India: Clarity On Enforcement Of Bank Guarantees Delhi High Court In Larsen & Toubro Limited v. Punjab National Bank

1. Introduction

Bank guarantees (BG) are a crucial component of global business and trade being widely used to ensure financial commitments. A BG is effectively treated as liquid cash with guarantor banks being obliged to honour guarantees on demand without any delay.

2. Validity Period and Claim Period

The "validity period" is the tenor or duration of the BG. The "claim period" is the period within which the beneficiary must make a claim.

3. Section 28 of the Contract Act

Under Section 28 of the Indian Contract Act, 1872 (Contract Act) a clause limiting the time within which a party's rights are to be enforced is void, if such period is shorter than the statutory period of limitation, being 3 years for non-governmental beneficiaries and 30 years for governmental beneficiaries under the relevant provisions of the Limitation Act, 1963 (Limitation Act). However, the exception to this principle is in the third exception (Exception 3) to Section 28 of the Contract Act, which allows banks to issue BGs with claim periods of not less than 1 year i.e., less than the limitation period (Exception 3).

4. The Issue

Exception 3 created confusion on whether: (a) the claim period under the BG has to be 1 year; or (ii) whether the enforcement of contractual rights has to be a minimum 1 year period. It is important to understand the nuances since for any BG applicant the requirement to pay commission for the entire limitation period is commercially burdensome.

5. Judgement

The Delhi High Court in Larsen & Toubro Limited v. Punjab National bank¹ (Larsen & Toubro) concluded that it is the enforcement period for the beneficiary to approach a court that is 1 year not the period within which the beneficiary can claim against the BG bank. This must not be confused with the claim period for invocation of the BG, which is clearly a contractual matter between bank, applicant and beneficiary. The Court was only of the view that no beneficiary can be restricted from approaching a court for a period less than 1 year (which is anyway not done in BGs). The BG must make clear that the liabilities of the bank under the BG is extinguished after 1 year for this to be effective.

6. Conclusion

This area that has not had sufficient jurisprudence and this judgement provides much needed clarity of approach to the banking industry on bank guarantees. We may see further market and jurisprudence in this area over the coming years.

Footnote

1. W.P. (C)7677/2019

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