HC Delhi (28.07.2021) in Larsen & Toubro Limited & Anr. vs Punjab National Bank & Anr. [W.P.(C) 7677/2019] held as under:
# 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.
# 42. . . . . Exception 3 to section 28 of the Contract 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.
# 48. . . . . .A perusal of para 15 of the writ petition shows that a claim period has been explained as a time period contractually agreed between the creditor and the 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 has occurred during the validity period. . . . . . 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.
# 50. I may now deal with another plea raised by the respondents, namely, that the issue of prescribing the bank charges and the period for retention of security are matters of contract and this court cannot interfere in such contractual matters especially as they are not contrary to any rules or regulations or stipulations framed by RBI.
Excerpts of the order;
# 1. This writ petition is filed by the petitioners seeking the following reliefs:
“(a) Issue a Writ, Order or Direction in the nature of Certiorari or any other Writ, Order or Direction of like nature quashing and setting aside the letters dated 18.08.2018 and 28.03.2019 both issued by Respondent No.1 to Petitioner No.1 directing the Petitioners that the Claim period in the Bank Guarantee must be for at least 12 months;
(b) Issue a Writ, Order or Direction in the nature of Certiorari or any other Writ, Order or Direction of like nature quashing and setting aside the letter dated 10.02.2017 bearing reference No. Legal/Cir2102/BG Opinion and letter dated 05.12.2018 issued by Respondent No.2 to all Member Banks in relation to the minimum period for lodging a claim with the Bank under the Bank Guarantee;
(c) Issue a Writ, Order or Direction in the nature of Mandamus or any other Writ, Order or Direction of like nature directing the Respondents to discard any interpretation of Section 28(b) read with Exception 3of the ICA which prescribes a minimum period of 12 months of validity, for making a demand by a Creditor of a Contract of Guarantee under Section 126 of the ICA issued upon a Bank or a Financial Institution as a "surety", where such Bank Guarantee has been issued at the instance of the Petitioner No.1 as a Principal Debtor or issued for the benefit of the Petitioner No.1.”
# 2. Essentially the dispute in the present petition centers around interpretation of section 28 of the Indian Contract Act, 1872 (hereinafter referred to as the ‘Contract Act’). The grievance of the petitioner is that based on an erroneous interpretation of section 28 of the Contract Act, respondent bank forces a mandatory and an unalterable claim period of a minimum 12 months for the bank guarantee. It is stated that the 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. This claim period may or may not even exist in a bank guarantee.
# 3. Section 28 of the Indian Contract Act, 1972 reads as follows:
“28 Agreements in restraint of legal proceedings, void.- Every agreement,-
(a) by which any party thereto is restricted absolutely from enforcing his rights under or in respect of any contract, by the usual legal proceedings in the ordinary tribunals, or which limits the time within which he may thus enforce his rights, or
(b) which extinguishes the rights of any party thereto, or discharges any party thereto from any liability, under or in respect of any contract on the expiry of a specified period so as to restrict any party from enforcing his rights, is void to that extent.
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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.
# 4. A perusal of the impugned communication issued by respondent No.1/PNB dated 18.08.2018 addressed to the petitioners shows that as per respondent PNB a claim period in a bank guarantee which is less than 12 months would render the claim period void and will effectively increase the claim period under the bank guarantee to 3 years under the Limitation Act, 1963. The above plea is reiterated by respondent No.1 in its communication to the petitioners dated 28.03.2019.
Respondent No.2 in its communication/circular addressed to the banks dated 10.02.2017 states that it would be open for the banks to stipulate as a condition precedent that if the claim is not lodged before a stipulated time, the bank guarantee shall be revoked or terminated but the stipulated date cannot be less than one year in any event. The communication dated 05.12.2018 of respondent No.2 which is addressed to all the banks also reiterates the above contentions stating that if a bank issues a claim period of less than one year on top of the guarantee period then such a bank guarantee would not have benefit of Exception 3 to section 28 of the Act. Such banks issuing a bank guarantee would stand exposed to the period of limitation under the Limitation Act, 1963 which would be 30 years in a case when the Government is the guarantee beneficiary and 3 years when some other party is the guarantee beneficiary.
# 6. It is further stated that the Standard Bank Guarantee would usually contain the following terms:
a) Expiry Period/Validity Period: A bank guarantee would prescribe a specific date by which a bank guarantee would expire. This is a time determined by the Principal Debtor and the Creditor. The right to invoke the bank guarantee is only for a default of the Principal Debtor which occurs during the validity period of the bank guarantee.
b) Claim Period: This is a time period contractually agreed between the Creditor and the Principal Debtor which provides a grace period beyond the validity period to make a demand on the bank for a default which has occurred during the validity period. A claim period may or may not exist in the bank guarantee. The guarantor again has no role to play.
c) Enforcement Period: The Enforcement period is a time period within which the Creditor can enforce his accrued rights pursuant to a demand made by him within the validity period or the claim period before a competent court of law. This period, it is stated, is statutorily governed by section 28(b) read with Exception 3 to section 28 of the Contract Act. In the absence of any such clause in the guarantee, the said period would be determined by the Limitation Act, 1963.
# 7. It is pleaded that on a complete misinterpretation of section 28 of the Contract Act, respondent No.1 bank insists that the claim period should be 12 months. Adverse fallout for the petitioner of such interpretation is that the petitioner is unnecessarily made liable to pay commission charges for such extended bank guarantee when as per the contract between the principal debtor and the creditor, the claim period would be much shorter. In addition, the petitioners also become liable to maintain collateral security for supporting such extended claim period. The extended claim period effects the petitioners’ capability to do business by entering into new contracts and effects the fundamental rights of the petitioners under Article 19(1)(g) of the Constitution of India.
# 8. The petitioner has pleaded the entire historical background of the present section 28 of the Contract Act to support its contentions that the impugned communications issued by respondents No.1 and 2, respectively are grossly illegal and misinterpret section 28 of the Contract Act and cause grave prejudice and damage to the petitioners.
# 9. To support its plea about wrong interpretation of Section 28 of the Contract Act by the respondents, reliance is placed on the Ninety-Seventh report of the Law Commission of India dated 31.03.1984, the statement of objects and reasons for the amendment to section 28 of the Contract Act carried out on 08.01.1997 and the amendment to the Contract Act on 18.01.2013 which added exception 3 to section 28 of the Act. Reliance is also sought to be placed on the opinion of Justice B.N.Srikrishna (Former Judge of the Supreme Court of India). Reliance is also placed on the judgment of a Co-ordinate Bench of this court in the case of Explore Computers Pvt. Ltd. v. Cals Ltd & Anr., 2006 (90) DRJ 480.
# 11. It is also pleaded that respondent No.1 bank can charge commission or retain the margin money beyond the period of the bank guarantee, including the claim period. It is pleaded that such terms are a matter of contract between the parties and cannot be a subject matter of the present writ petition.
Reliance is also placed on the judgment of the Supreme Court in the case of Union of India & Anr. v. Indusind Bank Ltd. & Anr., 2016(9) SCC 720 to plead that the issue raised by the petitioners in the present writ petition is squarely covered by the aforesaid judgment.
# 13. Respondent No.3 in the counter affidavit relies upon the Master Circular dated 01.07.2015 on Guarantees and Co-acceptances and states that the same provides an enabling framework for the issuance of bank guarantee. It is stated that the bank guarantees are structured according to the terms of the agreement. The terms are decided mutually between the parties, namely, applicant, bank and the beneficiary. Respondent No.3/RBI has not prescribed any terms to be incorporated in the bank guarantee. It is reiterated that terms of the bank guarantee to be issued by the issuing bank are decided in terms of the respective policy of the concerned banks and on the basis of contractual arrangement between the parties.
# 27. I will now deal with the issue relating to interpretation of section 28 of the Contract Act. I may first look at the historical facts pertaining to section 28 of the Contract Act. The said provision, as it is stood prior to its amendment in 1997, reads as follows:
“28. Agreements in restraint of legal proceedings, void.—Every agreement, by which any party thereto is restricted absolutely from enforcing his rights under or in respect of any contract, by the usual legal proceedings in the ordinary tribunals, or which limits the time within which he may thus enforce his rights, is void to that extent.”
# 28. The interpretation of the said original section 28 of the Contract Act was dealt with by a Division Bench of the Kerala High Court in the case of Kerala Electrical & Allied Engineering Co.Ltd. v. Canara Bank & Others(supra). The main defence raised by the bank/defendant in the said case was that the plaintiff had lost its rights under the bank guarantee as it did not institute a suit within a period of six months from the date of the expiry of the period of the bank guarantee. The said clause was noted in para 2 of the said judgment, which reads as follows: . . . . . . .
# 29. Hence, the court held that limiting the time within which the rights are to be enforced is void provided rights to be enforced under the contract continue to exist even beyond the shorter agreed period for enforcing the rights. If beyond the shorter period agreed between the parties, the rights under the contract are not kept alive, no limiting of the time to enforce the rights under the contract arises and such an agreement putting a time limit to sue will not be hit by section 28 of the Act.
# 30. The Law Commission of India in his Ninety-Seventh Report dated 31.03.1984 dealt with the aforesaid interpretation of section 28 of the Contract Act. The Law Commission took up the matter suo moto. The Commission noted the then position regarding section 28 of the Contract Act as follows:- . . . . . . .
# 31. The Commission noted the settled legal position about old Section 28 of the Contract Act including the aforesaid judgment of the Kerala High Court in Kerala Electrical & Allied Engineering Co.Ltd. v. Canara Bank & Others(supra). The Commission concluded that by providing for the extinction of a right, the parties are actually creating a law of prescription of their own, which is a far more important matter than merely creating a law of limitation of their own. The Commission recommended suitable amendment to Section 28 of the Contract Act to render invalid contractual clauses that extinguish on the expiry of a stated period the rights accruing from the contract.
# 32. It is in this background that on 08.01.1997 section 28 of the Contract Act was amended. The Statement of Objects and Reasons for such amendment reads as follows:
“The Law Commission of India has recommended in its 97th Report that Section 28 of the Indian Contract Act, 1872 may be amended so that the anomalous situation created by the existing section may be rectified. It has been held by the courts that the said Section 28 shall invalidate only a clause in any agreement which restricts any party thereto from enforcing his rights absolutely or which limits the time within which he may enforce his rights. The courts have, however, held that this section shall not come into operation when the contractual term spells out an extinction of the right of a party to sue or spells out the discharge of a party from all liability in respect of the claim. What is thus hit by Section 28 is an agreement relinquishing the remedy only i.e. where the time limit specified in the agreement is shorter than the period of limitation provided by law. A distinction is assumed to exist between remedy and right and this distinction is the basis of the present position under which a clause barring a remedy is void, but a clause extinguishing the rights is valid. This approach may be sound in theory but, in practice, it causes serious hardship and might even be abused.
It is felt that Section 28 of the Indian Contract Act, 1872 should be amended as it harms the interests of the consumer dealing with big corporations and causes serious hardship to those who are economically disadvantaged.
The Bill seeks to achieve the above objects.”
# 34. Union of India, thereafter, constituted an Expert Committee for Recommending Changes in the Legal Framework Concerning Banking System which was headed by Sh.T.R.Andhyarujina, Senior Advocate and Former Solicitor General of India on 15.02.1999. The Committee noted the effect of amended section 28 of the Contract Act as incorporated by amendment of 1997 as follows: . . . .
# 36. It is, thereafter, on 18.01.2013 that the Parliament added Exception 3 to section 28 of the Contract Act, which reads as follows:
“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.”
# 37. . . . . . . The above 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 Contact Act deals with the rights of a creditor to enforce his rights under the bank guarantee after happening of a specified event.
# 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.
# 42. 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.
# 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. A perusal of para 15 of the writ petition shows that a claim period has been explained as a time period contractually agreed between the creditor and the 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 has occurred during the validity period. Respondent No. 1 does not deny the above averments of the petitioner in the counter-affidavit. 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.
# 49. In view of the above communications dated 18.08.2018 and 28.03.2019 as issued by respondent No. 1 and the circulars dated 10.02.2017 and 05.12.2018 to the extent that they reproduce erroneous interpretation of Exception 3 to Section 28 of the Contract Act are clearly vitiated. It is ordered accordingly.
# 50. I may now deal with another plea raised by the respondents, namely, that the issue of prescribing the bank charges and the period for retention of security are matters of contract and this court cannot interfere in such contractual matters especially as they are not contrary to any rules or regulations or stipulations framed by RBI.
# 51. I may only note that in the writ petition, no relief is sought by the petitioner pertaining to the bank charges to be charged by the banks or the duration for which the bank may seek to maintain collateral security. Hence, this court has not in any manner dealt with the said aspects.
# 52. The petition is accordingly disposed of as above. All pending applications, if any, are also disposed of.
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Blogger’s Comments; Hon’ble High Court has clearly demarcated difference between -
Claim period has been explained as a time period contractually agreed, . . . . . which provides a grace period beyond the validity period of the guarantee to make a demand on the bank for a default which has occurred during the validity period.
Section 28 of the Contract Act does not deal with the said claim period. It deals with the 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.
Court further observed; “I may now deal with another plea raised by the respondents, namely, that the issue of prescribing the bank charges and the period for retention of security are matters of contract and this court cannot interfere in such contractual matters especially as they are not contrary to any rules or regulations or stipulations framed by RBI.”
This ruling has far reaching implications.
Banks may revise their proforma bank guarantee to provide for the suitable clause to take benefit of “Exception 3 to section 28 of the Contract Act,”
Banks may revise their proforma counter indemnity guarantee / application of the corporate debtor to provide for retention of margin money &/or security till such time the liability of bank is subsisting under “Exception 3 to section 28 of the Contract Act,”
IRP/RP to examine the claim of bank for bank guarantee in CIRP, in light of the rulings in this judgement.
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