The Third Exception To Section 28 Of The Contract Act, 1872 And Claim Periods Under Bank Guarantees

• Published date: 03 August 2021
• Subject Matter: Government, Public Sector, Government Contracts, Procurement & PPP
• Law Firm: Khaitan & Co
• Author: Mr Thriyambak Kannan

Larsen & Toubro Limited (L&T) filed a writ petition against Punjab National Bank (PNB), the Indian Banks Association (IBA) and the Reserve Bank of India (RBI) before the Delhi High Court challenging PNB's and IBA's interpretation of the third exception to Section 28 of the Indian Contract Act, 1872 (ICA). The issue arose because L&T in its ordinary course of business, routinely submitted performance bank guarantees/ advance bank guarantees while bidding for government contracts and also submitted bid bonds/ bid security in the form of bank guarantees (BGs). PNB compelled L&T to keep the claim period under the BG alive for a minimum period of one year, regardless of whether L&T required the BG for a shorter period. The implications of this for L&T was that it incurred unnecessary expenses for payment of commission charges on the BG and for maintaining collateral security in support of the BG during the extended claim period. Hence L&T also joined IBA and RBI as Respondents in the writ petition as it was a policy decision which affected all persons who availed of such banking facilities.

A Single Judge of the Delhi High Court by judgment dated 28^th July 2021 in "Larsen and Toubro Limited v. Punjab National Bank and Another", Writ Petition No. 7677 of 2019, has for the first time, in interpreting the third exception to Section 28 of the ICA in the context of a BG held that the provision did not provide for a minimum claim period under a BG.

The dispute arose since PNB, by way of communications dated 18.08.2018 and 28.03.2019, insisted on a mandatory and an unalterable claim period of a minimum 12 months for BGs. This interpretation was pursuant to circulars issued by the IBA dated 10.02.2017 and 05.12.2018. The claim period in a BG is a grace period awarded beyond the validity period of the BG to make a demand on the bank for a default, which default occurred while the BG was valid. PNB was of the view that a claim period which is less than 12 months would render the claim period void and will effectively increase the claim period under the BG to 3 years (or 30 years for the government) under the Limitation Act, 1963 (Limitation Act).

The High Court in interpreting the provision set out the historical amendments made to Section 28 of the ICA. Prior to the first amendment, the ICA voided all agreements that restrained contractually, but not statutorily, the right to enforce a legal remedy. As a result, in 1997, Section 28 was amended with an exception that...