Claim period of bank guarantee

Section 28 of the Indian Contract Act, 1872 (ICA), in its original form inter alia made all such contracts void that limited the time within which a party may enforce its rights under a contract by the usual legal proceedings in the ordinary tribunals.

In the recent case of Larsen & Toubro Limited v Punjab National Bank, the Delhi High Court has delved into the interpretation of section 28 of ICA, with special emphasis on exception 3. L&T contended in its writ petition that in the ordinary course of its business, it was required to furnish bank guarantees while bidding for contracts. However, PNB, based on an erroneous interpretation of section 28 of ICA, had stipulated a compulsory minimum claim period of 12 months for the guarantee, even though L&T required the guarantee for a shorter period. Such claim period provided for a grace period beyond the validity period of the guarantee, during which a demand could be made on the bank for a default which occurred during the validity period. Under the guarantee, the creditor could also enforce his right before a court of law within the validity period or claim period, in the event the bank failed to honour its commitment, as per exception 3 to section 28 of the ICA. In the absence of such a clause in the guarantee, the said period would be determined by the Limitation Act.

Punjab National Bank argued that a claim period in a bank guarantee whose duration was less than 12 months would render the claim period void, and increased the claim period under the guarantee to that prescribed under the Limitation Act. This was further based on the clarification provided by the Indian Bank Association (also a respondent).

The court has held in the matter that exception 3 deals exclusively with curtailment of the period for the creditor to institute proceedings before a court of law to enforce his rights (the enforcement period), which shall be not be less than 12 months. Further, in the absence of such a clause limiting the enforcement period to 12 months, the limitation period as set out under the Limitation Act shall be applicable (which is three years for private parties and 30 years for the government). However, it does not in any manner deal with the duration of claim period or mandate the stipulation of a claim period of at least 12 months in a bank guarantee.