Interpretation of Section 28 of the Indian Contract Act and its Impact on Bank Guarantees | Schemes and Mind Maps Science education

Larsen and tourbo (Petitioner) v. Punjab national bank (Respondent No.1) & Indian banks

association (Respondent No.2)

Brief facts of the case

The controversy arose because the PNB, with communications dated 08/18/2018 and

03/28/2019, insisted on a binding and unchangeable claim period of at least 12 months for

BGs. This interpretation was in accordance with the circulars of the IBA dated February 10,

2017 and December 5, 2018. The Claim Period in an Bank guarantee is a grace period,

beyond the period of validity of the bank guarantee to sue the bank for default that

occurred during the period of validity of the bank guarantee. The PNB felt that a claim

period of less than 12 months would remove the claim period and effectively increase the

claim period under the bank guarantee to 3 years (or 30 years for the government) under

the Statute of Limitations Act 1963 (limitation act).

The Issue

Whether the concerned Court has the territorial jurisdiction to entertain the writ petition?

Exception 3 of section 28 (ICA) created confusion on whether:

(a) the claim period under the BG (bank guarantee) has to be 1 year; or

(b) 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 (bank guarantee)

applicant the requirement to pay commission for the entire limitation period is

commercially burdensome.

Jurisdiction of the Court by the petitioner

On the issue of Jurisdiction of the particular Court, the Petitioners while filing a replication

reiterated that the head office and the registered office of Respondent No. 1 is Delhi.

Moreover, the letters dated 18.08.2019 & 28.03.2019 of Respondent No. 1 clearly shows

that the Law Division of the Respondent No. 1 that is situated in Delhi took care of all the

decisions and communications.

Jurisdiction of the court by the Respondent

The Respondent No. 1 contended that the concerned Court does not have the territorial

jurisdiction to entertain the particular writ petition. It was contended that the head office

of the Petitioner is in Mumbai and the letters issued by Respondent No. 1 that are in

challenge in the current proceedings were issued from the Mumbai branch of the

Respondent No. 1.

Court’s view on this matter

The Hon’ble High Court observed that question as to whether a high court has territorial

jurisdiction to entertain a writ petition must be answered on the basis of the averments

Partial preview of the text

Download Interpretation of Section 28 of the Indian Contract Act and its Impact on Bank Guarantees and more Schemes and Mind Maps Science education in PDF only on Docsity!

Larsen and tourbo (Petitioner) v. Punjab national bank (Respondent No.1) & Indian banks association (Respondent No.2) Brief facts of the case The controversy arose because the PNB, with communications dated 08/18/2018 and 03/28/2019, insisted on a binding and unchangeable claim period of at least 12 months for BGs. This interpretation was in accordance with the circulars of the IBA dated February 10, 2017 and December 5, 2018. The Claim Period in an Bank guarantee is a grace period, beyond the period of validity of the bank guarantee to sue the bank for default that occurred during the period of validity of the bank guarantee. The PNB felt that a claim period of less than 12 months would remove the claim period and effectively increase the claim period under the bank guarantee to 3 years (or 30 years for the government) under the Statute of Limitations Act 1963 (limitation act). The Issue Whether the concerned Court has the territorial jurisdiction to entertain the writ petition? Exception 3 of section 28 (ICA) created confusion on whether: (a) the claim period under the BG (bank guarantee) has to be 1 year; or (b) 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 (bank guarantee) applicant the requirement to pay commission for the entire limitation period is commercially burdensome. Jurisdiction of the Court by the petitioner On the issue of Jurisdiction of the particular Court, the Petitioners while filing a replication reiterated that the head office and the registered office of Respondent No. 1 is Delhi. Moreover, the letters dated 18.08.2019 & 28.03.2019 of Respondent No. 1 clearly shows that the Law Division of the Respondent No. 1 that is situated in Delhi took care of all the decisions and communications. Jurisdiction of the court by the Respondent The Respondent No. 1 contended that the concerned Court does not have the territorial jurisdiction to entertain the particular writ petition. It was contended that the head office of the Petitioner is in Mumbai and the letters issued by Respondent No. 1 that are in challenge in the current proceedings were issued from the Mumbai branch of the Respondent No. 1. Court’s view on this matter The Hon’ble High Court observed that question as to whether a high court has territorial jurisdiction to entertain a writ petition must be answered on the basis of the averments

made in the petition. By analyzing the letters dated 18.08.2018 & 28.03.2018, the Court held that the communications were made through the Law Division of the Respondent No. 1 which is situated in Delhi. Hence, the infraction of the rights of the petitioner also occurs in Delhi. “In view of the above facts, it is manifest that the p art of cause of action has arisen within the territory of this court.” The court came to this decision based upon the case of Eastern Coalfiels Ltd. & Ors. v. Kalyan Banerjee, (2008) 3 SCC 456 (“Eastern Coalfields”). that under Article 226 (2), an order or writ can be issued by a high court in relation to territories within which the cause of action wholly or in part arises. Interpretation of section 28 by petitioner The senior counsel for the Petitioner argued that if section 28 is interpreted in its simplest terms, it could be construed that even though the right to invoke a remedy is not guaranteed, the right to extinguish it is. Relying on the report of the expert committee headed by Sh. T. R. Andhyarujina. Based on this report, it was contended that Exception 3 of Section 28 of the Act was inserted which gives the bank a reprieve from having to file a suit within a period of 12 months instead of the 3 year or 30 year mandatory period as per the Limitation Act. However, the exception does not deal with the issue of the claim period in a bank guarantee. Exception 3 of the Section 28 does not deal with the claim period at all. Interpretation of section 28 by respondent With reference to Exception 3 of the Section 28 of the Act, the Respondent No. is in contravention of section 28 of the Act. A party may stipulate a term in the bank guarantee for extinguishment of the right or discharge of any party from any liability after the expiry of such stipulation which is not less than one year from the date of occurrence of a specified event. The counter-affidavit filed by RBI was also relied upon, stating that banks could have autonomy in making commercial decisions in this regard, again falling outside the scope of Regulation 283. It was argued that the requirement of a minimum claim period of one year has been endorsed by the Ministry of Finance, Department of Financial Services in consultation with RBI. These letters were communicated during these dates 23.04.2019 and 21.05. Interpretation by the court The Court in determining the scope of the bank guarantee placed reliance on the Kerala Electrical & Allied Engineering Co. Ltd. case, which held that Section 28 makes two types of agreements void. “(i) an agreement which limits the time within which a party thereto may enforce his rights under or in respect of a contract by the usual legal proceedings in the ordinary tribunals; (ii) an agreement relinquishing the remedy only, by providing that if a suit is to

Case analysis The issue arose when punjab national bank compelled the petitioner to keep the claim period in bank guarantee alive for minimum of period of 1 year, not considering the fact that whether the petitioner required bank guarantee for shorter period. The petitioner incurred unnecessary commission charges due to this. The demand made by the respondents was based on the wrongful interpretation of section 28 of ( ICA ) which stated that any claim under 12 months would be declared void. Aggrieved by this interpretation Larsen and tourbo filed a case against Punjab national bank. The court held that the social control period for the beneficiary to approach a court that's one year not the amount at intervals that the beneficiary will claim against the BG bank. This should not be confused with the claim period for invocation of the BG, which is clearly a written agreement matter between bank, applier and beneficiary. The Court was solely of the read that no beneficiary is restricted from approaching a court for a period below 1 year (which is anyway not tired BGs). The BG must clarify that the liabilities of the bank under the BG is destroyed when 1 year for this to be effective. In the end the court said this is a matter of contractual matters and the petition was disposed off. What was the reason of this wrongful interpretation of Punjab national bank? A committee of experts set up in 2013 recommended reducing this period to one year in order to enforce the rights under the bank guarantee after a specific event had occurred. Subsequently, an exception 3 was added to Section 28 of the Contracts Act in 2013, allowing banks and financial institutions to include clauses providing for the cessation of the beneficiary's rights or the release of the bank from liability upon maturity of a specified period. thereby reducing the statute of limitations for a beneficiary to pursue their claim in court. The whole purpose of setting up this committee was to ensure that the enforcement of the bank guarantee will start from the day that the defaulter defaults the payment during th e bank guarantee not from the start of the bank guarantee. So let’s say that A’s bank’s make a guarantee to c for a period of 1 year from 2017 april to 2018 april and a defaults a payment on June of 2017. The bank interpretated this amendment as. The perio d of enforcing A’s right will be of till 2018 april not till 2018 june. But the right and correct interpretation says that the period of enforcement will start from June 2017 not April 2017. So exception 3 does not deals with the claim period. It deals with the rights of the creditor to enforce his rights under bank guarantee. 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 consequence of incorporating a minimum claim period of 12 months in the bank guarantee is that the liability of the issuing bank remains open during such a claim period. Also, the applicant/borrower has to pay commission and keep alive the collaterals/cash

margins for or during such claim period, even if validity of a bank guarantee is much shorter or has expired. Moreover, the period of limitation under the Limitation Act, 1963, for initiating proceeding would be available beyond the said claim period. Basis the Judgement, banks may now have to prescribe a minimum period of 12 months for a beneficiary to approach a court/tribunal and not a minimum claim period of 12 months for making a claim. The Judgement provides much needed clarity and interpretation on the said Exception 3 and will help the banks and applicants to prescribe the claim period as per the contractual arrangement (and not the minimum claim period of 12 months) between the parties (applicant and beneficiary) and to keep open their (issuing bank’s and applicant’s) liabilities only for a contractually agreed period. Supreme court observation in Indusind bank v. union of India a bank guarantee was issued in favor of the Union of India by various importers of cotton. These guarantees provided for invocation period which was three months beyond the period of validity. These guarantees were invoked after period of three months lapsed. Bank refused to make payment as claim was beyond claim period fixed in guarantee. Union of India said that in view of Section 28 of Contract Act, period for making claim cannot be limited to three months and that the period should be the period of limitation prescribed under Limitation Act. Bombay High Court held that since bank guarantee was not invoked within time prescribed, suits will have to be dismissed. SC agreed with this view. Supreme Court held amendments made in 1997 were not declaratory but were substantive changes to law and applied only prospectively and not retrospectively. Put it simply, if a claim is not lodged within limitation period, no claim can be made afterwards. However, if a claim is made within time and no payment is made against the claim, the claimant is entitled to sue within the limitation period. History of section 28 exemption 3 The 97th Law Commission is suo moto analyzing the irregularities under Section 28 of the Contract Act where, a right can be extinguished but a remedy cannot be barred. The Legal Commission has proposed amendments to prevent Article 28 from becoming a highly litigious provision and to reduce the difficulties consumers face when negotiating with large companies. Section 28 of the Australian Constitution was amended in 1997, adding 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. The Banking Law (Amendment) Bill 2012 was promulgated in order to exempt guarantee agreements of banks from the purview of section 28 of the Contract Act. This will bring finality to redemption of such guarantees. According to this, exception three was added.

Interpretation of Section 28 of the Indian Contract Act and its Impact on Bank Guarantees, Schemes and Mind Maps of Science education

Related documents

Partial preview of the text

Download Interpretation of Section 28 of the Indian Contract Act and its Impact on Bank Guarantees and more Schemes and Mind Maps Science education in PDF only on Docsity!