The Scope Of Exception 3 To Sec.28 Of The Indian Contract Act 1872, Judgement In Larsen & Toubro Ltd Vs Punjab National Bank: An Analysis

Update: 2021-11-02 09:59 GMT
story

Section 28 of Indian Contract Act, 1872—which provides that every contract in restraint of legal proceedings is void—is one of the restrictions on the freedom of contract. Exception 3 incorporated to the said section by the 2013 amendment, is one of the significant, and yet least understood, provisions to the banks. While a precise scope of these provisions remained elusive,...

Your free access to Live Law has expired
Please Subscribe for unlimited access to Live Law Archives, Weekly/Monthly Digest, Exclusive Notifications, Comments, Ad Free Version, Petition Copies, Judgement/Order Copies.

Section 28 of Indian Contract Act, 1872—which provides that every contract in restraint of legal proceedings is void—is one of the restrictions on the freedom of contract. Exception 3 incorporated to the said section by the 2013 amendment, is one of the significant, and yet least understood, provisions to the banks. While a precise scope of these provisions remained elusive, the recent judgment of the High Court of Delhi in the matter of Larsen & Toubro Ltd & Anr. v Punjab National Bank & Anr[1] has the effect of dethroning certain provisions of the Limitation Act, 1963 so far it relates to bank guarantees. Since the amendment in the year 1997 to section 28 of the Indian Contract Act, 1872, it was a pounding question to many, whether banks can validly limit the period for lodgement of claim for the guaranteed amount? When the parliament tried to address this question by another amendment in 2013 by introducing a minimum period for extinguishment of right and liabilities, it gave rise to another question. Whether the period so granted is a 'period of limitation' like one under the Limitation Act, 1963?

In Larsen &Toubro Ltd & Anr v Punjab National Bank & Anr, the dispute arose when Punjab National Bank insisted on commission for the claim period of a bank guarantee. The bank's reason for the said commission—as the necessary fallout of 1 (one) year claim period mandated under Exception 3 of section 28 of the Indian Contract Act, 1872 (hereafter 'the Act')—did not satisfy Larsen & Toubro Ltd and the same was impugned before the High Court of Delhi. According to Larsen & Toubro, the bank erred in interpreting Exception 3 of Section 28 of the Act. It was argued that such period, being a contractual arrangement can be varied or even dispensed with. The scope of Exception 3 was the central point of contention in this case. The question was whether the Specified Period mentioned in Exception 3 is for lodging the claim under the bank guarantee, or is it like the period of limitation under the Limitation Act, 1963 (hereafter 'the Limitation Act'). The court answered the question affirmatively. The court relied on the historical background section 28 of the Act, especially the Reports of Committee on Banking Sector Reforms and the Expert Committee for Recommending Changes in the Legal Framework Concerning the Banking System (hereafter collectively referred to as 'the Reports') in deciding the case. This Article argues that the Reports and the findings of the court that the Specified Period in Exception 3 is a period for the creditor to approach the court/tribunal to enforce his rights[2], are erroneous. It further argues that the said Specified Period in Exception 3 was introduced to address a peculiar issue and that is extraneous to the period of limitation. It also attempts to resituate Exception 3 from being a nemesis of remedial rights, so that the banks and the beneficiaries of the bank guarantees can be good bedfellows.

1. The Original Section 28 Of The Act And Its Then Prevailing Interpretation

1.1 The original section 28 of the Act, situated under the Chapter II of the Act, is essentially a restriction on the freedom of contracts. It provided that every contract in restraint of legal proceedings is void to that extent. Two types of terms were hit by the original section viz. firstly clauses which absolutely restrict the party from enforcing his rights under or in respect of the contracts; and secondly clauses which limits the time within which the party may enforce his rights[3]. This section sought to prevent ousting or tampering of remedial rights available to the parties under the law.

1.2 To surmount the prohibition under section 28, the banks followed a practice of stipulating for a timely extinguishment of the rights and the liabilities (instead of the remedies) under bank guarantees. The Supreme Court and various High Courts upheld this practice holding that since such guarantees and policies provide for extinguishment of rights and liabilities of the parties, no rights or liabilities survive for enforcement. In other words, the rights accruing to a party ceases to exist under the contract itself by the expiry of time stipulated in the contract. There is a simultaneous relinquishment of the rights accruing under the contract and the remedy to enforce it; and therefore, such stipulations do not contravene section 28[4]. The Kerala High Court's decision in Kerala Electrical & Allied Engineering Co. Ltd. v. Canara Bank & Others[5] was one among the judgments that elucidated the scope of the original section in such manner. In this case, the following non-obstante clause in the bank guarantee issued by the respondent bank was under challenge[6].

"This guarantee will remain in force for a period of ONE YEAR from the date hereof and unless a suit or action to enforce claim under the guarantee is filed against us within six months from the date of expiry of the guarantee all your rights under the said guarantee shall be forfeited and [the bank] shall be relieved and discharged from all liability thereunder."

The court, while deciding this case made a distinction between two types of clauses, (1) that merely limiting the time within which the right is to be enforced, (2) that forfeiting the right if not sued/enforced within a specified time. The court held that the first category is void under section 28, but the second is not. The court then upheld the validity of the above said non-obstante clause for it provides for forfeiture of the rights simultaneously with the remedy.

1.3 In the 97th Report[7] of the Law Commission of India (hereafter 'Law Commission'), the above practice and its interpretation by the courts was referred to as an 'anomalous situation'. The Law Commission was of the view that the courts went astray from the legislative intent of section 28; and if these ratios are allowed to stand, the parties with greater bargaining power may undermine the remedial rights of the other party by stipulating a shorter period for enforcement of right[8]. Accordingly, it recommended for amendment of the original section and the same was amended in 1997 (hereafter "the 1997 Amendment') by introducing a new sub-section to section 28[9]. The new sub section (b) of section 28 was essentially aimed at addressing the issue of extinguishment of rights and liabilities after the expiry of a specified period so as to restrict any party from enforcing his rights.

2. Apprehension Of The Banks And The Committees over the 1997 Amendment

2.1 The 1997 Amendment raised an apprehension among the banks that it may cast shadow on the practice of stipulating for extinguishment of the rights and liabilities after a specified period, which was generally shorter than the period of limitation under the law. The Committee on Banking Sector Reforms under the chairmanship of M Narasimham (hereafter 'the Narasimham Committee-II') appointed by the Ministry of Finance for reviewing the implementation of the banking reforms, observed the predicament caused to the banks with the advent of 1997 Amendment[10]. The Expert Committee for Recommending Changes in the Legal Framework Concerning the Banking System, headed by Shri. T.R. Andhyarujina (hereafter the 'Expert Committee') also observed in its report to the government as "they (the Banks) can no longer limit their liabilities under the Bank Guarantees to a specified period and they will have to carry their Bank Guarantee commitments for long periods as outstanding obligations. Banks also apprehend that in case of Bank Guarantee to the Government, notwithstanding stipulation in the bank guarantee that it should be in force within a specified period, banks will be forced to treat in their books their liability under the Bank Guarantee to the Government as outstanding till the limitation period of 30 years available to the Government lapses." The Expert Committee, as a measure to mitigate this problem recommended for an exception to guarantees issued by the banks and financial institutions from the rigour of section 28[11]. Accordingly, Section 28 was later amended (hereafter 'the 2013 Amendment') to include Exception 3[12] as follows.

"Exception 3 - Saving of a guarantee agreement of a bank or a financial institution: - This section shall not render illegal a contract in writing by which any bank or financial institution stipulate a term in a guarantee or any agreement making a provision for guarantee for extinguishment of the rights or discharge of any party thereto from any liability under or in respect of such guarantee or agreement on the expiry of a specified period which is not less than one year from the date of occurring or non-occurring of a specified event for extinguishment or discharge of such party from the said liability."

3.A Brief Note On Working Of Bank Guarantees

3.1 For framing my arguments, let me first set out the working of a bank guarantee, of course, at the risk of stating the obvious. In the underlying contracts to the bank guarantees, the beneficiary's right to invoke the guarantee is invariably dependent on happening or non-happening of a future uncertain event (hereafter referred to as 'the Event'). Since banks are neither privy to such underlying contracts, nor obliged to take cognizance of the Event by themselves, the parties agree for lodgement of a demand—which will also be the conclusive proof of the Event—as an additional requirement for honouring the bank guarantee. Generally, the Event can be a payment default or a performance default. Ascertainment of performance defaults are often extensive or even inadvertently dilatory. It is, therefore, not reasonable, or just to coincide the expiry date of the bank guarantee with the last date for lodging the demand. Hence, the parties agree on a cushion time for making the demand which will be a reasonable period after the expiry date of the bank guarantee. So, a typical bank guarantee is a contract contingent on two events – the default and the demand. If the default has not taken place, the contract of guarantee will become void by operation of section. 35 of the Act[13]. In case where the default happens, but the demand is not made within the claim period, the bank will be relived from its liability by operation of two provisions of the Act namely section 38[14] and 48[15]. Speaking more precisely, every bank guarantee is a contract with an 'offer to perform' which is like 'We, the BANK irrevocably undertakes to pay without protest or demur INR………on demand'. For the reasons we have discussed above, the default alone shall not entitle the beneficiary to receive the guaranteed amount. Because every guarantee by its construction is a contract where the promise is to be performed on a certain day, and the promisor has not undertaken to perform it without application by the promisee. In such contracts, section 48 of the Act obligates the beneficiary to make an application for payment of the guaranteed amount. If the beneficiary does not make the application, which can also be construed as a non-acceptance of offer, the bank shall be relieved for non-acceptance as per section 38 of the Act. Hence, the demand by the beneficiary has multiple dimensions. It is a demand for performance under section 48; it is an acceptance of offer under section 38; and it is also a conclusive proof as to the default.

4.Nature Of The Concerns of the Banks Over Sub Section (b) Of Section 28 Of The Act

4.1 The heading of Exception 3 'Saving of a guarantee agreement of a bank or a financial institution' indisputably reinforce the fact that it was enacted to address certain concerns of the banks and financial institutions (FIs). But what were the banks/FIs grappled with before its incorporation? Answer to this question is expected to provide insights as to the nature and scope of Exception 3.

4.2 When section 28 was amended in 1997 and sub-section (b) was introduced, the banks apprehended that thenceforth they cannot legally stipulate a period beyond which their liability shall cease. Assume, a bank guarantee payable on demand where a specified period for making a demand is not stipulated. There may arise a situation where the default has happened, but the demand has not been made. In such a scenario the beneficiary of the bank guarantee can safely postpone the demand to an indefinite period. Because so far there is no demand, there will be neither honouring nor dishonouring of the bank guarantee. So far there is no dishonouring, there is no breach of contract; and unless there is no breach of contract, the period of limitation does not commence. This issue is problematic in the accounting of the potential liabilities of the banks under a guarantee because its discharge is uncertain. It could pose adverse effect on the profit of the banks due to provisioning for uncertain period. The banks wanted to limit its potential liabilities under their bank guarantees to a certain period so that it shall not be perpetual in their books of accounts. To put it in other words, it was crucial for the banks to have certainty as to the discharge of its liabilities either by extinguishment or by performance. Such certainty cannot be achieved without subjecting the demand to certitude. By contractually obligating the beneficiary to demand the performance of promise within a specified time, the banks can achieve this certainty. If the demand is made within the specified time the banks can shed its liabilities by performance; and if the demand is not so made, then by extinguishment. These liabilities, up to the demand is made, are contingent and essentially undisputed.

4.3 The banks, for they are mostly eager beavers in honouring the bank guarantees, have never disclaimed its liabilities under guarantees so extensively that it could unbalance its balance sheet. Therefore, under any stretch of imagination, it cannot be assumed that the bank's concern also included accounting of its liabilities arising from its own breach. The appeal from the banking sector, and the legislative intent in addressing that appeal, therefore might not have been for reducing the period of limitation because the real issue that the banks were facing was extraneous to the period of limitation. I have further argued on this point in the coming paragraphs.

5.Was The Concern of The Banks over The New Sub-Section (b) Of Section 28 Of The Act Substantial?

5.1 Was sub section (b) of section 28 a real huddle to the banks in stipulating for discharge of its liabilities within a specified time shorter than the period of limitation under the limitation law? Had the apprehension of the banks had any basis? Sub section (b) of section 28 is operative only against clauses providing for extinguishment of right or discharge of liabilities which invariably results in barring the party from enforcing his rights. What kind of rights or liabilities should be extinguished/discharged to bar a person from enforcing his rights? The Law Commissions' 97th Report is pertinent in understanding the intention behind the 1997 Amendment whereby sub section (b) of section 28 was enacted. The said report says "On a consideration of all the aspects of the matter, we recommend that section 28 of the Indian Contract Act, 1872 should be suitably amended so as to render invalid contractual clauses which purport to extinguish, on the expiry of a specified term, rights accruing from a contract'[16]. For reaching this recommendation, the then prevailing interpretation of original section 28, including the decision in Kerala Electrical & Allied Engineering Co. Ltd. v. Canara Bank & Others were influential[17]. While enacting sub section (b) after the Law Commissions report, legislature has qualified the expression 'extinguishes the rights of any party thereto, or discharges any party thereto, from any liability' appearing in sub section (b) of section 28 with the expression 'so as to restrict any party from enforcing his rights' in order to mean that the rights and the liabilities extinguishment or discharge is prohibited thereunder are accrued or vested ones as recommended by the Law Commission. Hence, to attract sub section (b) of section 28, the guarantee shall provide for extinguishment of an accrued right/liability within a period shorter than the period of limitation under the period of limitation under the Limitation Act.

5.2 A usual non obstante clauses of bank guarantees provide for extinguishment of right/discharge of liabilities which are essentially contingent in nature; i.e., they are not accrued rights or liabilities. The beneficiaries have no vested right against the banks for enforcing his rights until a demand is made on the banks. That be case, let alone enforcement of rights, there will not be even a cause of action at the time of such extinguishment. Therefore, a scenario where no demand for guaranteed amount is made within the stipulated time, is not ripe for an enforcement action. The non obstante clause that the Kerala High Court has dealt with in the matter of Kerala Electrical & Allied Engineering Co. Ltd. v. Canara Bank & Others is one would fall within the purview of sub section (b) of section 28[18]. Because, by providing for '…unless a suit or action to enforce claim under the guarantee is filed against us within six months from the date of expiry of the guarantee all your rights under the said guarantee shall be forfeited…' the clause seeks to prevent the beneficiary from enforcing his accrued rights by limiting the time for enforcement. But, typical clause like 'This guarantee will remain in force for a period of one year from the date hereof and unless a demand is made on us within six months from the date of expiry of the guarantee all your rights under the said guarantee shall be forfeited and the bank shall be relieved and discharged from all liability thereunder' would pass the test of section 28 if a purposive construction or construction by Mischief Rule is applied. The apprehension of the banks contrary to this position was indeed irrational.

5.3 The prevalent apprehension of the banking sector that the legislature might have discerned from the Reports is about the legality of a clause for timely extinguishment of contingent liabilities and rights in a contract of guarantee. Thus the 'mischief' the legislature was trying to address by Exception 3 is that misapprehension of the banks. So, it was necessary for the legislature to clarify the position of law in this regard. For which it had to first acknowledge the banking practice of stipulating for extinguishment of rights/liabilities; and second provide a period beyond which the liabilities shall be off the books of accounts of the banks. Exception 3 was, thus incorporated—the Reports might have been a compelling reason for the legislature to come up with a clarification to section 28—and the practice of timely extinguishment of rights and liabilities got a statutory recognition. When an exception is attached to a provision in a statute, it is prima facie to be assumed that the legislature thought that the thing excepted would otherwise have been within the enactment[19]. But Crawford in his book 'Statutory Constructions[20]' says sometimes it (exceptions) is also used to explain the general words of the Act and to exclude some grounds of misinterpretation which would extend it to cases not intended to be brought within its operation or purview. In Dattatraya Govind Mahajan v. State of Maharashtra[21] Supreme Court said that the mere description of certain provision is not decisive of its true meaning, and ultimately it is the intention of the legislature is paramount and mere use of a label cannot control or deflect such intention. Exception 3—it is an 'Exception' titled as a 'Saving Clause' and the opening sentence 'this section shall not render illegal …' suggests that it is also an 'Explanation'—is an 'exception-cum-saving-cum-explanation clause'. It is significant to note that the Exception 3 does not state that the guarantees by banks/FIs providing for extinguishment of rights or liabilities so as to restrict the party from enforcing his rights shall not be illegal under section 28. Absence of the expression 'so as to restrict any party from enforcing his rights' in the Exception 3 implies that the rights and liabilities mentioned thereunder, unlike those mentioned in sub section (b) are not accrued rights or liabilities. A provision can be treated as an exception only when it exempts something which would otherwise fall within the purview of the general words of the statute. The rights and liabilities mentioned in section 28 and those in the Exception 3 are not of the same genesis. Therefore, although it is described as an exception, Exception 3 is, to a larger extent, an explanation in its content. It rather answers the misapprehension of the banks by way an explanation that the banking practice of providing for extinguishment of rights/liabilities after a specified period shall not be illegal under section 28.

5.4 The court in deciding the case held that 'Exception 3 to Section 28 of the Contract Act deals with curtailment of the period for the creditor to approach the court/tribunal to enforce his rights. It does not in any manner deal with the claim period within which the beneficiary is entitled to lodge his claim with the bank/guarantor'[22]. It appears that the court has approached the issue by trying to ascertain whether the Specified Period is a period of limitation or a claim period. The correct approach to the problem was to seek whether the Specified Period really deprives the remedial rights of the beneficiary. In the following part of this Article explores the same.

6.What The Specified Event In Exception 3 Of Section 28 of The Act Is?

6.1 What is the Specified Event mentioned in Exception 3? Is it the default or the demand? Ascertainment of this event is important because the Specified Period commences from that event. Let's see sections 126 and 31 of the Act for the answer.

Section 126. "Contract of guarantee", "surety", "principal debtor" and "creditor"A 'contract of guarantee' is a contract to perform the promise, or discharge the liability of a third person in case of his default.

Section 31. "Contingent contract" defined — A "contingent contract is a contract to do or not to do something, if some event, collateral to such contract, does or does not happen.

On a conspectus of Sec.126 of the Act, we can sum up that a contract is said to be a guarantee when it is a promise to perform or discharge a liability of a third person in case of his default. The default of a third person is the key attribute of a contract of guarantee, because without which the contract cannot be called a contract of guarantee. And since it is the key attribute of a contract of guarantee, it cannot go unspecified. Further, the expression '…in case of default…' in section 126 suggests that the happening of the default is only a probability. Therefore, if there is an event in a contract of guarantee (1) which is specified, and (2) happening of the same is uncertain; it is the default of the third person. The simulation of the expression '…occurring or non-occurring of a specified event…' in Exception 3 is deliberate and the allusion is loud and clear that it refers to the default of the third person. Also, going by section 31 of the Act[24], the event, that makes a contract a contingent contract, is collateral to such contract. The meaning of the word 'collateral' as defined in Black's Law Dictionary[25] is 'Supplementary, accompanying, but secondary or subordinate'. Its dictionary meaning[26] is 'parallel or corresponding in position, time or significance'. The default by a third person is an event collateral to the contract of guarantee. Because it is supplementary and corresponding in time and significance to the contract of guarantee. The default has an unmistakable characteristic of an outsideness to the contract of guarantee. On the other hand, the demand does not pass the above tests. The demand is not a quintessential attribute of a contract of guarantee; because a contract of guarantee can still be a guarantee even if there is no requirement of a demand. Also, the demand even if stipulated, is not collateral to the contract of guarantee. It is something inside the guarantee. Any argument that the Specified Event is the demand, is one leading to a mare's nest. The demand being subjective to the volition of the beneficiary, such argument would make him the harbinger of Specified Period with an unfettered freedom to decide when it should commence. That in effect begets the uncertainty as to the discharge of liabilities of the banks which Exception 3 is trying to address. An argument that the Specified Event can be the demand therefore is incompatible with the scheme of Exception 3. Therefore, the Specified Event in Exception 3 is the default and not the demand. The Specified Period commences from the date of the Specified Event. Since the Specified Event is the default, the Specified Period commences from the default.

7.Is The Specified Period In Exception 3 Of Sec. 28 Of The Act A Period Of Limitation?

7.1 Now arises the pertinent question – Is the Specified Period like a period of limitation? As direct evidence lacks, the answer may be found by the reductio ad impossibile method aka proof by contradiction. It tells that if a false statement is reached via a valid logic from an assumed statement, then the assumed statement is false. The court inferred from the Reports that Exception 3 was brought for the Purpose of reducing the period of limitation thereby to achieve an Ulterior Purpose of reducing the period which liabilities of the banks must be kept in books of account. Here, both the Purpose and the Ulterior Purpose are assumptions inferred by the court from the above Reports. Applying the proof by contradiction, if it is proved that the reduction of the period of limitation does not reduce the period which the contingent or undisputed liabilities must be kept in the books of account, would imply that the Purpose has failed to achieve the Ulterior Purpose; and as a corollary the assumption of the Purpose becomes suspicious.

7.2 Though, a cursory reading of the Reports swings the balance in favour of construing the Specific Period as 'period of limitation', a closer look into the matter poses serious doubts to that hypothesis. The findings in the Reports that the banks are forced to keep their liabilities under the bank guarantees from 3 to 30 years (in guarantees favouring governments) in their books of account is specious and fallacious. Under the Indian Accounting Standard (Ind AS) 37 or in the Indian Accounting Standard (Ind AS) 109, which deals with financial instruments like guarantees, banks are not bound to keep such contingent/undisputed financial liabilities in their books of account once they cease to exist. Such cessation happens either (1) on expiry of BG or, (2) by honouring the BG, or (3) on expiry of the claim period (if any given). In cases where the banks have refused to honour the bank guarantee, such liabilities must be kept in the books of accounts till such disputes are resolved in a litigation or the expiry of the period of limitation. A reduction in period of limitation may result in reduction of period during which the liabilities arising from a breach to be kept in the balance sheet. However, as discussed earlier in this Article, the bank's concern was not about accounting their disputed liability i.e., a liability that arise from a breach of bank guarantee. It was about certainty as to the discharge of its contingent/undisputed liabilities either by extinguishment or by performance. Exception 3 addresses this issue of accounting by legally enabling them to fix a minimum period of 1 (one) year from the default beyond which its contingent liabilities can be extinguished.

7.3 Dishonouring of bank guarantees are sporadic; maybe it is attributable to the fact that the circumstances under which the banks may deny payment is limited to grounds like fraud, or irretrievable harm or injustice to the banks[27]. The liabilities of the banks arising from such dishonouring have never been alarmingly high warranting a legislative intervention to save banks from keeping such liabilities for aeon in its books of accounts. Therefore, it is strange to think that the legislature might have intended to save the banks from liabilities arising from its own breach by reducing the period of limitation. To construe Exception 3 in such a way as to bar the beneficiary from initiating legal action in respect of a breach of guarantee by the banks is therefore, beyond the legislative intent. Even without such extended construction, Exception 3 serves the purpose for which it was enacted. In other words, the period of limitation under the general law has no bearing in the accounting of a contingent or undisputed liability arising from a bank guarantee and therefore, reduction of the period of limitation does not help the banks in keeping the contingent or undisputed liabilities for a shorter period. This fact will annihilate the argument that Exception 3 is purported to reduce the period of limitation. The Reports, to that extent, are erroneous and cannot be factored in for inferring the legislative wisdom in enacting Exception 3.

7.4 Was it proper for the Delhi High Court to place reliance on the Reports to arrive at the decision? The courts are generally hesitant in resorting even to debates on Bills and when they do, they do it with extreme caution. In State of Travancore-Cochin v. Bombay Company Ltd[28]., Supreme Court stated that 'Court is not authorised to look into the proceedings of the legislature to see what took place there during the passage of the Bill, which passed into law or why a particular clause was put in for the purpose of interpreting a statute'. The reason for the above rule can be better understood from Gopalan v. State of Madras[29] where the court held 'A speech made in the course of the debate on a Bill could at best be indicative of the subjective intention of the speaker, but it could not reflect the inarticulate mental process lying behind the majority vote which carried the Bill. Nor is it reasonable to assume that the minds of all those legislators were in accord. A reflection of the same rule can be seen in an American case, United States v. Trans-Missouri Freight Association[30], where the court observed that 'Those who do not speak may not have agreed with those who did, and those who spoke might differ from each other'. When the courts have to be careful in resorting even to legislative debates, resorting to an external report, like Law Commission's Report or an expert committee's report, considering those are pivotal or axiomatic in interpreting a statute, the court has committed a mistake of assuming that the same was accepted by the legislature completely. The 97th Report of Law Commission itself is an example of nonacceptance by the legislature of the report in its entirety as substantial differences between the recommended and the enacted section 28 of the Act are conspicuous.

7.5 No one can be sure of whether the legislature has noticed the fallacy of both the Reports. But while interpreting statutes, it must be presumed that the legislature has taken cognizance of the existing circumstances correctly in bringing forth a new law. The legislature must be presumed to know the course of legislation, and the judicial decisions of the country[31]. It would be disrespectful of the legislature to assume that it did not take cognizance of the fallacy in the proposition that reduction of the period of limitation results in the reduction of the period which the contingent/undisputed liabilities must be kept in books of accounts. As can be seen from the judgment, the court was deluded by the said propositions in the Reports in concluding that the Specified Period is a period for the creditor to approach the court/tribunal to enforce his rights.

8.Does the Specified Period extinguish remedial rights of the beneficiaries?

8.1 Let me illustrate a scenario where a demand is made within the Specified Period of one year, but the bank failed to honour the guarantee. And the beneficiary has not filed a suit within the said Specified Period. Will it bar him from filing a suit thereafter by operation of Exception 3? Exception 3 grants liberty to the banks to stipulate for extinguishment of rights or discharge from its liabilities under or in respect of the guarantees on expiry of a specified period. The right and liability under a guarantee can broadly be construed as the right to get the payment and the liability to make the payment. But what are the rights or liabilities in respect of the guarantee referred to in the Exception? Does this expression have a wider connotation to include an accrued right or a right to remedy? In order to take away an accrued right, it must be shown that the legislature has authorised in express terms the taking away of such rights irrespective the possible interference with the existing right[32]. If the application of the provisions of an amending Act makes it impossible to exercise a vested right of suit, the Act should be construed as not being applicable to such cases[33]. A remedial right is a secondary right to have a remedy that arises when a primary right is broken[34]. In case of breach of contract, the party who suffers such breach is entitled to receive compensation for loss and damage, or specific performance of the contract, or both. These are remedial rights under the statutes. As a rule of interpretation, the courts should lean in favour of construction which keeps the remedy alive, that is if two interpretations are possible then one favouring continuance of the suit is to be preferred than the one barring the remedy[35]. A disabling provision of law must be construed strictly[36]. If there is any ambiguity as to the meaning of the section, inasmuch as it is disabling section, the construction, which is in favour of the freedom of the individual, should be given effect to[37]. There is a raft of judgments which is protective of accrued and remedial rights. Such be the case, and also the banks were not concerned about the liabilities arising from a breach of contract, a wider connotation to the expression 'in respect of' to include an accrued right or remedial right is unnecessary and against many judicial precedents.

8.2 Further, section 28 is one of the contours of the freedom of contract. The period of limitation prescribed under the Limitation Act reflects the policy of the state on the remedial rights. 'A pactis privatorum publico juri non derogator'; which means 'private agreements cannot alter the general law' is the underlying policy that the government seeks to achieve through section 28. Subjectivity of contracts to section 28 ensures that the residuum is not deprived of their remedial rights against unscrupulous corporate might. It is hence, unimaginable that the legislature has delegated the power to prescribe the period of limitation to its subjects.

9.Few Thoughts If The Specified Period Is To Be Considered As Period Of Limitation

9.1 The findings of the court that Exception 3 deals with curtailment of the period for the creditor to approach the court/tribunal to enforce his rights[38] implies that Exception 3 would exclude the operation of the provisions of the Limitation Act so far it relates to a guarantee by banks/FIs. Is this an anticipated outcome of Exception 3? The Limitation Act 1963 is, as its preamble reveals, an Act to consolidate and amend the law for the limitation of suits and other proceedings and for purposes connected therewith. If the intention of the legislature was to reduce the period of limitation in relation to contract of guarantees by the banks, why did not it amend the Limitation Act? If the Specified Period is a period of limitation, why doesn't Exception 3 cap it? Can the parties agree for a Specified Period of 10 years to the exclusion of Limitation Act? A striking feature of the law of limitation is that it bars the remedy. Exception 3 apparently does not bar any remedy. If the intention of the legislature was to limit the period for enforcement of rights, why did not the legislature employ language something similar to -- Exception 3 —Saving of a guarantee agreement of a bank or a financial institution.—This section shall not render illegal a contract in writing by which any bank or financial institution stipulate a term in a guarantee or any agreement making a provision for restricting any party thereto absolutely from enforcing his rights under or in respect of any contract, by the usual legal proceedings in the ordinary tribunals on the expiry of a specified period which is not less than one year from the date of occurring or non-occurring of a specified event. These are few thoughts that surface if the Specified Period is to be considered as a period of limitation.

9.2 The court, in Larsen & Toubro Ltd & Anr. v Punjab National Bank & Anr, has not only gleaned from the Reports of the Expert Committee and the Narasimham Committee-II but also kept them at vanguard to conclude that the Specified Period in Exception 3 is a period of limitation. The court has apparently yielded to the Reports of these Committees which erroneously observed that bereft of a clause for extinguishment of rights/liabilities, banks will be forced to keep their liabilities arising from a bank guarantee up to the period of limitation under the Limitation Act.

9.3 Exception 3 enables the banks to limit its contingent liabilities arising from a contract of guarantee to a Specified Period not bellow 1 (one) year commencing from the default and to remove such liabilities from its books of accounts thereafter. It thereby, squarely addresses the long pending concerns of the banks regarding the accounting of such liabilities. An expansive construction of Exception 3 to oust the remedial rights (for damages, specific performance, or both) of beneficiary arising from a breach of guarantee by the banks is beyond the purpose of the enactment. Exception 3 is a solid bed where both the bank's interests and the remedial rights of the beneficiaries can be good bedfellows.

The author is a Chief Manager (Law), State Bank of India, Corporate Client's Group, Mumbai. The views expressed here are personal and not of State Bank of India.

[1] W.P.(C) 7677/2019

[2] See paragraph No 40 of the judgment

[3] Section 28 - Agreements in restraint of legal proceedings, void — Every agreement, by which any party thereto is restricted absolutely from enforcing his rights under or in respect of any contract, by the usual legal proceedings in the ordinary tribunals, or which limits the time within which he may thus enforce his rights, is void to that extent.

[4] Vulcan Insurance Co. Ltd v. Maharaj Singh [1976] 2 SCR 62, Baroda Spg. And Weaving Co Ltd v. Satyanarayana Marine & fire Insurance Co. Ltd AIR 1914 Bom.225, National Insurance Co. Ltd v. Sujir Genesh Nayak & co. AIR 1997 SC 2049.

[5] AIR 1980 Ker.151

[6] Paragraph 28 of the judgment in Larsen & Toubro Ltd & Anr. v Punjab National Bank & Anr

[8] See para 5.1 of the 97th Report of Law Commission of India, March 1984

[9] Section.28. Agreements in restraint of legal proceedings, void — Every agreement,—

(a) by which any party thereto is restricted absolutely from enforcing his rights under or in respect of any contract, by the usual legal proceedings in the ordinary tribunals, or which limits the time within which he may thus enforce his rights; or

(b) which extinguishes the rights of any party thereto, or discharges any party thereto, from any liability, under or in respect of any contract on the expiry of a specified period so as to restrict any party from enforcing his rights,

is void to the extent.]

** [the Exception I and II of the amended section 28 are not incorporated as they are irrelevant for this discussion]

[10] The paragraph No. 8.10 of the Narasimham Committee II Report (extracted from paragraph 35 of the judgment) - "Banks also apprehend that in case of Bank Guarantee to the Government, notwithstanding stipulation in the bank guarantee that it should be in force within a specified period, banks will be forced to treat in their books their liability under the Bank Guarantee to the Government as outstanding till the limitation period of 30 years available to the Government lapses. This will also force banks to continue to hold the securities taken for bank guarantees especially the funds deposited as margins, for long periods, and also severely curtail issue of fresh bank guarantee for their customers. If a bank chooses to continue the issuance of bank guarantees to its customers, it will have to reflect in its books the progressively increasing levels of bank guarantee obligations, thereby inflating the risk weighted assets of the banks without any real increase in the banking assets. This will pre-empt the available capital to meet the capital adequacy requirement and will also overstretch the exposure to the customers beyond acceptable levels"

[11] Expert Committee Report (extracted from paragraph 35 of the judgment) "... Accordingly, a reasonable period has to be provided to the creditor to enforce his rights under the guarantee after the happening of the specified event. The Committee believes that a period of one year would be reasonable for banks and financial institutions."

[12] Ins. by Act 4 of 2013, s. 17. (w.e.f. 18-1-2013).

[13] Sec. 35. When contracts become void which are contingent on happening of specified event within fixed time.—Contingent contracts to do or not to do anything if a specified uncertain event happens within a fixed time become void if, at the expiration of the time fixed, such event has not happened, or if, before the time fixed, such event becomes impossible

[14] Sec. 38. Effect of refusal to accept offer of performance.—Where a promisor has made an offer of performance to the promisee, and the offer has not been accepted, the promisor is not responsible for non-performance, nor does he thereby lose his rights under the contract. [only the main section is reproduced]

[15] Sec. 48. Application for performance on certain day to be at proper time and place.—When a promise is to be performed on a certain day, and the promisor has not undertaken to perform it without application by the promisee, it is the duty of the, promisee to apply for performance at a proper place and within the usual hours of business.

Explanation.—The question "what is a proper time and place" is, in each particular case, a question of fact.

[16] Paragraph 5.3 of the 97th Report of the Law Commission

[17] Paragraph 3.4 of the 97th Report of the Law Commission. Also see non obstante clause dealt with by the Kerala High Court in the said case. Supra 2.2

[18] Para 2.2 supra

[19] Richardson v Austin 12 CLR 463, p 470.

[20] pp 128, 129

[21] AIR 1977 SC 915

[22] See para 40 of the judgment

[23] only the relevant part of sec.126 necessary for the discussion is reproduced.

[24] Sec. 31. "Contingent contract" defined—A "contingent contract is a contract to do or not to do something, if some event, collateral to such contract, does or does not happen.

[25] Tenth edition

[26] The Penguin English Dictionary 3rd Edition.

[27] Uttar Pradesh State Sugar Corpn. Vs. Sumac International Ltd., (1997) 1 SCC 568

[28] A.I.R 1952 S.C 366 at p 368

[29] 1950 S.C.R 88

[30] (1897) 169 U.S 290 at p.317

[31] Shanta Nand V. Basudeva Nand AIR 1930 All 225

[32] Sreeram Durgaprasad v. Dy. Collector of Customs AIR 1965 AP 294

[33] Ajit Singh v. Bhagbati Charan AIR 1922 Cal 491

[34] Black's Law Dictionary 10th Edition

[35] Food Corporation of India Vs. New India Assurance Co. Ltd, 1994(3) S.C.C 324

[36] Lachhaman v. Bansi, I.L.R. 12 Lah. 275

[37] Janathan Edward David v. S.P.A De Silva, A.I.R.1939, P.C 36

[38] Paragraph 40 of the judgment

Tags:    

Similar News