India – Banks Cannot Force A Mandatory Claim Period Of One Year For A Bank Guarantee.

Summary:

Larsen & Toubro Ltd (“L&T”), a construction company in India, would routinely submit performance bank guarantees/ advance bank guarantees while bidding for government contracts and would also submit bid bonds/ bid security in the form of bank guarantees. Punjab National Bank (“PNB”) compelled L&T to keep the claim period under the bank guarantees alive for a minimum period of one year, regardless of whether L&T required the bank guarantees for a shorter period. The fallout of this for L&T was that it incurred unnecessary commission charges on the bank guarantees for the extended period. PNB had based its demand for a mandatory and an unalterable claim period of a minimum twelve months on its interpretation of Section 28 of the Indian Contract Act, 1872 (“Contract Act”) that any claim period below twelve months would render the claim period void. Aggrieved by this, L&T filed a writ petition challenging PNB’s interpretation of the Contract Act.

The Delhi HC noted that earlier, the beneficiary of the bank guarantee i.e., creditor would have time to approach the appropriate court for enforcement of their rights under the bank guarantee within 3 (three) years for private parties and 30 (thirty) years for government parties. However, the HC observed that an expert committee constituted in 2013 had recommended that the said period be reduced to one year for enforcing the rights under the bank guarantee after happening of a specified event. Thereafter, an exception 3 to Section 28 of the Contract Act was added in 2013, which 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.

The Court held that the narration of the historical facts leading to the present Section 28 of the Contract Act 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 the occurrence of a specified event and 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 Delhi HC held that PNB had erred in interpreting the scope of Section 28 of the Contract Act, and the law does not mandate a claim period of 12 (twelve) months in the bank guarantee.
 

For further information, please contact:  

Souvik Ganguly, Partner, Acuity Law