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In a recent judgement the Delhi High Court has held that "Exception 3 to Section 28 of the Indian Contract Act deals with curtailment of the period for the creditor to approach the court/tribunal to enforce his rights. It does not in any manner deal with the claim period within which the beneficiary is entitled to lodge his claim with the bank/guarantor."

The order was passed by a single Judge bench of Justice Jayant Nath on a grievance raised by Larsen and Toubro Ltd that on an erroneous interpretation of section 28 of the Contract Act, in which the Punjab National Bank forces a mandatory and an unalterable claim period of a minimum 12 months for the bank guarantee.

Adverse fallout for the petitioner of such interpretation is that the petitioner is unnecessarily made liable to pay commission charges for such extended bank guarantee when as per the contract between the principal debtor and the creditor, the claim period would be much shorter. In addition, the petitioners also become liable to maintain collateral security for supporting such extended claim period. The extended claim period effects the petitioners’ capability to do business by entering into new contracts and effects the fundamental rights of the petitioners under Article 19(1)(g) of the Constitution of India

The petitioner argued that the claim period is a time period contractually agreed upon between the creditor and principal debtor, which provides a grace period beyond the validity period  of the guarantee to make a demand on the bank for a default, which occurred during the validity period. This claim period may or may not even exist in a bank guarantee.  

section 28 of the Contract Act prior to the amendment provided that a clause limiting the time within which the rights are to be enforced, is void, if the rights to be enforced under the contract continued to exist even beyond the shorter period agreed for enforcing the rights. If beyond the shorter period agreed between the parties for enforcing the rights, the rights under the contract are not kept alive, then such an agreement putting a time limit to sue was not hit by section 28 of the Contract Act.

The newly added section 28 of the Contract Act   provides that the beneficiary of the bank guarantee i.e. creditor would have time to approach the appropriate court for enforcement of his rights under the bank guarantee in terms of the provision of the Limitation Act i.e. 3 years for private parties and 30 years for government parties. Exception 3 of Section 28  allows banks and financial institutions to incorporate clauses providing for extinguishment of the rights of the beneficiary, or discharge of bank's liability on the expiry of a specified period, thereby curtailing the Limitation Period for a beneficiary to enforce his claim before a court of law. In order for such clauses curtailing the Limitation Period to pass muster of Section 28, the specified period must not be less than one year from the date when the cause of action arises.

The Court after going through the historical facts leading to the present interpretation of Section 28 of the Contract Act was of the view that “ Exception 3 to section 28 of the Contact Act deals with the rights of a creditor to enforce his rights under the bank guarantee after happening of a specified event”.

The Court further pointed out that respondent in the counter affidavit admits that Exception 3 to section 28 of the Contract Act deals with a clause in a bank guarantee to the effect that in case no claim is filed before the court of law within a period which is not less than 12 months from the date of occurring or non occurring of the specified event, the liability of the bank shall get extinguished. Such a term is not contrary to law.

“There is a clear admission that Exception 3 to section 28 of the Contact Act deals with the period within which the beneficiary is to approach an appropriate court to raise its claim. Exception 3 does not deal with the claim period i.e. the extended period within which the beneficiary can invoke the bank guarantee after expiry of the validity of the bank guarantee for a default that occurred during the validity period”

In view of the above communications issued by the bank  to the extent that they reproduced erroneous interpretation of Exception 3 to Section 28 of the Contract Act were held by the Court to be erroneous.

Case Title: Larsen & Toubro Ltd and Anr  vs Punjab National Bank and Anr