1. Essential Features

Parties:

• Applicant/Buyer - purchases machinery on deferred payment
• Beneficiary/Seller - supplies machinery [domestic or foreign supplier]
• Guarantor Bank/FI - issues guarantee

Transaction Structure:
Seller delivers machinery now. Buyer pays in installments over 5-7 years with interest. Bank guarantees each installment. If buyer defaults, bank pays seller on demand without demur.

Unlike Term Loan:
With term loan, borrower makes upfront payment of principal. With DPG, borrower does not make upfront payment of principal. Funds must be used to purchase goods or services from seller. Liability remains contingent till invocation.

Use Cases:
Import of machinery under RBI/EXIM policy, purchase of heavy equipment, power plant turbines, aircraft, railway wagons.

2. Types

a) Domestic DPG: Supplier and buyer both in India. Governed by Indian Contract Act.
b) Foreign DPG / DPG for Import: Buyer in India, supplier abroad. Requires RBI approval under FEMA, usually backed by 100% cash margin or counter-guarantee.
c) Standby DPG: Used as credit enhancement for deferred payment bonds.

3. Legal Nature and Documentation

DPG is a contract of guarantee under Section 126 Indian Contract Act 1872 - but courts treat bank guarantee as independent contract.

Documents:

1. Bipartite Agreement between buyer and FI - containing terms and conditions for deferred payment guarantee amount
2. Promissory Note for guarantee amount
3. Equitable mortgage / Legal mortgage by deposit of title deeds as security for DPG facility
4. DPG Deed issued to beneficiary - unconditional, irrevocable, payable on first demand

Key Clauses in DPG:

• Amount: Purchase price + interest on deferred installments
• Validity: Co-terminus with deferred period + claim period [usually 3-12 months extra]
• Payment mechanism: On presentation of claim that buyer failed to pay, without proof of default
• Devaluation clause: If rupee devalued, increase in liability borne by buyer

4. Regulatory Framework - India

• RBI Master Direction on Guarantees and Co-acceptances 2021: Banks can issue DPG only for capital goods, not for consumables. Tenor not to exceed 10 years. Bank must assess commercial viability.
• FEMA Guidelines: For import DPG, AD bank can issue up to USD 20 mn without RBI approval for import of capital goods with minimum 3-year deferred period.
• Capital Adequacy: DPG carries 100% credit conversion factor - risk weight as per borrower rating.

5. Difference Between DPG and Performance Guarantee

6. Case Laws

A. Leading Supreme Court on DPG - IFCI Ltd. v. Cannanore Spinning & Weaving Mills Ltd. (2002) 5 SCC 54

Facts: IFCI granted term loan Rs. 35 lakhs which included deferred payment guarantee facility of Rs. 5,62,230.40 for purchase of machinery on 30.04.1963. Equitable mortgage by deposit of title deeds in respect of movables at Cannanore as security for DPG facility. Buyer executed bipartite agreement. Indian Rupee devalued on 06.06.1966 which increased liability under DPG by Rs. 2,37,580.33. Buyer defaulted, repaid only Rs. 3,50,000. IFCI invoked guarantee and paid supplier.

Issues:

1. Whether increase due to devaluation is covered by mortgage?
2. Rights of surety under Section 141 Contract Act?

Held:

DPG liability is contingent liability, but once FI pays supplier on buyer's default, it becomes debt recoverable from buyer. Bipartite agreement + amendatory agreement made devaluation increase also liability of defendants, secured by subsequent equitable mortgage dated 11.07.1970.

Crucial on Section 141: Supreme Court held surety is entitled to benefit of every security which creditor has against principal debtor at time contract of suretyship entered, whether surety knows of security or not. Even if security is lost due to creditor's negligence, surety discharged to extent of security value. This judgment is cornerstone for surety protection in DPG - bank cannot release underlying mortgage without surety consent.

Contingent liability on account of default worked out at Rs. 1,11,199.11 - total DPG increased to Rs. 6,73,429.51.

B. Bank Guarantee is Independent Contract - Case Law Line Applicable to DPG

1. UP Co-operative Federation Ltd. v. Singh Consultants (1988) 1 SCC 174:
Supreme Court held bank guarantee is independent of underlying contract between buyer and seller. Court should not grant injunction against invocation except in case of fraud of egregious nature or irretrievable injustice. Applies equally to DPG.

2. Larsen & Toubro Ltd. v. Maharashtra SEB (1995) 6 SCC 68:
Invocation of DPG need not be justified with evidence of default. If guarantee says payable on demand, bank must pay.

3. Hindustan Construction Co. Ltd. v. State of Bihar (1999) 8 SCC 436:
Difference between conditional and unconditional DPG. If DPG says "on buyer's failure to pay", beneficiary need only state failure, need not prove.

4. Standard Chartered Bank v. Heavy Engineering Corp. (2019) 16 SCC 547:
Even if underlying contract for supply of machinery is disputed, DPG cannot be stayed. Beneficiary's claim under DPG is separate.

C. Limitation

Major Gen. Darshan Singh v. BSES [Not DPG but principle]: For DPG, limitation starts from date of payment by guarantor bank to seller, not from date of buyer's default to seller. Article 55 Limitation Act - 3 years from payment.

7. Invocation and Enforcement Procedure

1. Beneficiary presents claim letter stating installment due date + default, within guarantee validity + claim period
2. Bank verifies claim on face, pays within 24-72 hours
3. Bank converts contingent liability to funded liability - debits buyer's account, recovers via mortgaged securities
4. If buyer disputes, must file separate suit, cannot restrain payment

8. Risk Points for Lawyers

• Devaluation / exchange rate clause must be explicitly covered in bipartite agreement, else buyer not liable for increase - as seen in IFCI case where subsequent mortgage was needed.
• Ensure DPG deed has claim period beyond validity - Supreme Court in BSES Ltd. v. Fenner India Ltd. (2006) 2 SCC 728 held claim made after expiry of claim period not enforceable.
• RBI now requires banks to disclose DPG as contingent liability under AS-29.