Generally, a Bank Guarantee would have a clause which would provide for a validity period or claim period or expiry period, collectively referred as Claim Period. Claim period would mean exercise of right by the beneficiary to have any claim under the Bank Guarantee.

For illustrative purposes, the clause may read as under:

“Unless a claim under this Bank Guarantee is lodged by the beneficiary before the expiry date (and/or within the claim period), the bank shall be relieved and discharged from all its liabilities and the rights of the beneficiary under this Guarantee shall be forfeited.”

The aforesaid clause in the Bank Guarantee is not limiting the rights of the beneficiary to enforce his claim but is only providing for the time period within which the beneficiary must exercise his right. 

However, in some Bank Guarantees, the bank may also provide enforcement period to read that the beneficiary right shall be forfeited unless a suit or action to enforcement its claim is filed within one year from the date of expiry of the Bank Guarantee (Enforcement period).

Section 28 of the Indian Contract Act, 1872 (“Contract Act”) provides that any Agreement in restraint of legal proceedings would be void. Section 28 of the Contract Act was amended with effect from January, 8, 1997.

Prior to amendment in 1997 and also post amendment in 1997, the judgments on Section 28 of the Contract Act ruled that a clause in a contract which does not seek to curtail the time for enforcement of a right but only provides for the forfeiture or waiver of the right itself would be valid. Therefore, the clause providing for a claim period was held to be valid and not hit by Section 28 of the Contract Act. But a clause curtailing the enforcement period was hit by Section 28 of the Contract Act.

The Supreme Court in the matter of Union of India vs. IndusInd Bank Ltd., (2016) 9 SCC 720 interpreted Section 28 as it originally stood prior to amendment of 1997. In this case, a clause in the Bank Guarantee provided that if the claim is not lodged by April 30,1997, the bank would be discharged from all its liabilities.

The claim was lodged after April 30, 1997, that is, on May 15, 1997 and was refuted by the bank. It was held by the Supreme Court that the clause appearing in the Bank Guarantee did not limit the time within which rights are to be enforced and did not curtail the period of limitation within which a suit could be brought to invoke the Bank Guarantee. Thus, it was held that the clause is not hit by Section 28.

The Court relied upon its earlier judgment given in the matter of Food Corporation of India Vs New India Assurance Co. Ltd. reported in 1994 AIR 1889 = 1994 SCC (3) 324. A similar ruling was passed by the Full Bench of the Punjab and Haryana High Court in Pearl Insurance Co. vs. Atma Ram, AIR 1960 Punjab 236.

Post the amendment in 1997, Section 28 of the Contract Act came up for interpretation before Hon’ble High Court of Delhi in the matter of Explore Computers Pvt. Ltd. Vs. CALS Limited, reported as 131 (2006) DLT 477 in which it was held:

“From the case law referred to above the legal position that emerges in that an agreement which in effect seeks to curtail the period of limitation and prescribes a shorter period than that prescribed by law would be void as offending Section 28 of the Contract Act.  That is because such an agreement would seek to restrict the party from enforcing his right in Court after the period prescribed under the Agreement expires even though the period prescribed by law for the enforcement of his right has yet not expired.  But there could be agreement which does not seek to curtail the time for enforcement of the right but which provides for the forfeiture or waiver of the right itself if no action is commenced within the period stipulated by the agreement.  Such a clause in the agreement would not fall within the mischief of Section 28 of The Act.  To put it differently, curtailment of the period of limitation is not permissible in view of Section 28 but extinction of the right itself unless exercised within a specified time is permissible and can be enforced.”

Thus, a limitation on the Claim Period was permissible but no curtailment was permissible on Enforcement Period. The clause to the extent that it restricted the enforcement of the right after the period of expiry would be void, being hit by Section 28 of the Contract Act.

With this background, Section 28 of the Contract Act was amended on January 5, 2013 pursuant to enactment of the Banking Laws (Amendment) Act, 2012.

Exception No.3 was introduced to Section 28 of the Contract Act, which permitted the bankers to specify a period (a period which should not be less than one year from the date of occurring or non-occurring of a specified event) for the extinguishment or discharge of a liability.

On the amendment of Contract Act in 2012, the introduction of Exception-3 has been a subject matter of discussion and deliberation in the banking circles on its interpretation. The question which has been deliberated is as to whether the introduction of Exception-3 gives right to a banker to provide a clause providing a timeline for enforcement period. 

Exception 3 reads as under:

Exception-3:  Saving of a guarantee agreement of a bank or a financial institution:- This section shall not render illegal a contract in writing by which any bank or financial institution stipulate a term in a guarantee or any agreement making a provision for  guarantee for extinguishment of the rights or discharge of any party thereto from any liability under or in respect of such guarantee or agreement on the expiry of a specified period which is not less than one year from the date of occurring or non-occurring of a specified event for extinguishment or discharge of such party from the said liability.

Exception 3 of Section 28 of contract Act, now gives right to the banking company to provide limitation to enforcement period, which limitation should not be less than one year.

Therefore, a clause in the Bank Guarantee to the effect that beneficiary’s right shall be forfeited unless a suit or action for the enforcement of the claim is filed within the period of 366 days from the date of expiry would be a valid clause. 

Exception 3 of Section 28 of Contract Act was interpreted by the Delhi High Court in the matter of Larsen & Toubro Ltd. Vs Punjab National Bank & Anr., 2021 SCC online Del 3827. It was noted by Hon’ble Court that generally, a Bank Guarantee would have terms containing claim period and enforcement period. It was held by the Hon’ble Court that limiting the enforcement period which is not a period less than one year, will not be contrary to law. Relevant paragraph 42 of the judgment is reproduced below:

“Clearly, 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 this context, it would be appropriate to refer to the observation made by the Hon’ble Supreme Court in the judgment of IndusInd Bank (supra), where the Hon’ble Apex Court did not interpret the amendment of 2012 but observed that,

“Parliament has to a large extent redressed any grievance that may arise qua bank guarantees in particular, by adding an exception (iii) by an amendment made to Section 28 in 2012 with effect from 18.1.2013. Since we are not directly concerned with this amendment, suffice it to say that stipulations like the present would pass muster after 2013 if the specified period is not less than one year from the date of occurring or non-occurring of a specified event for extinguishment or discharge of a party from liability.”

Thus, a Bank Guarantee would have a validity period/ claim period/ expiry period and can also have an enforcement period.

A bank guarantee may not have an enforcement period and in that event, the enforcement period would be the period prescribed under the Limitation Act, 1963.

The beneficiary must invoke the Bank Guarantee within the validity period and/or claim period and if not invoked during that period, the rights of the beneficiary under the Bank Guarantee would stand extinguished and forfeited.

Earlier, prior to amendment carried out in 2012, the curtailment of enforcement period was not permitted. However, after the amendment of 2012, the position in law would be that in case there is a period prescribed in the Bank Guarantee for the enforcement, which is not less than one year, then it would be a valid clause. This is, however, subject to the condition that invocation of the Bank Guarantee is in accordance with the validity clause of Bank Guarantee.

About the author: Sanjay Gupta is the Managing Partner, Dispute Resolution [Leads and Chairs the Contentious Practice] at SNG & Partners.

Disclaimer: The opinions expressed in this article are those of the author(s). The opinions presented do not necessarily reflect the views of Bar & Bench.

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