by Rajesh Narain GUPTA and Sanjay GUPTA along with DCW Executive Editor Christopher Brynes

This article will present a comparative analysis of two important amendments to Section 28 of The Indian Contract Act, 1882 (The Act).
This law was first amended by Act No.1 of 1997, followed by the Banking Laws (Amendment) Act, 2012, passed on 5 January 2013, which introduced a new exception (Exception No. 3) to Section 28 of The Act. The question is
often asked whether a bank guarantee can or should have a limitation clause and, if so, what is the legal position.
Let us first examine Section 28 of The Indian Contract Act, 1882 as it stood prior to amendment.

Section 28 of The Act stated:
“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’.”
After amendment in 1997, The Act stated:
“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.’

Following this amendment, the restrictive clause in a bank guarantee wherein a beneficiary was required to enforce its claim within a stipulated period after expiry of a bank guarantee was subject to Section 28 of The Act. Thus, the clause in a bank guarantee which provided that “unless a suit or action to enforce claim under the guarantee is filed against us within six months from the date of expiry of the guarantee, all your rights under the said guarantee, shall be forfeited” was determined to be subject to Section 28 of The Act.

COMMENTARY ON THE INDIAN CONTRACT ACT by Pollock & Mulla (14th Edition, Volume I, p. 676) makes reference to this. It reads:
“A distinction must also be made between an agreement restricting any party from enforcing his right, and one requiring him to make a claim or assert his right within a specified time, or prescribing a period for operation of the contract. Thus, a contract requires that a party to it assert his rights or requiring a party to make a claim within a certain time, will not be affected by the amendment viz a clause in a bank guarantee given for a term and requiring the beneficiary to make a claim within the term of the guarantee. Such agreements cannot however, affect the right of a party enforce his rights by approaching any court or other forum within the normal period of
limitation if and after the party has asserted the right or made the claim within the period stipulated in the contract”.

The 1997 amendment came up for interpretation before the Delhi High Court in Explore Computers Pvt. Ltd. v. CALS Ltd. (131 (2006) DLT 477) and also in Pandit Construction Company v. DDA (2007 (3) RBLR 205 Delhi) where the Courts held that the time prescribed within which the beneficiary can lodge a claim under a bank guarantee will not be subject to Section 28 of The Act but any curtailment of right on the enforcement of claim will be offending the provisions of Section 28 of The Act. The relevant portion of the judgment in Explore Computers stated:
“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. If the policy of insurance provides that if a claim is made and rejected and no action is commenced within the time stated in the policy the benefits flowing from the policy shall stand extinguished and any subsequent action would be time barred. Such a clause would fall outside the scope of Section 28 of The Act. This in brief, seems to be the settled legal position. We may now apply it to the facts of this case.”

The Judgment of the Delhi High Court in Explore Computers was quoted by the Division Bench of Bombay High Court in M/S. Indusind Bank Ltd. v. Union of India (Appeal No. 258 of 2008) decided on 20 April 2011. In this case the Court considered whether due to the provisions of Section 28 of The Act, the term in the bank guarantee that the claim should be made with the Bank on or before 30 April 1997 is void or not.
After dealing with various case law, the Division Bench of the Bombay High Court quoted from the Supreme Court of India’s conclusion in M/S. Indusind Bank Ltd. v. Union of India:

“Thus, the Supreme Court has held that the term in the contract which deals with assertion of right is in no way connected with what is contemplated by section 28 of the Act. The term in the bank guarantee requiring the respondents to make their claim or demand with the Bank on or before 30th April 1997 does not affect the right of the respondents to enforce their rights by approaching the court of law within the normal period of limitation if the respondents assert their right or make a demand or claim with the Bank within the period mentioned in the bank guarantee. In our opinion, really speaking, in view of the law laid down by the Supreme Court in its judgment in the case of Food Corporation of India, there does not remain any possibility of any debate whether a term in the bank guarantee requiring beneficiaries of the bank guarantee to make claim under the bank guarantee within the stipulated period would be void because of the provisions of section 28 of the Act because such a term in the agreement is relatable to the assertion of right so as to perfect that right and not in relation to enforcement of that right in the court of laws.”
This judgment has been challenged before the Supreme Court and is pending consideration. Thus, it can be concluded that by virtue of the 1997 amendment (i) normal clauses appearing in a Bank Guarantee whereby time was prescribed within which the claim was to be lodged by the
beneficiary with the bank was held to be valid, but (ii) curtailment of right so as to enforce the same, was held to be invalid and void.
To further clarify, the following clauses appearing in bank guarantees show what was held to be valid and invalid after the 1997 amendment.

Valid Clause
“Our liability under the Bank Guarantee is restricted to Rs._ (Rupees only); and this bank guarantee will be alive for a period of one year till __ (Expiry date). Unless we receive a claim before expiry date, upon the expiry of this Guarantee, all of the (Beneficiary’s) rights under this Guarantee shall be forfeited and the Bank shall be relieved and discharged from all our
liabilities there under.”
It is important to note that this clause of the bank guarantee does not prescribe any time for the enforcement of the claim. Often, a clause appearing in a bank guarantee in addition to the period of validity also prescribes time for enforcement of the claim. The further clause which provides time for enforcement of the claim becomes relevant only in the event where the beneficiary of the bank guarantee has made a claim under the bank guarantee during the period of validity but for some reason, the bank refuses to pay the amount and then the only option left with the beneficiary is to enforce the claim by filing a civil suit before the court of law. Therefore, the question which arises is as to whether the bank can restrict the right of the beneficiary to enforce its claim.
Conversely, there is a clause which commonly appears in many bank guarantees and prescribes time for enforcement of the claim.

Invalid Clause
“This guarantee will remain in force for a period of one year from the date hereof and unless a suit or action to enforce claim under the guarantee is filed against us within six months from the date of expiry of the guarantee all your rights under the said guarantee shall be forfeited and we shall be relieved and discharged from all liability thereunder.”
This clause has two options: one relates to the period of validity of the bank guarantee, i.e. a period of one year; and the other option is the period of enforcement which is six months. The clause so far as it prescribes the period of validity of the bank guarantee was held to be valid, however, the clause which restricts the right to enforce the claim was held to be hit by Section 28 of The Act as it extinguishes or restricts the right to enforce a claim as provided for under the Limitation Act, 1963.
Based on this interpretation of Section 28 of the Act as it stood after the 1997 amendment, banks were exposed to a situation where the bank guarantee was invoked during the period of its validity but for some reason, banks were unwilling to pay and this led to a situation where banks were
keeping the claim in a bank guarantee alive for a period of 3 years for non-Government organizations. In cases where the bank guarantee was given in favour of the Government, the claim was kept alive for a period of 30 years. We emphasize here that this situation emerges only where the beneficiaries have invoked the bank guarantee during the period of its validity. Any invocation after the period of validity has no force and banks were relieved of their obligations under the bank guarantee.
It is our understanding that banks took up the matter with Indian Bank Associations and the Law Commission of India which led to a further amendment.
By virtue of the Banking Laws (Amendment) Act, 2012 which entered into force in 2013, The Act was further amended and an Exception has been carved out which states:

“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.”

Banks, as well as Financial Institutions, were further defined in the explanation to Exception 3 as to mean a Bank, Multi State Coop. Banks etc. and Financial Institutions to mean any Public Financial Institution within the meaning of Section 4A of the Companies Act, 1956.
As of 1 May 2019, we are not aware of any judgment on the interpretation of Exception 3 as it relates to Section 28 of the Act.
In our understanding and in the light of past difficulties faced by banks, by virtue of this amendment, Banks can now restrict the right of the beneficiary to enforce its claim, but not for less than one year. However, if the time for enforcement has been restricted in the bank guarantee for a
period not less than one year then in view of the amendment carried out in 2013, the same will be valid and will not be subject to Section 28 of The Act.
We are conscious of the fact that in Exception 3 to Section 28, the expression ‘enforcing his rights’ has not been used, although the expression is used in Section 28 of the Act. In our opinion, looking into the background and the necessity for introducing Exception 3 to Section 28 of the Contract Act, any other interpretation does not merit justification. The only reasonable interpretation of Exception 3 which can be made is that Banks and Financial Institutions as defined in explanation to Exception 3 are now within their rights to restrict the time for enforcement.

Yet there is another school of thought on the interpretation to Exception 3. It has been debated that Exception 3 can be interpreted to mean that the Legislature has now given an extended window of at least one year to beneficiaries to invoke the bank guarantee even after the period of expiry of the bank guarantee. We do not subscribe to this view. In our understanding, the correct view is that banks and financial institutions are now within their rights to restrict the time for enforcement of the claim in respect of a bank guarantee and the said time has to be a period of one year or more.
Whether our view is correct or the other view is correct will be determined as and when there is any effective judicial pronouncement on this issue. Until such time, we conclude:

A bank guarantee can be invoked during the period stated in the guarantee. For the purpose of invocation of the bank guarantee, the beneficiary can file the claim with the bank for payment and upon receipt of such demand for payment the bank is obliged to pay;
In case the bank does not make payment upon receipt of a valid demand, the beneficiary shall have legal recourse against the bank to initiate a lawsuit which can be filed within three years (30 years for government) from the date the cause of action arises (for example, from the date of invocation of the guarantee);
In case the text of the bank guarantee provides for a claim period (which is filing of the claim with the court), then (in view of the recent amendment) such claim period cannot be less than one year from the date of expiry of guarantee;
In case a guarantee does not have a claim period then the legal recourse shall be as per point (2) above.
In case there is a claim period of at least one year then the period available for filing a claim with the court gets restricted (this is the recent amendment).
Rajesh Narain Gupta is Managing Partner and Sanjay Gupta is Senior Partner at SNG & Partners, an Indian law firm with offices in New Delhi and Mumbai. The authors acknowledge the assistance of DCW Executive Editor Christopher Byrnes in preparing this article.