As per section 28 of the Indian Contract Act, 1872; an agreement is void to the extent it restricts absolutely, a party from enforcing his contractual rights by usual proceedings in ordinary courts; or if it limits the time within which he may enforce his rights.1 It saves three types of contracts: (a) those with a stipulation that an arbitration award shall precede a cause of action, (b) a contract to refer existing disputes to arbitration and, (c) clauses in guarantees stipulated by banks and other financial institutions of the types indicated in the exception to the provision.2

This contribution elaborates upon the amendment to section 28 of the Indian Contract Act, 1872 in light of recent judicial pronouncements specifically with respect to the interpretation of exception 3 to the provision. Firstly, the 1997th amendment to the provision is elaborated upon. Secondly, the 2013 amendment to the provision and the circumstances leading up to the amendment has been touched upon. Lastly, the provision as it stands today in light of exception 3 has been dealt with in detail.

I. The 97th Report of the Law Commission of India: The 1997 Amendment

(i) Section 28 as it existed prior to the 1997 amendment: the right can be extinguished but the remedy cannot be curtailed

Prior to the amendment, a condition in a contract providing for forfeiture of all benefits/rights unless an action is brought within a specified period, surprisingly, did not violate the section.3 What was hit by section 28 was an agreement relinquishing the remedy only, by providing if suits are to be filed, then it should be filed within the specified time limit.4

(ii) The suggested amendment

In light of the above mentioned, it was noted that a clause barring a remedy is void, but a clause extinguishing a right is valid. To correct this anomaly, the commission recommended a suitable amendment to section 28 of the Contract Act to render invalid contractual clauses that extinguish on expiry of a stated period, the rights accruing to and from the contract5 The Contract Act was then amended on 18.01.1997 to render void clauses which (a) restricts the enforcement of rights under/in respect of any contract and (b) extinguishes the rights of the parties.6 This amendment equated the extinguishment of right with the extinguishment of remedy. However, there was still a complicated issue that was not addressed, i.e. banks could no longer limit their liabilities under the bank guarantees to a specified period and they would now have to carry their bank guarantee commitments for longer durations as outstanding obligations.

II. Sh. T.R. Andhyarujina Expert Committee Report: 2013 Amendment

Bank Guarantees are independent contracts, which, vest the beneficiary therein with a right to make a claim against the bank to pay for the loss suffered due to default committed by a borrower. After the abovementioned 1997 amendment, the banks were curtailed to follow the limitation period as prescribed under the Limitation Act, 1963 for discharging their liabilities under the bank guarantee, i.e. 3 years for private parties as beneficiaries and 30 years for government parties because they were no longer allowed to curtail their liabilities under the bank guarantees.

(i) Raison d' être behind the constitution of the committee

The expert committee which was constituted by the Union of India on 15.02.1999 noted the apprehensions expressed by the banks and financial institutions and while quoting from the Second Narasimham Committee Report7 noted that,

"With the aforesaid amendment in force, banks will have to carry their liabilities under the bank guarantee till 30 years. Unless, the original guarantee is received back from the beneficiary Government departments, the Banks will not be able to round off all their entries till the limitation period of 30 years."

(ii) Recommendation by the committee

Accordingly, the committee recommended a reasonable period of one year to the creditor to enforce his rights under the guarantee after the happening of the specified event. Thereafter, Parliament added Exception 3 to section 28 of the Contract Act.8

III. Exception 3 and what it deals with: the current position

What follows from the aforesaid historical narration is that Exception 3 to section 28 of the Contract Act clearly deals with the rights of the creditor to enforce his rights under the bank guarantee after happening of a specified event. The said view is fortified by the judgment of the Hon'ble Delhi High Court in Larsen & Tubro Limited & Anr v. Punjab National Bank and Anr. 9 The court in this case while relying upon the judgment of a co-ordinate bench of the Hon'ble Delhi High Court in Explore Computers Pvt. Ltd. v. Cals Ltd & Anr10 noted the difference between 'invocation of the bank guarantee' from 'a suit or claim to be filed by the plaintiff on account of the refusal of the bank to pay the amount under the guarantee'. The Hon'ble while noting this difference observed in clear terms that, "It is clear that Exception 3 to Section 28 of the Contract Act deals with curtailment of the period of 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."11

If section 28 is interpreted in its simplest terms, it can be construed that even though extinguishment of the remedy or curtailing the time period for invoking the remedy is not permitted under the provision, the extinguishment of the right of the beneficiary to approach the appropriate court for raising its claim under a bank guarantee is not hit by section 28 of the Indian Contract Act, 1872 by virtue of the exception contained therein. This is because the very purpose for which Exception 3 was inserted was for rescuing the banks by curtailing the period of limitation to institute proceedings before a court of law to a period of 12 months rather than the compulsory period of 3 for private parties to 30 years for government parties as per the Limitation Act.12

Exception 3, therefore, deals with the period within which the beneficiary is to approach an appropriate court to raise its claim ("Limitation Period"). Consequently, Exception 3 does not deal with the claim period, i.e. the extended period within which the beneficiary can invoke the bank guarantee after the expiry of the validity of the bank guarantee for a default that occurred during the validity period ("Claim Period").

What follows is, that, since, exception 3 does not deal with the claim period, but with the limitation period, banks are not required to stipulate a minimum claim period of 12 months. Since the claim period is the grace period to make a written demand to a bank it is not governed by exception 3 to section 28, and, the said exception only deals with the limitation period to approach the court, which must be for a minimum of 12 months.13

While upholding the validity of a clause restricting the claim period for assertion of a right, the Hon'ble Supreme Court in the case of Union of India v. IndusInd Bank Ltd. and Ors 14 upheld the legality of clauses curtailing the Limitation Period, which according to the Hon'ble apex court, would pass the muster of section 28 after the 2013 amendment, since Exception 3 now allows banks and financial institutions to even specify the Limitation Period provided the same was not less than one year.15

Conclusion

The limitation period for approaching the appropriate court to raise claims pertaining to the bank guarantee is, therefore, different from the claim period which is solely related to the period within which the beneficiary can make a demand on the bank for invocation of bank guarantee.

In light of the above, it is noted that the scope of section 28, read with exception 3 is clearly discernible in the sense that it allows banks and financial institutions to incorporate clauses providing for extinguishment of the rights of the beneficiary, or discharge of the bank's liability upon the expiry of a specified period, thereby curtailing the Limitation Period for the beneficiary to enforce his claim before a court of law. To be valid under provision 28 of the Indian Contract Act, 1872 such limitation period must not be less than one year from the date on which the cause of action arises.

Footnotes

1 Section 28, Indian Contract Act, 1872 [25th April, 1872].

2 Section 28: Indian Contract Act, 1872; Law Commission of India, 97th Report; Government of India, Ministry of Law Justice and Company Affairs [March, 1984], ¶ 2.4, Page 2.

3 Law Commission of India, 97th Report (n.2), ¶ 2.5, Page 2.

4 The time limit being shorter than the period of limitation provided by the Limitation Act, 1963.

5 Law Commission of India, 97th Report (n.2), ¶ 5.1, Page 8.

6 Id., ¶5.3, Page 9.

7 Committee on Banking Sector Reforms (Narasimham Committee II); See also Larsen & Tubro Limited & Anr v. Punjab National Bank and Anr.W.P.(C) 7677/2019, ¶ 35, Page 30.

8 The Banking Laws (Amendment) Act, 2012 (Act No. 4 of 2013).

9 Larsen & Tubro Limited & Anr v. Punjab National Bank and Anr.W.P.(C) 7677/2019.

10 Explore Computers Pvt. Ltd. v. Cals Ltd & Anr., 2006 (90) DRJ 480.

11 Larsen & Tubro Limited v. Punjab National Bank, W.P.(C) 7677/2019, ¶ 40, page 37.

12 Larsen & Tubro Limited (n.11), ¶ 42, page 37.

13 Larsen & Tubro Limited (n.11), ¶ 48, page 42.

14 Union of India v. IndusInd Bank Ltd. and Ors.CIVIL APPEAL NOS.9087-9089 of 2016.

15 Id., ¶ 36.

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