming ever greater, but underneath all the fraud there remained in existence an active business in mining and smelting non-ferrous metals, particularly tin. Substantial quantities of tin had been delivered to Sogem during the previous two years and there is no reason to think that Madhav Patel did not think that Hamco could maintain a similar level of production in the future. In the event the business collapsed after only a few months, but that does not seem to me to tell one very much about the parties’ intentions at the time it was made. I accept that one of the principal motives behind the refinancing arrangements was to obtain further funds to prop up the group generally rather than to invest in Dravya’s mining project, but it does not follow that the contract between Dravya and Solo was a sham, either in the sense that Dravya had no intention from the outset of performing it, or in the sense that neither party intended it to give rise to legal rights or obligations of any kind.
58. Canara’s defence to the claim under the guarantee depended entirely on establishing that the second Dravya supply contract was a sham. It has failed to do so and accordingly Standard is entitled to recover the sum of US$10 million under the demand guarantee.

5. The consequences of a sham contract

59. However, Mr. Higham submitted that, even if the second Dravya supply contract was a sham, Standard was nonetheless entitled to recover against Canara under the guarantee which, as between the two banks, was intended to operate entirely independently of the underlying contract between Dravya and Solo. In view of my conclusion on the nature of the underlying contract it is unnecessary to decide this question, but it raises a number of important questions which were fully argued before me and I therefore think it right to express my conclusion on them.

(a) The construction of the guarantee

60. The first question concerns the construction of the guarantee. The guarantee was issued by Canara in the form of a copy telex sent by the London branch of the bank to Standard under cover of a letter dated 16^th December 1997 for onward transmission to Solo. It was expressed as an amendment to the original demand guarantee issued on 13^th May 1996, but the terms set out in the telex are complete in themselves and I do not think that anything turns on the reference to the previous instrument. The operative parts of the guarantee provided as follows:

“Whereas by purchase contract No.SIL/DICL/001/97-98 dated 19/09/1997 entered into between M/S Dravya Industrial Chemicals Limited (“Dravya”) and yourselves (hereinafter referred to as the ‘purchase contract’) you have agreed to purchase from Dravya up to 7200 mts of tin ingots on the terms set out therein

And whereas in terms of the purchase contract you have agreed to pay to Dravya a sum of U.S. Dollars 20,000,000 (U.S. Dollars Twenty million) as a pre-export pre-payment of (part of) the purchase price payable in respect of tin ingots upon Dravya procuring a first loss guarantee for and up to U.S. Dollars 10,000,000 (U.S. Dollars Ten million only) in your favour and whereas Dravya has requested us to provide such guarantee

We, Canara Bank, Nariman Point Branch, Mumbai do hereby irrevocably and unconditionally agree to pay to you a sum not exceeding US$10 million (U.S. Dollars Ten million only) upon your first written demand, which demand shall certify without the need to prove or provide evidence of the same that there has been a breach by Dravya of its obligations under the purchase contract.

1. It is a condition precedent to our being liable under this guarantee that you pay Dravya the sum of U.S. Dollars 20,000,000 by way of a pre-export pre-payment of the purchase price under the purchase contract. We agree that written confirmation from Standard Bank London Limited that such payment has been made to Dravya or to their order shall be absolute and conclusive evidence that such payment has been made . . . . . . . .

. . . . . . . . . . . .

3. This guarantee shall be a continuing guarantee for the due and punctual performance by Dravya of its obligations under the said purchase contract . . . . . . .

. . . . . . . . . . . .

7. Our liability under this guarantee shall not be reduced, discharged or otherwise adversely affected by

A) any variation, extension, compromise, discharge, dealing with, exchange or renewal of any right or remedy which you may now or hereafter have against Dravya or any other person in respect of the purchase contract.

. . . . . . . . . . . .

C) any termination, amendment, variation, novation, illegality or supplement or to the purchase contract.

. . . . . . . . . . . .

F) any invalidity, illegality, unenforceability, irregularity, frustration or discharge by operation of law or any actual or purported illegality of or any security held from Dravya or any other person in connection with the purchase contract.”

61. Mr. Hunter submitted that it was an express or implied condition of the guarantee that there was in existence a genuine contract between Dravya and Solo for the sale of tin and in support of that submission he drew my attention to the decision of Steyn J. in Associated Japanese Bank (International) Ltd v Crédit du Nord S.A. [1989] 1 W.L.R. 255. That case concerned a transaction under which the plaintiff bank agreed to purchase certain machinery from a customer for the purpose of leasing it back to him. The defendant bank agreed to guarantee the obligations of the customer under the leaseback agreement. After paying one instalment of rent the customer defaulted and was declared bankrupt. It was discovered that the machinery did not exist and the plaintiff sought to make a claim under the guarantee. Steyn J. held that it was an express condition of the guarantee that the machinery existed and that since it did not exist, the defendant was not liable.
62. The guarantee in that case was expressed to be given in consideration of the plaintiff’s leasing the machines described in the lease. It also contained a provision allowing the lessor, with the consent of the guarantor, to substitute other machinery for that originally covered by the contract. In those circumstances the judge held that the guarantee was subject to an express condition that the machinery existed. He would if necessary have held, however, that it was an implied condition of the guarantee that the machines existed on the grounds that any impartial observer would have regarded that as too obvious to require mention (page 263). A substantial part of the judgment is devoted to the question whether the guarantee was void for mutual mistake. I need not deal with that aspect of the case, however. Mr. Hunter did not put his case on that basis and indeed could not do so since Solo itself would inevitably have been a party to the construction of the sham transaction.
63. Mr. Higham submitted that there are important distinctions between Associated Japanese Bank (International) Ltd v Crédit du Nord S.A. and the present case. In the first place, he contended, the contract in that case was a true contract of suretyship and therefore necessarily ancillary to the principal contract, whereas the guarantee in the present case is simply an undertaking to pay a sum of money on demand. Moreover, the terms of the guarantee itself and the commercial context in which it was issued make it clear that it was intended to take effect quite independently of the underlying transaction. It was impossible, therefore, to construe the guarantee in this case as subject to an express or implied condition that the underlying contract was genuine.
64. I accept that there clearly are some important distinctions between the two cases. In particular, one can point to the different nature of the transactions and the terms of the instruments themselves. I am unable to accept that the contract in Associated Japanese Bank (International) Ltd v Crédit du Nord S.A. was nothing more than a simple contract of suretyship since it also contained an express undertaking by the defendant of liability as a principal debtor. Nonetheless, it clearly was a case in which the existence of the machinery was fundamental to the bargain, partly because the machinery was intended to provide the real security for the guarantors. However, each transaction must be considered by reference to its own terms and in its own commercial context and although Associated Japanese Bank (International) Ltd v Crédit du Nord S.A. provides an illuminating example, it is necessary to examine the present guarantee with care in order to ascertain to what extent it is conditional upon the status of the underlying agreement.
65. The context in which the guarantee was given is in my view of the greatest importance. Canara was well aware that Dravya was seeking to replace its existing financing arrangements with Standard with new arrangements structured in substantially the same way and it must have been recognised by all concerned from the outset, therefore, that the guarantee represented only one element in a complex transaction involving Dravya, Solo, Canara and Standard (together, of course, with the other members of the syndicate). This is borne out by the fact that clause 1 of the guarantee not only makes it clear that it was not to become effective unless and until the pre-export payment had been made, but also recognises that the funds would be advanced by Standard rather than Solo.
66. The loan agreement between Standard and Solo required, as one would expect, that the demand guarantee called for under the second Dravya supply contract should be assigned to Standard as part of the security for the loan. Given the nature of the transaction it would be surprising if Canara as a major bank itself had not appreciated that that would be required, but a letter dated 28^th November 1997 from the International Division of the bank to its Circle Office in Mumbai shows that Canara must have been aware of that possibility. That letter not only shows that there had been a request that the guarantee should contain a clause permitting its assignment, but that the bank was aware that if the guarantee were capable of being assigned it might become an essential part of the security supporting the financing of the underlying transaction. This is an important matter when one comes to consider the construction of this particular contract.
67. It is well established that demand guarantees of this kind are normally intended to operate as autonomous contracts in the sense that the guarantor’s obligation to pay is not linked to the underlying transaction but depends only on the making of a demand which conforms to the requirements of the guarantee. This principle was established in Edward Owen Engineering Ltd v Barclay’s Bank International Ltd [1978] 1 Q.B. 159 and has been consistently applied in subsequent cases. This is a well-recognised aspect of international banking practice which forms another important aspect of the background against which the guarantee falls to be construed.
68. Mr. Higham based his submission on clause 7 of the guarantee which I quoted earlier. Although the wording of this clause leaves something to be desired, I think its general intention is reasonably clear and indeed it was common ground that paragraph F) should be read as follows:

“Our liability under this guarantee shall not be reduced, discharged or otherwise adversely affected by any invalidity, illegality, unenforceability, irregularity, frustration or discharge by operation of law or any actual or purported illegality of [the purchase contract], or [of] any security held from Dravya or any other person in connection with, the purchase contract.”

69. It is apparent from this clause that the parties to the guarantee had turned their minds to the possibility that the purchase contract might fail for various reasons, some within and some outside the control of the parties to it. More importantly, perhaps, they contemplated the possibility that the contract might be altogether invalid or unenforceable as a matter of law. They agreed, however, that in none of these cases should Canara’s liability under the guarantee be affected. This is the strongest of indications not simply that the guarantee was intended to be independent of the purchase contract, but that it was intended to be independent of the legal efficacy of the purchase contract. The fact that Canara’s liability was to remain unaffected by the invalidity, illegality or unenforceability of the purchase contract is a clear indication that the existence of enforceable obligations between Dravya and Solo under the purchase contract was not in any sense a prerequisite of its liability under the guarantee.
70. Mr. Hunter sought to draw a distinction in this context between a contract which is nothing more than a sham because neither party intended it to create legal relations and a contract which, although intended to create legal relations, is invalid or unenforceable for some reason of which the parties were at the time unaware. He sought to reinforce his argument by pointing to the requirement that any demand under the guarantee had to include a certificate that Dravya was in breach of its contract.
71. At first sight the distinction Mr. Hunter sought to draw is an attractive one, but I do not think it is sound. I do not think that much help can be gained from the requirement that a demand under the guarantee must include a certificate that Dravya is in breach of contract. Given the terms of clause 7 F), the guarantee necessarily contemplates that a demand may be made in cases where Dravya is not in fact in breach of contract, though that may well not be known to the beneficiary at the time the demand is made. Such a situation could easily arise, for example, in a case where the contract was said to have been frustrated, let alone when the contract turned out to be invalid. Provided the demand is made honestly, the guarantee will work as intended, even though Dravya was not in fact in breach of contract. Indeed, I think that even in a case where the beneficiary knew that the purchase contract was invalid or unenforceable it would still be open to him to make a valid demand under the guarantee because that is what it contemplates.
72. The reason for that is not far to seek. The commercial purpose of the guarantee was not so much to secure the performance by Dravya of its obligations under the purchase agreement, but to secure in part the pre-export advance made by Solo. It is for that reason that it took the form of a simple demand guarantee rather than a contract of suretyship and it is for that reason that it was expressed to remain unaffected by the invalidity of the purchase contract. If the purchase contract was invalid or unenforceable for any reason it could scarcely matter to Canara how that had come about. Moreover, it is particularly important to bear in mind, first, that Canara knew before it issued the guarantee that Standard was going to advance the sum of US$20 million to Solo to enable the loan to be made to Dravya and, secondly, that it contemplated that the benefit of the guarantee would be assigned by Solo to Standard as security for that advance. Against this background the function of the guarantee as security for the repayment of the pre-export advance becomes even clearer. Its purpose was to ensure that if the purchase contract failed for whatever reason the lender had a means of recovering the loan, albeit only in part. It is difficult to see why the position should be different in a case where the purchase contract, although apparently genuine, is nothing but a sham. The pre-export advance has still been made and the lender to whom the guarantee has been assigned requires the same protection. The absence of any enforceable obligations between the buyer and seller is something the guarantor already had in contemplation. The only difference is the fact that in such a case the guarantor will have been induced by fraud to issue the guarantee. That may give rise to a right to avoid the guarantee, but is not in my view something that as a matter of construction takes the case outside the very wide terms of the guarantee. Solo itself could not make a valid demand, of course, not because the claim would fall outside the terms of the guarantee, but because it was itself a party to the fraud (see the comments of Lord Diplock in United City Merchants (Investments) Ltd v Royal Bank of Canada [1983] 1 A.C. 168 at pages 183-184). But I see no reason why Standard as an assignee having no knowledge of the fraud could not do so. For these reasons I am unable to accept that as a matter of the construction a claim cannot be made under the guarantee if the purchase contract was a sham.

(b) Canara’s right to avoid the contract

73. If the second Dravya supply contract was a sham, Canara’s real complaint is that it was induced to issue the guarantee by the fraud of Solo and Dravya and it was common ground that in those circumstances Canara would be entitled as against Solo to avoid the guarantee. This follows from the application of ordinary principles of the law to which demand guarantees are subject as much as any other contract: see Solo Industries UK Ltd v Canara Bank [2001] 1 Lloyd’s Rep. 578 per Mance L.J. at page 587. Ordinarily the position of a third party such as Standard to whom the benefit of the guarantee has been assigned is no better than that of the original beneficiary since the assignee takes subject to equities, but as a matter of principle it is open to the parties to provide by contract for the protection of assignees: see Banco Santander S.A. v Bayfern Ltd [2000] Lloyd’s Rep. Bank. 165 per Waller L.J. at pages 168-170.
74. Mr. Higham put forward two answers to this argument. The first was that at the time of acknowledging the assignment of the guarantee Canara assumed a direct obligation to Standard in terms of the guarantee that was unaffected by any fraud on the part of Solo. The second argument was that Canara was precluded from avoiding the guarantee by reason of its inability to restore the benefits it obtained under the contract.

(i) The relationship between Canara and Standard

75. On 18^th December 1997 Solo gave formal notice to Canara of the assignment to Standard of its rights under the guarantee and shortly afterwards on 30^th December Dravya asked Canara to send a letter to Standard acknowledging receipt of that notice in the terms prescribed by the loan documentation. In response on 19^th January 1998 Canara’s Foreign Department in Mumbai sent a telex to the London branch of the bank containing a further amendment to the original guarantee. The London branch was asked to advise Standard of the amendment which it did by sending it a copy of the telex the same day.
76. The telex read as follows:

“Please advise the following amendment to the above referred guarantee duly authenticated.

To: Standard Bank London Limited

. . . . . . . . . . . .

Re: All of the assignor’s rights, title and interest in a guarantee given by Canara Bank to Solo Industries Limited . . . . . . . . dated 13^th May 1996 and amendment dated 16^th December 1997 (the Assigned Property).

We hereby acknowledge receipt of a notice of assignment made between Solo Industries Limited (Assignor) and Standard Bank London Limited (Assignee) pursuant to which, inter alia, the Assignor assigned the Assigned Property to the Assignee.

1. We agree to pay all amounts payable by us pursuant to any provision of or otherwise in relation to the Assigned Property to the Assignee and to only accept instructions or demands in respect to the Assigned Property from the Assignee until the Assignee notifies us to the contrary.

2. . . . . . . . . . . . .

3. We agree with the Assignee that all sums payable by us to the Assignee pursuant to the Assigned Property shall be paid in full without any set-off or counterclaim and free and clear of all deductions or withholding on account of taxes.

All other terms and conditions contained in our letter of guarantee . . . . . . dated 13^th May and amendment to the subject guarantee dated 16^th December 1997 remain unchanged.

. . . . . . . . . . . .

This is second amendment to above letter of guarantee.

All other terms and conditions remain unchanged.

This telex is an operative instrument.

Kindly advise beneficiary.”

77. Apart from the fact that it took the form of an amendment to the guarantee, the terms of telex followed the form of acknowledgment prescribed by the documentation covering the loan by Standard to Solo.
78. Mr. Higham submitted that although the document opens with an acknowledgment of receipt of notice of assignment, its effect was not intended to be limited to a formal recognition of the assignment. He submitted that by virtue of its status as an amendment to the guarantee this document was understood and intended by both Canara and Standard to have contractual effect. It was addressed to Standard rather than to Solo as the original beneficiary and contained in the numbered paragraphs language that is clearly capable of amounting to an express agreement with Standard. He submitted that the intention and effect of this amendment was to put Standard in the position of a beneficiary free of any defences that Canara might have against Solo.
79. Mr. Hunter submitted that to construe this document as containing a contract of any kind between Canara and Standard would be contrary to the object and intention of the parties because it would create a relationship between them fundamentally different from that which would result from a simple assignment of rights by Solo. He pointed to the fact that all the documentation surrounding the loan speaks in terms of an assignment of Solo’s rights under this and other instruments and not of any requirement that the guarantee be amended to add Standard as a beneficiary.
80. It is quite true, of course, that all the documents refer to an assignment of the guarantee and I can see nothing to suggest that either party intended there to be a novation of the guarantee in favour of Standard. The real question, however, is whether they intended the assignment to be on terms that Canara should not be entitled to rely on defences that would have been available against Solo. In other words, was it their intention that Standard should take the assignment of the guarantee free of equities in the manner contemplated by Waller L.J. in Banco Santander S.A. v Bayfern Ltd?
81. In my judgment a number of matters suggest that they did. The form of the acknowledgment letter itself, and hence of the amendment telex, goes some way beyond what would be required simply to confirm receipt of a notice of assignment and suggests that the parties were seeking to modify the ordinary incidents of an assignment. In particular, paragraph 3 is designed to ensure that claims that might otherwise be raised by Canara to extinguish or reduce its liability to make payment under the guarantee are to be excluded. That is consistent both with the autonomous nature of the demand guarantee and with the general nature and objective of the commercial enterprise. Canara was aware that the guarantee was intended to form one of the basic securities for the loan and it would therefore be consistent with the nature and object of the wider transaction that once it had been assigned to Standard the guarantee should be isolated from matters arising out of the relationship between Canara, Solo and Dravya. Canara was not asked to issue an amendment to the guarantee; the fact that it chose to deal with the matter in that way may reflect its understanding that the terms in which it was being asked to acknowledge the assignment of the guarantee affected its legal rights. However that may be, the loan was made available by Standard partly in reliance on this amendment which must be construed according to its terms and in its commercial context. This is not a matter that admits of a great deal of elaboration. Reading the amendment as a whole I am satisfied that it was the parties’ intention that Standard should take the benefit of the assignment free of cross-claims of any kind, including any claim by Canara to avoid the guarantee on the grounds of fraud on the part of Dravya and Solo. For these reasons I accept that once the transaction was completed by the transfer of the funds from Standard to Canara on 25^th February 1998 it was no longer open to Canara to avoid the guarantee on the grounds that the second Dravya supply contract was in fact a sham.

(ii) Restitution

82. Mr. Hunter accepted that as the law currently stands a party may only exercise a right to avoid a contract if he is willing and able to restore any benefits he has received under it. In my view this principle is too well established to require citation of authority, but is well illustrated by the following dictum of Lord Blackburn in Erlanger v The New Sombrero Phosphate Co. (1878) 3 App. Cas. 1218, 1278:

“It is, I think, clear on principles of general justice, that as a condition to a rescission there must be a restitutio in integrum. The parties must be put in statu quo. . . . . . . . . . . . . . . . . . . It is a doctrine which has often been acted upon both at law and in equity.”

83. On this basis Mr. Higham submitted that Canara could not in any event avoid the guarantee without restoring to Standard the benefit it had received under it, namely, the pre-shipment advance of US$20 million. Mr. Hunter submitted, however, that Standard could not take advantage of this principle in the present case, either because the contract which Canara sought to rescind was not made with Standard but with Solo, or because the contract was in any event subject to a condition precedent that there should be a genuine underlying sale contract and in the absence of such a contract was void. The latter point is one with which I have already dealt.
84. Rescission involves the dissolution of the contract from its very inception so as to put the parties in the positions they would have occupied if it had never been made. For this reason a party who wishes to exercise the right to rescind must restore whatever benefits he has received under the contract. The guarantee in the present case was a contract between Canara and Solo. The consideration for that contract was provided in part by Solo in entering into the contract with Dravya and partly by Dravya in the form of an undertaking to indemnify Canara against a demand under the guarantee supported by a cash deposit of US$10 million. No immediate financial benefit passed from Solo to Canara under the guarantee itself and although Canara received the pre-export advance of US$20 million from Standard, the payment was made by way of a loan to Solo and received by Canara as banker for Dravya rather than in its own right. That remains the case even though the transfer of the funds to Canara was a condition precedent to its liability under the guarantee.
85. Putting the assignment on one side, if Canara wished to avoid the guarantee the obligation to restore benefits received under the contract would require it to release Dravya from its obligation to indemnify it against a demand (which would in any event automatically disappear) and release the cash deposit. Apart from that it is difficult to see what benefits capable of being valued in monetary terms Canara could be said to have received. The involvement of Standard as assignee does not in my view alter the position. As assignee of Solo Standard became the beneficiary of the guarantee, but it had no effect on the benefits provided to Canara under the contract. The fact that the issue of the guarantee was one, but only one, of the essential steps that led to Canara’s obtaining control over the US$20 million advance does not mean it received those funds as a benefit under the guarantee. For these reasons I do not think that the exercise by Canara of a right to avoid the guarantee (had such a right continued to exist) would have required it to return any part of the advance to Standard.
86. This makes it unnecessary for me to consider a further argument, somewhat tentatively advanced by Mr. Hunter, to the effect that the obligation to make restitution in these circumstances may be tempered by a change in position on the part of the party seeking to rescind. This proposition seems to me to be in direct conflict with what both parties recognised as being the principle hitherto accepted, namely, that the ability to make substantial restitution is a precondition to the exercise of that right. Mr. Hunter recognised that it raised a very difficult question and it is not one with which I need to grapple in this case. However, if this matter goes further, it will be open to Mr. Hunter to develop the argument as he thinks fit.

6. The claim in restitution

87. As an alternative to its claim under the guarantee Standard made a claim in restitution. Following an amendment made in the course of the trial this claim was extended to cover the funds advanced under the first loan agreement as well as those advanced under the second. The claim proceeded on the assumption that both the first and second Dravya supply contracts were shams and that Canara was therefore entitled to avoid liability under the guarantee. In view of the conclusions I have reached on these questions this alternative claim does not arise, but the issues were fully argued before me and I think it right to state my conclusions on this part of the case as well.
88. It was common ground that if the guarantee was unenforceable for the reasons advanced by Canara, Standard was in principle entitled to recover the outstanding amount paid to Canara in restitution as money paid under a mistake. In answer to that claim Canara contended that it was relieved from any obligation to make restitution insofar as it had paid the money away to its customer, Dravya, or otherwise changed its position before learning of Standard’s claim.
89. The starting point for a consideration of the principles governing the defence of change of position is the following passage in the speech of Lord Goff in Lipkin Gorman v Karpnale Ltd [1991] 2 AC 548 at page 579F-580G:

“In these circumstances, it is right that we should ask ourselves: why do we feel that it would be unjust to allow restitution in cases such as these? The answer must be that, where an innocent defendant's position is so changed that he will suffer an injustice if called upon to repay or to repay in full, the injustice of requiring him so to repay outweighs the injustice of denying the plaintiff restitution. If the plaintiff pays money to the defendant under a mistake of fact, and the defendant then, acting in good faith, pays the money or part of it to charity, it is unjust to require the defendant to make restitution to the extent that he has so changed his position. Likewise, on facts such as those in the present case, if a thief steals my money and pays it to a third party who gives it away to charity, that third party should have a good defence to an action for money had and received. In other words, bona fide change of position should of itself be a good defence in such cases as these. The principle is widely recognised throughout the common law world. . . . . . . . . . . . .

. . . . . . . . . . The time for its recognition in this country is, in my opinion, long overdue.

I am most anxious that, in recognising this defence to actions of restitution, nothing should be said at this stage to inhibit the development of the defence on a case by case basis, in the usual way. It is, of course, plain that the defence is not open to one who has changed his position in bad faith, as where the defendant has paid away the money with knowledge of the facts entitling the plaintiff to restitution; and it is commonly accepted that the defence should not be open to a wrongdoer.”

90. Subsequent decisions have, as Lord Goff envisaged, begun to establish in greater detail the principles governing the defence of change of position. Thus, it was common ground in this case that in order to afford a defence the defendant’s change of position must have been causally linked to the receipt of the payment in question: see Philip Collins Ltd v Davis [2000] 3 All E.R. 808 and Scottish Equitable plc v Derby [2001] 3 All ER 818. Moreover, it is clear from the decision of the Court of Appeal in Scottish Equitable plc v Derby that the right to recover in restitution and the right to rely on a defence of change of position are matters which depend on established principles of law rather than the discretion of the court: see per Robert Walker L.J. at pages 825h and 828c-d.
91. The present case is complicated by the fact that in each case Canara received the funds in question as banker for Dravya. It has long been recognised that an agent to whom money has been paid for the account of his principal has a good defence to a claim to recover the money from him if before learning of the claim he has paid the money over to his principal. A banker who receives money on behalf of his customer can take advantage of this rule: see Kerrison v Glyn, Mills, Currie & Co. (1912) 81 L.J.K.B. 465 (H.L.). However, merely crediting money to an account of the customer in credit will not be regarded as the equivalent of paying it over to the customer: see Bavins & Sims v London & South Western Bank Ltd [1900] 1 QB 270. It will often be appropriate to treat the payment of money by the banker into a customer’s overdrawn account as a payment to the customer and a repayment by the customer to the bank so that the bank can take advantage of the defence. This was the view expressed by Sir Richard Henn Collins M.R. in Continental Caoutchouc and Gutta Percha Co. v Kleinwort, Sons & Co. (1904) 90 L.T. 474 at page 476. If, on the other hand, the banker is not a mere agent but is himself personally interested in the funds, e.g. because they have been assigned to him as security, the position is different: see Kleinwort, Sons & Co. v Dunlop Rubber Company (1907) 97 L.T. 263. These and other related principles make it important to consider with some care the precise circumstances in which Canara received and disposed of the funds in question.
92. The first payment of US$10 million was made on 22^nd May 1996. It was converted into rupees and retained by Canara in various fixed term deposits as security against its liability under the guarantee. As its exposure under the guarantee reduced Canara released part of the funds to Dravya so that by February 1998 the amount on deposit had fallen to the equivalent of approximately US$7.6 million. (The dollar equivalent value of the deposits was adversely affected throughout this period by the depreciation of the rupee, but it was accepted that this was broadly cancelled out by the accrual of interest).
93. Part of the pre-export advance made under the first Dravya supply contract had been repaid in the manner envisaged by the contract and as part of the refinancing arrangements Canara agreed to pay a little over US$8 million to Standard to liquidate the outstanding balance of the advance. This payment was in fact made using part of the funds transferred under the new loan, though the important fact for present purposes is that the payment was directly linked to the receipt by Canara of the new advance of US$20 million. The balance of US$11.98 million was converted into rupees and credited to Dravya’s current account which was then in credit to the extent of INR1,910. A sum in Rupees approximately equivalent to US$2.4 million was then withdrawn from that account and placed on fixed term deposit in order to bring the total value of the bank’s security back up to US$10 million. Mr. Hunter accepted that that transfer did not involve a relevant change of position.
94. Leaving aside discrepancies caused by the accrual of interest on the deposits and the depreciation of the rupee against the dollar, therefore, by close of business on 25^th February 1998 Canara had effectively disposed of an amount equal to the whole of the original US$10 million payment in a manner consistent with the arrangements between the parties to the two transactions. At that point it continued to hold an amount equivalent in total to the new advance of US$20 million, partly in the form of the sums held on deposit and partly in the form of funds credited to Dravya’s current account.
95. On 26^th and 27^th February various sums were withdrawn from Dravya’s current account still leaving it in credit, but only in the sum of INR730,667. However, by 27^th March 1998 the account was overdrawn and it follows that in the intervening period all the funds received from Standard had been paid away in one way or another.
96. Mr. Hunter submitted that each drawing on the account represented an instance of Canara’s accounting to its customer, or changing its position, in good faith in a way that would make it unjust to require it to make restitution to Standard. Mr. Higham accepted that a large proportion of the withdrawals, amounting in all to INR285,854,705 (approximately US$7.3 million), should be regarded in that light, but he pointed out that sums equivalent to US$1.9 million which were transferred to the accounts of Hamco and Nariman Point Chemicals were in fact simply blocked by Canara and retained by it on account of liabilities incurred by those two companies. He submitted that neither Hamco, Nariman Point nor Canara had a right to retain those funds.
97. The accounts of Hamco and Nariman Point were both overdrawn when the transfers from Dravya’s account were made. This might suggest in accordance with the dictum of Sir Richard Henn Collins M.R. in Continental Caoutchouc v Kleinwort that the transfer should be treated as a payment away by Canara in accordance with its duty as Dravya’s banker of funds which were then used by Hamco and Nariman Point to pay off debts owed to Canara itself. However, Mr. Higham submitted that there is no all-embracing principle that money paid by a banker into a customer’s overdrawn account is irrecoverable from him and that it is necessary to examine the circumstances of the case more closely.
98. In Barclay’s Bank Ltd v W. J. Simms, Son & Cooke (Southern) Ltd [1980] 1 Q.B. 677 Robert Goff J. reviewed many of the authorities in this area and at page 695B-D identified certain principles to be derived from them as follows:

“From this formidable line of authority certain simple principles can, in my judgment, be deduced: (1) If a person pays money to another under a mistake of fact which causes him to make the payment, he is prima facie entitled to recover it as money paid under a mistake of fact. (2) His claim may however fail if (a) the payer intends that the payee shall have the money at all events, whether the fact be true or false, or is deemed in law so to intend; or (b) the payment is made for good consideration, in particular if the money is paid to discharge, and does discharge, a debt owed to the payee (or a principal on whose behalf he is authorised to receive the payment) by the payer or by a third party by whom he is authorised to discharge the debt; or (c) the payee has changed his position in good faith, or is deemed in law to have done so.”

These propositions, especially proposition 2(b), were considered in some depth and approved by the Court of Appeal in Lloyds Bank plc v Independent Insurance Co. Ltd [2000] QB 110.

99. The dictum of Sir Richard Henn Collins M.R. in Continental v Kleinwort, was not considered by Goff J. in Barclay’s Bank Ltd v W. J. Simms, Son & Cooke (Southern) Ltd nor by the Court of Appeal in Lloyds Bank plc v Independent Insurance Co. Ltd, but I think Mr. Higham was right in submitting that as it stands it cannot be reconciled with those and other earlier authorities. I think it can best be viewed as an example of the operation of the principle approved by the Court of Appeal in Lloyds Bank plc v Independent Insurance Co. Ltd rather as authority for any wider principle. In particular, I think that Mr. Higham was right in saying that there is no general rule that the crediting by a banker of funds to a customer’s overdrawn account operates as a bar to a claim against him for repayment. In order for the payee to have given good consideration it is necessary that the payment operate in discharge of the debt and for that to occur the payment must have been made and received with the necessary authority.
100. As Mr. Higham pointed out, there are several reported cases in which the crediting by a banker of money to a customer’s overdrawn account has not provided him with a good defence. In The Colonial Bank v The Exchange Bank of Yarmouth, Nova Scotia (1885) 11 App. Cas. 84 (P.C.). Rogers, a customer of The Colonial Bank, gave instructions to remit a sum of money to his account with a bank at Halifax. As a result of a mistake the money was paid to a bank in New York for transmission to the defendant which, when it learned of the transfer, debited the New York bank and credited the money to Rogers’ account with it which was then overdrawn. Before anything further had occurred the defendant was informed of the mistake, but it declined to return the money. The Privy Council held that the defendant was bound to repay the money, despite the fact that it had been credited to the overdrawn account. The argument that the payment had been “used” was rejected and I think Mr. Higham is right in saying that this was a case which can be explained on the basis that the payment to the defendant had not been made with authority to discharge any part of Rogers’ liability. Dicta supporting the same proposition can be found, as Robert Goff J. observed, in Kerrison v Glyn, Mills, Currie, another case in which the crediting of money to an overdrawn account did not prevent recovery on the grounds of mistake.
101. The statements relating to the accounts of Hamco and Nariman Point indicate that the bulk of the sums transferred from Dravya’s current account on 26^th and 27^th February amounting to INR75,578,124 (approximately US$1.9 million) were immediately transferred to a margin account and retained by Canara as security for its exposure under existing letters of credit. There is no evidence to explain the ultimate fate of these amounts and certainly nothing to show that they were used to discharge liabilities of Hamco or Nariman Point. In the circumstances I accept Mr. Higham’s submission that Canara has failed to establish a change of position in relation to this part of the money received from Standard.
102. The main area of dispute, however, concerns the cash deposits. The original sum of US$10 million was held in a number of separate term deposits in Dravya’s name. From time to time during the currency of the first contract Dravya had executed letters of pledge over these deposits in favour of Canara on the bank’s standard form of wording. The primary purpose of these pledge letters was to secure Dravya’s counter-indemnity in relation to the guarantee, but the standard wording included provisions which extended the security to any liabilities that Dravya might incur to the bank. The position in relation to the deposits held as security for the second guarantee was broadly similar. The original guarantee had been for US$10 million reducing in accordance with the reducing amount outstanding in respect of the pre-export advance under the first Dravya supply contract. It had therefore agreed to accept a reducing cash deposit, but in return for its agreement to reissue the guarantee in support of the much larger advance being made under the second contract Canara stipulated that the cash deposit should be retained in full throughout the life of the guarantee. Dravya had no choice but to agree to that and in its letter dated 18^th September 1997 requesting the amendment of the guarantee it also agreed that Canara should be entitled to hold the cash deposit as security for any of its outstanding liabilities.
103. Mr. Hunter submitted that Canara had entered into a number of additional transactions with Dravya in reliance on the security of the cash deposits and to the extent that those transactions had resulted in a loss Canara had suffered a change of position that would make it unjust to require it to restore the payment to Standard. The transactions on which Canara relied consisted of opening four letters of credit on 6^th October and 23^rd December 1997 and 16^th and 18^th March 1998 respectively to a total value of US$6,731,600 and discounting nine foreign bills of exchange to a total value of US$679,240 of which US$234,282 remained outstanding when the Hamco group collapsed. Mr. Higham submitted, however, that Canara could not establish any causal link between its receipt of the payment from Standard and these particular transactions. He submitted that where the payee has disposed voluntarily of money paid to him by mistake he must, if he is to succeed in establishing a relevant change of position, be able to show that he took a conscious decision to pay it away as a consequence of its receipt. In other words, he must be able to show that his decision to pay the money away was prompted by his awareness of its receipt and, of course, his belief that it was available to him to dispose of. He submitted that in the present case Canara could not discharge that burden. It did not embark on any fresh transactions with Dravya on the faith of the cash deposits because the whole amount of the deposits was already earmarked as security for the guarantee.
104. I accept that in order to establish a change of position by voluntarily parting with or disposing of the money it will normally be necessary for the payee to be able to show that the receipt of the money operated on his mind and caused him to act as he did. That is in my view borne out by the decisions in both Philip Collins Ltd v Davis and Scottish Equitable v Derby to which I referred earlier. It is necessary, therefore, to examine each transaction to see to what extent Canara can establish a link between its receipt of the funds and the transactions on which it seeks to rely.
105. The evidence in relation to this part of the case was provided by Mr. George Joseph who took over responsibility for the Nariman Point branch of the bank in September 1997 with the rank of Assistant General Manager. It is apparent, however, that other members of the bank’s staff at the Nariman Point branch were closely involved in these transactions. Many of them have provided statements, but none of them deals with this aspect of the case. Indeed, even Mr. Joseph dealt with it only in a witness statement made when he arrived in London a few days after the beginning of the trial. The fact that this evidence was provided so late in the day does not, of course, mean that it is inherently unreliable, but it is one factor which causes me to approach it with some caution.
106. I am satisfied that in general Mr. Joseph was a careful and reliable witness, but there were occasions when it became quite clear that his recollection was faulty or even non-existent. That is not in itself surprising or a matter for criticism, but he was not always ready to admit his difficulty and was inclined to suggest that his recollection was clearer than was the case. This was particularly striking in the case of the letter of credit opened on 6^th October. In his statement he had said that he had authorised that transaction, but at the outset of his evidence he withdrew that evidence having had the opportunity in the meantime to review some of the documents which showed that he was away on leave at the time. His explanation for this change of position exposed a tendency on his part to reconstruct events from the documents without making it clear whether and to what extent he was able to speak from recollection. Having said that, however, I am satisfied that Mr. Joseph was doing his best to assist the court and I am grateful to him for the effort he made.
107. Before Mr. Joseph took over responsibility for the Nariman Point branch on 23^rd September 1997 he spent two weeks there during which he was briefed by the outgoing manager, Mr. Kini, on the branch’s customers and business. In the course of that briefing he was informed of the arrangements being made for the amendment of the demand guarantee, including the fact that the bank required cash cover to be maintained for the full amount of the amended guarantee throughout its life. He realised that there was a substantial risk that a demand might be made on the guarantee. He was also informed about the credit facilities available to the Hamco group and to Dravya in particular. Dravya’s letter of credit and bill discounting facilities had expired in November 1996, but an application for renewal of those facilities had been submitted through the Nariman Point branch to the Mumbai Circle Office which exercised a supervisory role in these matters and pending a decision by that office the branch manager, as was the custom, had continued to make facilities available to Dravya on a case by case basis. Mr. Joseph knew, however, that if liability for a letter of credit finally devolved upon the bank, the branch would not be allowed to open any further letters of credit.
108. Mr. Joseph was on leave between 3^rd and 18^th October 1997. He was not at the branch, therefore, when the first letter of credit was opened on 6^th October and did not himself authorise that transaction. In a letter written to the bank’s Enforcement Directorate in September 1999 when the granting of various facilities to Hamco group was under investigation Mr. Joseph identified two other members of staff, Mr. Ambavane and Mrs. Thakur, as the persons responsible for issuing this letter of credit, but it is clear from Mr. Joseph’s evidence that their involvement as signatories of the relevant documents was essentially ministerial. The officer responsible for the decision must, in my view have been his deputy, Mr. Shanbhag, who was in charge of the branch in his absence. However, there is no evidence of what considerations lay behind it. Mr. Joseph does not appear to have established any policy of his own in relation to Dravya before he went on leave and there is no evidence of the approach taken by Mr. Kini. It is not clear whether at that stage Mr. Shanbhag had seen Dravya’s letter of 18^th September 1997, or if he had, what view he took of the matter. It is quite possible, therefore, that he authorised the opening of the letter of credit simply on the basis that he knew that previous applications of a similar kind had routinely been granted.
109. Mr. Hunter submitted that in circumstances where Dravya had signed a letter agreeing that Canara could hold the cash deposit as security for any of its liabilities the court should not be over-demanding in requiring proof that the bank relied on the existence of those deposits when making subsequent credit facilities available. I see the force of that argument, but given that the bank had only recently agreed to reissue a demand guarantee on condition that it was fully covered by cash deposits, I should expect to have seen some positive evidence from those responsible for the decision that the bank was willing to extend further credit to Dravya on the strength of the same security. In the absence of any such evidence Canara is unable to show that the decision to open this letter of credit was taken on that basis.
110. The next letter of credit was opened on 23^rd December 1997. Despite Mr. Joseph’s initial insistence that he had a clear recollection of this transaction, I am quite satisfied that he did not and that he was doing his best to reconstruct events by reference to the documents. The circumstances in which this letter of credit was opened differed in one very material respect from those that had obtained in October in that Dravya’s application for a renewal of its credit lines had by then been “lodged”, that is rejected, by the Mumbai Circle Office. This meant that the branch no longer had any authority to grant further facilities to Dravya.
111. The letter from the Circle Office dated 10^th December 1997 informing the Nariman Point branch that the application had been lodged was marked for the attention of Mr. Joseph and was sent to the branch by fax, probably the same day, but in any event within a day or so at the most. It is very likely that it arrived before Mr. Joseph went on leave on 12^th December, but in any event it must have arrived by 15^th December when the bank wrote to Dravya informing it of the decision. The letter was therefore in the branch when Mr. Joseph returned to work on 21^st December.
112. The Hamco group was an important customer of the Nariman Point branch, so a letter of this kind would have been viewed by Mr. Joseph and other senior members of staff as a matter of great importance. I find it impossible to accept, therefore, that its contents were not brought to his notice at the first opportunity. Mr. Joseph could not remember exactly when he first saw it, but I am satisfied that he was probably aware of it before he went on leave. If he was not, it must certainly have been drawn to his attention immediately on his return to the office.
113. Mr. Joseph was adamant that if he had been aware of the existence of the letter from Circle Office he would not have authorised the opening of any further letters of credit for Dravya. When Mr. Joseph authorised the issue of a letter of credit for which specific authority was required it was his normal practice to sign a piece of paper to indicate that fact, but it became clear in cross-examination that in this case he had no recollection of authorising the letter of credit and no piece of paper bearing his signature has been found. In these circumstances the account given by Mr. Joseph in his witness statement of his reasons for authorising this second letter of credit must be entirely discarded. He described himself at one point as “a very obedient employee of the bank” and having seen him give evidence I would accept his description of himself since he struck me as someone who was generally conscientious in the performance of his job. He would have been acting quite contrary to instructions if he had authorised the opening of this letter of credit and I do not think he did so. How it came to be opened is another matter, but it is unnecessary for me to make any finding about that. It is enough for present purposes that Canara is unable to show that the decision owed anything to the existence of the deposits securing the guarantee.
114. This brings me to the letters of credit opened on 16^th and 18^th March 1998. Mr. Joseph said in his witness statement that he had obtained permission to open these from the acting General Manager at the Circle Office, Mr. Shenoy, at a time when the General Manager, Mr. Kamath, was away on leave. He described a meeting at the Circle Office attended by himself and Mr. B. M. Patel at which Mr. Patel had explained that without the letters of credit Dravya would be unable to import the concentrate it needed to perform its contract with Solo. Mr. Joseph said that he had told Mr. Shenoy that the bank had the security of the US$10 million deposit and that that played a part in his decision to grant the additional facilities.
115. Mr. Shenoy was unable to give evidence on this matter because he has since unfortunately died, but there are a number of contemporaneous documents touching on it. The first document of interest is a letter from the Nariman Point branch to the Circle Office dated 16^th March 1998 signed by Mr. Joseph and Mr. Ambavane. This refers to a meeting that had taken place earlier that day between Mr. Joseph, Mr. Patel, Mr. Shenoy and Mr. Kamath at which the primary topic of discussion appears to have been irregularities in the accounts of the companies in the Hamco group. In that letter Mr. Joseph recorded that Mr. Kamath had told him not to open any new letters of credit until the Hamco group’s borrowing limits had been renewed, but he nonetheless asked that Dravya be permitted to make further borrowing because it wished to open fresh letters of credit urgently. A manuscript note dated 17^th March made by one of the staff of the Circle Office, Mr. Kulkarni, shows that the application was initially rejected, but that following a telephone conversation to Circle Office later that day Mr. Shenoy and Mr. Kelkar gave permission for the opening of a single letter of credit for US$1,502,200 in favour of Frobevia S.A.
116. Mr. Kulkarni’s note also shows that on 17^th March 1998 Mr. Shanbhag telephoned Circle Office in Mr. Joseph’s absence seeking permission to open a second letter of credit in favour of Frobevia, but that that request was refused because the branch had apparently indicated that there was some problem with the transaction. However, on 18^th March Dravya asked the Nariman Point branch to open a letter of credit for US$1,036,000 in favour of Soficom S.A. and the request was sent on to Circle Office the same day, as is recorded in a note made by Mr. Kulkarni on 18^th March. In his note Mr. Kulkarni recommended that the request be denied, but in the event Mr. Shenoy decided to permit the opening of this letter of credit. Nariman Point appears to have been informed of the decision by telephone.
117. The picture that emerges from the documents is strikingly at odds with the account given by Mr. Joseph. For example, he said that he had obtained permission to open both letters of credit from Mr. Shenoy at a meeting which took place before 16^th March, but it is impossible to reconcile that with his own letter of 16^th March or the other documents to which I have referred. Moreover, he was unable to give any satisfactory explanation for the discrepancies between his account and Mr. Kulkarni’s notes or to shed any further light on the various matters to which they refer. I have no doubt that Mr. Joseph attended many meetings at the Circle Office and I accept that a meeting did take place there on 16^th March which he attended with Mr. B. M. Patel. However, I think his recollection of these matters was very confused and insofar as his evidence differed from the picture which emerges from the contemporaneous documents I am unable to accept it.
118. There is nothing in the documents or indeed in the statements of any of the other witnesses to suggest that the cash deposit was mentioned in the discussions that took place on 16^th March. Nor do Mr. Kulkarni’s notes give one any insight into the thinking of those at the Circle Office who decided to give permission for the opening of these two letters of credit. The only indication of any kind is to be found in a letter written by the Circle Office to Canara’s Head Office in Bangalore in May 1998 reporting on the position of the various companies in the Hamco group. That letter identified Dravya’s potential liability in relation to the guarantee which it noted was fully secured by the cash deposit, but no mention is made of the deposit in the context of outstanding liabilities in connection with letters of credit. The explanation given for permitting the opening of the two letters of credit in March 1998 was the need to avoid liabilities devolving on the bank.
119. In these circumstances I am unable to find that the existence of the cash deposits played any part in the bank’s decision to open these letters of credit. I agree with Mr. Higham that it is inherently unlikely in the prevailing circumstances that the bank would have regarded the cash deposits as providing any real security other than for the guarantee itself and there is no reliable evidence that it did so.
120. Finally I come to the discounted bills of exchange. On 10^th June 1998 Mr. Joseph sought permission from the Circle Office to allow Dravya to make use of the expired facilities for discounting bills of exchange. In the event permission was given only on the basis that the entire proceeds of the bills should be used to clear liabilities that had devolved on the bank under letters of credit. Three bills of exchange were discounted on 24^th and 25^th June and the entirety of the proceeds were used to discharge part of the liabilities arising under the letters of credit opened in October and December 1997. I think Mr. Higham was right, therefore, in saying that the discounting of these bills did not involve giving fresh credit to Dravya. In any event, however, there is no evidence that the existence of the cash deposits played any part in the decision to discount these bills.
121. For these reasons I reject Canara’s submission that these transactions constituted a change in position linked to the receipt of the payments from Standard.
122. Canara also set off part of the funds received from Standard against certain other sums owed by Dravya, but in none of those cases was there satisfactory evidence that credit had been allowed on the faith of the cash deposits. Finally, Mr. Hunter submitted that the depreciation of the rupee also represented a change of position on the part of Canara, but since he accepted that interest earned on the deposits should also be taken into account and since that broadly made up for the depreciation, it is unnecessary to devote further time to that question.
123. In these circumstances if Standard had not been entitled to recover under the guarantee I should have held that it was entitled to recover the sum of approximately US$12.45 million in restitution.