A Single Bench of the Delhi High Court in the case of, Larsen & Toubro Limited v. Punjab National Bank, [W.P.(C) 7677/2019, decided on July 28, 2021], adjudicated upon the critical issue of whether a bank needs to stipulate a claim period clause (an 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) of at least 12 (twelve) months in a bank guarantee in order to prevent the said clause from being rendered void under Exception 3 to Section 28 of the Indian Contract Act, 1872 (“Contract Act”).

Decision of the Court:

The Delhi High Court while laying emphasis upon Section 28 of the Contract Act opined that, Section 28 clearly demonstrates that Exception 3 to Section 28 of the Contract Act deals with the rights of a creditor to enforce his rights under the bank guarantee after happening of a specified event.

“28. Agreements in restraint of legal proceedings, void:
  ………….

Exception 3.—Saving of a guarantee agreement of a bank or a financial institution.

This section shall not render illegal a contract 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.”

The Delhi High Court thus, enumerated that:

“40. 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.”                                      (emphasis supplied)

Further, the Court also took note of the fact that the respondent in its counter affidavit had admitted 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 (twelve) months from the date of occurring or non-occurring of the specified event, the liability of the bank shall get extinguished. 

The Court therefore, in light of the above, stipulated 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 and it does not deal with the claim period. 

Additionally, the Delhi High Court also distinguished the judgment of the Supreme Court in the case of Union of India v. IndusInd Bank, [(2016) 9 SCC 720], by stating that:

“44. A perusal of para 28 of the judgment clearly shows that the court interpreted the relevant clauses of the bank guarantee holding that neither of the clauses seeks to limit the time within which the right is to be enforced, namely, in other words neither of the clauses purports to curtail the period of limitation within which a suit may be brought to enforce the bank guarantee. The said clauses were not dealing with the claim period i.e. the grace period beyond the validity of the bank guarantee to make a demand on the bank for a default which had occurred during the validity period. The above judgment is of no help to respondent No. 1.” 
(emphasis supplied)            

The Court thus, while reiterating its view that Exception 3 to Section 28 of the Contract Act does not deal with the claim period and instead, 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, held that:

“48. It is clear that respondent No. 1 is erroneously 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” 
(emphasis supplied)

Argus View:

This judgment is expected to have a far reaching consequences, as it has now become almost a standard practice to specify the claim period under a bank guarantee to have at least 12 (twelve) months. This obviously created problems for the borrower/ procurers, who are unnecessarily made liable to pay commission charges for an extended guarantee period, even where the validity period may have been for a shorter duration. It is hoped that, the banks would take due note of the decision and stop insisting on specifying a minimum 12 (twelve) months claim period. 

Please find a copy of the judgment here.

This update has been contributed by Arka Majumdar (Partner) and Kunal Dey (Associate). 

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