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JC - Law firm | Mumbai | Delhi | Benglore

Article

06 Oct 2020

Enforcement of Indian bank guarantees: a dichotomy in law

Pratish Kumar
Juris Corp, Mumbai


Ankit Sinha
Juris Corp, Mumbai
ankit.sinha@jclex.com


Garima Parakh
Juris Corp, Mumbai
garima.parakh@jclex.com

Legal background

Section 28 of the Indian Contract Act 1872 (the 'Contract Act') seeks to render void agreements, including those absolutely restricting the parties from enforcing their rights under any contract by way of legal proceedings, or restricting the time limit within which they may enforce their rights; or restricting parties from enforcing their rights by extinguishing the right or discharging the liability, on the expiry of a specified period.

Prior to addressing the continuing debate on section 28, with specific reference to bank guarantees, it would be valuable to understand the origins of this debate.

Amendments to section 28: 1997 to 2013

The 97th Law Commission (Law Commission) suo moto analysed the anomalies prevailing under section 28 of the Contract Act where, extinguishment of a right was permissible but mere barring of a remedy not. In order to prevent section 28 from being a highly litigious provision and to alleviate the hardship faced by consumers when negotiating with large corporations, the Law Commission proposed an amendment. Pursuant to the Law Commission’s report, section 28 was amended in 1997 (the 1997 Amendment), inserting sub-section(b).The 1997 Amendment blurred the pre-amendment distinction between ‘right’ and ‘remedy’ and resulted in a number of litigations for banks, further adding to the contradiction in the existing position. As a redress mechanism, on recommendation of the Indian Banks’ Association, the Banking Law (Amendment) Bill 2012 was promulgated with the intention to exempt guarantee agreements of banks from the purview of section 28 of the Contract Act to bring finality to redemption of such guarantees’. Pursuant to this, exception three was inserted.

Judicial pronouncements

In Union of India & Anr v M/s Induslnd Bankd Ltd & Anr (CA No 9087-9089/2016, 15 September 2016), the Hon’ble Supreme Court of India held the 1997 Amendment to be a substantive change in law not having retrospective effect. Accordingly, the bank guarantees in question were held to be valid under the unamended Section 28. The Supreme Court, deeming it irrelevant, did not assess the impact of Section 28(b) on the bank guarantee in question. However, it did make the following observation in passing, in relation to the 2013 Amendment:

‘It may only be noticed, in passing, that Parliament has to a large extent redressed any grievance that may arise qua bank guarantees in particular, by adding an exception by an amendment made to Section 28 in 2012, with effect from 18 January 2013. Since we are not directly concerned with this amendment, suffice it to say that stipulations like the present would pass muster after 2013 if the specified period is not less than one year from the date of occurring or non-occurring of a specified event for extinguishment or discharge of a party from liability.’

The Delhi High Court in D Pal & Co v MCD, ILR (2007) Supp(6) Delhi 175, while interpreting section 28(b) of the Contract Act held that prescriptive clauses which restrict a party’s right to initiate legal proceedings or provide for discharge of liability by a time period less than what has been statutorily provided, shall be void. Reference was also made to the judgment of the Supreme Court of India in National Insurance Co Ltd v Sujir Ganesh Nayak & Co, (1997) 4 SCC 366, where restraint on approaching a judicial forum within a period of time less than is statutorily provided, was held to be void under section 28. It is relevant to note that, earlier judgments of Food Corpn of India v New India Assurance Co Ltd (1994) 3 SCC 324, and H P State Forest Co Ltd v United India Insurance Co Ltd v Sujir Ganesh Nayak & Co.

Conclusion

Following the 2013 Amendment, there have been two opposing views prevalent in the market, that: the claim period under a bank guarantee must be for a mandatorily one-year period; and banks have a right to restrict the claim period under a bank guarantee to less than a year, but that should not result in complete extinguishment of the obligations (ie, the parties are free to go to court, if the claim is made within the stipulated period).

If one has to agree with the former view that demand period under a bank guarantee must be for a mandatorily minimum one-year period, then the following aspects need to be considered:

  • Should an exception to a provision of law be read along with the main provision? Section 28 provides for any restrictions in relation to enforcement of rights under a contract ie, approaching courts or tribunals. The above judicial pronouncements are also about this point.
  • Can it be implied that, pursuant to section 28, no time period can be provided for making a claim under a contract, other than the exceptions provided under section 28?
  • What will happen to other commercial contracts such as share purchase agreements/guarantees issued under India’s existing foreign exchange laws, where time period needs to be provided?
  • Why did India’s legislature omit ‘failure to make a claim’ from the suggestions made by the Law Commission when amending section 28.

  • Does the omission imply that they did not want a claim period to be included as a part of section 28?

Given the dichotomy in law it would be prudent for the Indian government to clarify the position of law and, particularly, the interpretation of section 28.