Should Section 28 of the Indian Contract Act be Amended yet again?

Section 28 of the Indian Contract Act, 1872 is crucial for insurance companies and banks and was the focus of the 97^thLaw Commission’s report, based on which it was amended in 1997, raising a hue and cry from banks and insurance companies. Later in 2012, it was once again amended, possibly with the intention of giving succour to all aggrieved parties, but I seriously doubt if this amendment is the final word on this crucial provision.

English law prior to 1872

Prior to 1872 when the Indian Legislature undertook the codification of the law of contract, English law pertaining to the validity of a covenant to not sue was rather complex and made a distinction between a covenant to not sue at any time and one to not sue for a limited time. A covenant to not sue at any time operated to release the debtor upon the principle of avoiding circuitry of action even if it did not expressly release the debtor. However, a covenant not to sue for a limited time operated only as a covenant, and did not release the debtor. According to the Bombay High Court in The Baroda Spinning and Weaving Co. Ltd. Vs. The Satyanarayan Marine and Fire Insurance Co. Ltd, ‘the genesis of Section 28 is to be found in the Indian Legislature's desire to sweep away the refinements of the then English law and to enact for India a simpler and more suitable rule, that all agreements should be void which either absolutely restrict a contracting party's right to resort to the Courts or merely limit the time within which the rights should be enforced.’

The Original Text

Section 28 of the Indian Contract Act, 1872, as originally enacted, was simple and straight forward. It said:

‘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 the extent.’

It had a couple of exceptions, but they are not pertinent to the issue at hand.

Do note that Section 28, as originally drafted, talks of rights and enforcement of such rights. There is no specific mention of remedies, though enforcement of a right requires a remedy. The distinction between rights and remedies is well established in law. Rights arise from contract or statute and remedies are provided by courts, tribunals, government bodies and other authorities. Section 3 of the Limitation Act, 1963 states that every suit instituted, appeal preferred, and application made after the prescribed period shall be dismissed although limitation has not been set up as a defence. In other words, expiry of the prescribed period of limitation acts as an end to available remedies, though the right would survive.Usually, an acknowledgement of such right by the obligor after expiry of limitation would serve to revive the period of limitation, making it possible to enforce such right.

Judicial Approach to Section 28 Until 1984

Since Section 28, as originally drafted, only mentioned rights and not remedies, the implication was that a contract which required that any suit under such contract be filed within a period which is shorter than the statutory period of limitation would be void whilst a contract which merely extinguished a right prior to the expiry of the period of limitation would not be affected. In 1909, in the case of South British Fire and Marine Insurance Co. vs. Brojo Nath Shaha, the Calcutta High Courtupheld a clause in an insurance contract which provided that no suit should be sustainable unless brought within six months. Though the judgement does not refer to Section 28, this case has been cited in a number of subsequent cases involving Section 28 and seems to have been the first instance when a court in India ruled on a clause which limited the time period for filing a suit.

In 1912, in the case of Hirabhai Narotamdas vs.The Manufacturers Life Insurance Company, the Bombay High Court was faced with a clause in an insurance contract which read as follows: “No suit shall be brought against the Company in connection with the said policy later than one year after the time when the cause of action accrues.” The High Court ruled that the intention of the parties was that if no suit were brought within a year then neither party should be regarded as having any rights as against the other. In other words, the condition contained in the clause meant that there was to be a waiver of the rights of the respective parties if no suit was brought within a year. On this basis, the said clause was upheld as valid.

A year later, in the case of The Baroda Spinning and Weaving Co. Ltd. vs. The Satyanarayan Marine and Fire Insurance Co. Ltd, the Bombay High Court opined that the Hirabhai Narotamdas vs.The Manufacturers Life Insurance Company was probably incorrect and I tend to agree. The clause which was upheld in Hirabhai Narotamdas seems to be clearly violative of Section 28, as it existed then. In the The Baroda Spinning and Weaving Co. Ltd. Vs. The Satyanarayan Marine and Fire Insurance Co. Ltd., the Bombay High Court applied itself to a condition in a fire insurance policy which stated that if the claim be made and rejected and an action or suit be not commenced within three months after such rejection all benefit under this policy shall be forfeited."The High Court ruled that Section 28 forbids any limitation of the time within which one can enforce one’s rights and there is no bar on limiting the time within which one has any rights to enforce. It was further ruled that this approach was consistent with the Indian Limitation Act which does not extinguish rights, but only bars remedies. This was a landmark case which was quoted with approval in a number of subsequent cases.

In 1923, in the case of Girdharilal Honuman Bux vs. Eagle Star and British Dominions Insurance Co. Ltd., the Calcutta High Court upheld an insurance clause which stated that “if the claim be made and rejected and an action or suit be not commenced within three months after such rejection or (in case of arbitration taking place in pursuance of the 18th condition of this policy) within three months after the arbitrator or arbitrators or umpire shall have made their award, all benefit under this policy shall be forfeited.”The decision in the The Baroda Spinning and Weaving Co. Ltd. Vs. The Satyanarayan Marine and Fire Insurance Co. Ltd. was quoted with approval, whilst the one in Hirabhai Narotamdas vs.The Manufacturers Life Insurance Company was dissed.

In 1924, in the case of G. Rainey and AnotherVs.The Burma Fire and Marine Insurance Co, Ltd., the Rangoon High Court upheld an insurance clause which stated that if the claim be made and rejected and an action or suit be not commenced within three months after such rejection, all benefit under the Policy shall be forfeited. A year later, the same case came up before a division bench of the Rangoon High Court and Judges Robinson, C.J. and Maung Ba, J. upheld the impugned clause once again. It was ruled that conditions which clearly and distinctly limit the period within which a suit may be brought are distinctly conditions that are void by reason of the special provisions of section 28 of the Contract Act; but there is undoubtedly a marked distinction between a condition which so limits the time within which a suit may be brought to enforce rights, and one which provides that there shall no longer be any rights to enforce. In response to the argument that such a condition is, in effect, only an ingenious method of defeating the express provisions of the section, the Honorable High Court ruled that a man may contract, that on the happening of a certain event, he shall lose all his rights. In the Judges opinion, the distinction that was drawn by the Bombay High Court in The Baroda Spinning and Weaving Co.Ltd. Vs. The Satyanarayan Marine and Fire Insurance Co. Ltd., though a fine one, is a distinction that could be legitimately drawn.

In Haji ShakoorGany Vs. H.E. Hinde and Co. Ltd, the bill of lading issued by a shipping company provided that the carrier and the ship shall be discharged from all liability in respect of loss or damage unless suit is brought within one year after delivery of the goods or the date when the goods should have been delivered. It was ruled that the effect of the incorporation of the above condition into the bills of lading was that at the end of one year the rights of the plaintiffs to sue defendants No. 1 for short delivery were extinguished and that the plaintiffs having no rights to enforce, there was no question of the remedy having been barred.

In 1974, in The New India Assurance Co. Ltd. Vs. Radhe shyam Motilal Khandelwal and Ors., the Bombay High Court upheld an insurance clause which stated that if the claim be made and rejected and an action or suit be not commenced within three months after such rejection, all benefit under this policy shall be forfeited.

In 1980, in Kerala Electrical and Allied Engineering Co. Limited v. Canara Bank, a bank guarantee provided that a suit or action to enforce the claims under the guarantee was to be filed within six months from the date of expiry of the guarantee. The Kerala High Court held the clause to be valid since the liability of the bank was to remain alive only for a period of six months after expiry of the guarantee and that the rights of the person in whose favour the guarantee was executed was extinguished on expiry of that period.

The 97^th Law Commission’s Report

The Ninety Seventh Law Commission of India asked the most obvious question about Section 28, which was as follows. Even though Section 28 voided any agreement which limited the time within which a party to a contract can enforce his or her rights under such contract, it did not invalidate an agreement which provides that if at the end of a specific period (which may be prior to the prescribed limitation period), the rights under a contract are not enforced, such rights shall cease to exist. In the Law Commission’s own words, ‘the parties to an agreement are not allowed to substitute their own periods of limitation in place of the period laid in the general law of limitation. But the parties to an agreement are allowed to substitute their own periods of prescription, that is to say, they are free to provide that if a party does not sue within a specified period, then the rights accruing under the contract shall be forfeited, or extinguished or that party shall be discharged from all liability under the contract.’

For example, a guarantee contract which stated that any suit relating to a claim under such guarantee contract must be filed within 3 months of the claim arising would be void, but if a guarantee contract stated that the right to sue in respect of a claim under such guarantee contract would be extinguished if a suit is not filed within 3 months of such claim arising, it would be valid.

By providing for the extinction of the right, the parties are actually creating a law of prescription of their own, which is a far more important mater than merely creating a law of limitation of their own.  Why should the parties to a contract be allowed to invent their own rules of prescription when they are not allowed to invent something lesser – their own rules of limitation, the Law Commission wondered? If prompt settlement of claims under insurance policies is the justification for permitting the extinguishment of rights under the contract, why is it that clauses which limit the time for filing a suit are treated as objectionable?

The Law Commission noted that in England and the USA a clause imposing limitation of the period within which an action can be brought is valid.  Such a position is logical since both time limit clauses which bar the remedy and clauses which extinguish substantive rights are permitted. However, the Law Commission felt that it is unfair to have a situation where the former are barred, but the latter aren’t.

Accordingly, the Law Commission recommended that any contract which extinguished the rights of any party thereto, or discharged any contracting party from any liability, under or in respect of such contract on the expiry of a specified period,or on failure to make a claim, so as to restrict any party from enforcing his rights, should be void.The Law Commission’s views were clearly the result of the various cases in the preceding yearsand raised an important point of law as well as of policy. The Law Commission analysed the issues involved in a very theoretical manner and made its recommendations ignoring the practical issues involved.

Judicial Approach to Section 28 From 1984 Till 1997

Even after the 97^th Law Commission’s report was released, there was no substantial change in the judicial approach to Section 28. In 1994, in The Food Corporation of India vs.The New India Assurance Co. Ltd. and others, the Supreme Court reviewed a Fidelity Insurance Guarantee which stated that the Food Corporation of Indiashall have no rights under the Fidelity Insurance Guarantee after the expiry of six months from the date of termination of the contract. Noting that Section 28 is a departure from English law which has no statutory bar restraining parties from entering into an agreement limiting the period for filing a suit, the court went on to rule that the aforementioned clause is not contrary to Section 28 of the Contract Act nor does it impose any restriction on filing a suit after six months from the date of determination of the contract. According to the Supreme Court, the appellant would not have any right under the bond after the expiry of six months from the date of the termination of the contract, unless within such period, the appellant asserted its right and apprised the company of its claim. Therefore, the requirement to make a claim within 6 months served as a condition precedent for filing the suit. The Supreme Court made a distinction between assertion of a right and enforcement of such right in a court of law. According to the Supreme Court, the agreement does not anywhere deal with enforcement of right in a court of law. It only deals with assertion of right. Since the Corporation had issued a notice prior to the expiry of six months from the termination of contract, it was held that the the suit filed by the appellant was within time, even though it was filed after six months.

In my opinion, this judgement substantially deviates from previous case law. In a way, it meanders over to a logical position, an action which is within the domain of the legislature and one which is the exact opposite of the Law Commission’s recommendation.

In 1997, in National Insurance Co. Limited v. Sujir Ganesh Nayak and Co. and Another, the Supreme Court examined an insurance clause which stated that ‘in no case whatever shall the company be liable for any loss or damage after the expiration of 12 months from the happening of loss or the damage, unless the claim is the subject of pending action or arbitration.  The Supreme Court ruled that the said clause has the effect of extinguishing the right itself and consequently the liability also and upheld it as non-violative of Section 28 of the Contract Act, 1872.

The 1997 Amendment of Section 28

The Indian Contract (Amendment) Act, 1996, which received the President’s assent on 8 January 1997, introduced the following clause into Section 28.

Every Agreement 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.

As could have been expected, the abovementioned amendment caused a hue and cry from banks and insurance companies. It was felt that henceforth guarantors and insurers would not be able to extinguish rights under guarantees and insurance contracts prior to the expiry of the period of limitation. The Limitation Act, 1963 prescribes a period of three years for filing a suit in relation to a claim under a guarantee or an insurance policy. If the beneficiary of the guarantee happens to the government, the period of limitation is thirty years. Once a guarantee or an insurance policy expires, the issuer of such guarantee or an insurance policy would be required to maintain the contingent liability on its books until the period of limitation is over, unless contractually permitted to extinguish the rights arising out of such guarantee or insurance policy, within a reasonable time. Since Bank charge their clients for guarantees issued at their behest till the date of expiry, banks would have to charge guarantee commissions till the date of expiry of the period of limitation.

The 1997 amendment was in line with the recommendations of the 97^th Law Commission released in 1984, save for the omission of the words “failure to make a claim”.  What was the rationale behind omission of the Law Commission’s recommendation that extinguishment of rights on failure to make a claim should also make a contract void? Did it mean that bank guarantees and insurance contracts could validly provide that unless a claim was made in writing within a certain period of the claim arising, such claim would not give rise to an enforceable right? Either argument is possible. It can be said that extinguishment of rights on failure to make a claim is different from extinguishment of rights on expiry of a specific period. It can also be argued that extinguishment of rights on failure to make a claim within a specific period is within the ambit of the 1997 amendment.

The IBA’s Notwithstanding Clause – Playing With Words

In response to the 1997 amendment, the Indian Banks Association came up with a clause, popularly called the IBA’s standard Notwithstanding Clause, which was to be inserted in all bank guarantees in order to get around the nuisance caused by the 1997 amendment. The IBA’s standard Notwithstanding Clause read as follows:

Notwithstanding anything contained herein our liability under this Bank guarantee shall not exceed Rupees .................../- (Rupees ....................................... Only) This Bank guarantee shall be valid upto ............................ and we are liable to pay the guaranteed amount or any part thereof under this Bank Guarantee only and only if you serve upon us a written claim or demand on or before .............................

Please note that the above clause neither extinguishes rights nor prescribes a period within which any suit has to be filed. Rather, it takes a cue from the Supreme Court decision in The Food Corporation of India vs.The New India Assurance Co. Ltd. and others and indirectly provides that a right to make a claim on the bank would arise only if the claim is served within a certain period.

Banks started to use the above mentioned clause and took the position that unless a claim was received within the prescribed period, the bank had no further liability under the guarantee. By a simple play of words, the impact of the amendment was neatly deflected.

Introduction Of The Third Exception

In 2012, the Banking Laws (Amendment) Act, 2012 introduced a third exception to Section 28, which stated as follows:

Exception 3.--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.

Even after introduction of the Third Exception, Banks continue to use the IBA’s standard Notwithstanding Clause since even the provision of one year for making a claim is usually commercially unacceptable. In my opinion, the rationale behind the IBA’s standard Notwithstanding Clause is legally sound since it makes a distinction between creation of an enforceable right and the extinguishment of such right. Usage of this standard Notwithstanding Clause even after the introduction of the Third Exception would, in my opinion, entitle a guarantor to claim that no right subsists after expiry of the prescribed claim period, if no claim is made within such period.

In some cases, bank guarantees provide that any claim has to be made on or before the date of expiry of the guarantee. In effect, this means that if a claim arises on the last day of the guarantee, the claim has to be made the same day. I doubt if any court would uphold such an unreasonable clause.

Need For Further Amendment

In my opinion, guarantors and insurers should be able to prescribe a reasonable period within which any claim under the contract has to be notified to the guarantor or insurer. One needs to distinguish such a clause from a provision which states that any suit must be filed within a period which is less than the statutory minimum. Even though it is, in my view, currently possible for parties to a contract to prescribe a claim period using language akin to the IBA’s standard Notwithstanding Clause, it would be desirable for Section 28 to be further amended to make this point clear.

I also fail to see the rationale behind making available the benefit of the Third Exception only to banks and financial institutions. Why shouldn’t a corporate or a private individual offering an indemnity or a guarantee be entitled to the benefit of the Third Exception?

I also think that it is high time we asked ourselves if it is proper to prevent parties to a contract from agreeing on a period of limitation which is shorter than the statutory minimum. In most developed Common Law countries, contracting parties have the freedom to mutually decide on a period within which any suit under such contract must be filed. Isn’t it high time India followed suit, especially keeping in mind the exceptionally long period allowed to the government under the Limitation Act, 1963 to enforce its rights?  The 97^th Law Commission had argued that if it is against public policy to permit the contractual reduction of the statutory period of limitation for filing a suit, the extinguishment of rights before the expiry of the remedy should also be void. Ideally, the Law Commission should have taken the view that since it was permitted to extinguish rights before expiry of the relevant period of limitation, contracting parties should also be given the freedom to prescribe an appropriate period for expiry of the remedy.

In my view, Section 28 of the Contract Act, 1872 should be deleted as a whole. Further, the Limitation Act, 1963 should be amended to specifically provide that parties to a contract have the freedom to agree on a period of limitation that is different from the one prescribed by statute. Do remember that where a standard form contract prescribes an unreasonably short period for filing any suit, such a contract could be classified as a contract induced by `undue influence' under Section 16 of the Contract Act, 1872 and would be voidable at the instance of the customer as per Section 19A of the Contract Act, 1872. Section 16 states that a contract is induced by `undue influence' where the relations subsisting between the parties are such that one of the parties is in a position to dominate the will of the other and uses that position to obtain an unfair advantage over the other.  Section 19A of the Contract Act, 1872 says that ‘when consent to an agreement is caused by undue influence, the agreement is a contract voidable at the option of the party whose consent was so caused.’

Vinod Joseph holds a B.A. LL.B (Hons) from the National Law School of India University, Bangalore, and an LL.M from the London School of Economics. Currently he is Head Legal at Brand Capital, a business division of Bennett Coleman & Co. Ltd. The views expressed above are his personal views and may not be attributed to his employer or anyone else.