Aishwarya Rathore-
The Delhi High Court has interpreted Exception 3 to Section 28 of the Indian Contract Act 1872 holding that it does not apply to ‘claim period’ under Bank Guarantees. This clause deals with the creditor’s ability to approach the Court or tribunal to enforce his or her rights under the bank guarantee.
The judgment authored by Justice Jayant Nath held, “It is clear that Exception 3 to Section 28 of the 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.”
As a result of this interpretation, banks cannot insist that the claim period under bank guarantees be at least 12 months.
“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.
Section 28 of the Contract Act holds, among other things, that agreements which impose a time limit for initiating legal proceedings to enforce contractual rights are void.
However, Exception 3 to Section 28, which was added by the amendment made in 2013, saves the stipulations made by banks or financial institutions in bank guarantees for extinguishment of rights or discharge of liability after the expiry of the specified period.
Exception 3 also adds that such a specified period should not be less than one year.
The Indian Banks Association issued circulars in 2017 and 2018 interpreting Exception 3 to Section 28 and declaring that ‘claim periods’ under bank guarantees of less than 12 months are invalid.
The Punjab National Bank issued a letter to infrastructure giant Larsen & Toubro based on this circular, demanding a necessary and unalterable claim period of at least 12 months for the bank guarantee.
As a result of this interpretation, L&T is obligated to pay commission fees for such prolonged bank guarantees, even though the claim period would be significantly less than 12 months under the contract between the principal debtor and the creditor.
It was contended that the petitioners’ ability to do business by entering into new contracts is affected by the extended claim period, as well as their basic rights under Article 19(1)(g) of the Indian Constitution.
The judgment stated, “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.”
The High Court also referred to the Supreme Court Judgment in Union of India & Anr. vs. Indusind Bank & Anr.
It is clear that respondent No. 1(PNB) is erroneous of the view that they are in law mandated to stipulate a claim period of 12 months in the bank guarantee failing which the clause shall be void under Section 28 of the Contract Act.
The Court reiterated, “As noted above, Section 28 of the Contract Act does not deal with the said claim period. It deals with right of the creditor to enforce his rights under the bank guarantee in case of refusal by the guarantor to pay before an appropriate Court or tribunal.”
In conclusion, the Court held that the Circulars of the Indian Bank Association issued in 2017 and 2018 and the communication issued by the PNB as erroneous.
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