Dhyan Chinnappa

The Supreme Court in Union of India v. M/s Indusind Bank Ltd., (IndusInd Case) whilst dealing with an issue involving Section 28 of the Contract Act, prior to its amendment in 1997 made certain observations (although obiter) in relation to another amendment brought about to Section 28 in the year 2013 which has caused significant confusion to banks and financial institutions.

In the IndusInd Case, a bank guarantee was issued in favour of the Union of India by various importers of cotton. The bank guarantees provided for an invocation period which was a period of three months beyond the period of validity.

The bank guarantees were invoked after the period of three months had elapsed. Bank refused to make payment as the claim was beyond the claim period fixed in the bank guarantee.  It was however claimed by the Union of India that in view of Section 28 of the Contract Act, the period for making a claim cannot be limited to three months and that the period should be the period of limitation prescribed under the Limitation Act.

The Division Bench of the Bombay High Court held that since the bank guarantee was not invoked within the time prescribed the suits would have to be dismissed.  The Supreme Court agreed with this view.

The Supreme Court whilst dealing with this issue mainly examined the question as to whether the amendments brought about to Section 28 in the year 1997 would apply retrospectively or not.

The amendments to Section 28 brought about a substantive change in the law that even where an agreement extinguishes the rights or discharges the liability of any party to an agreement, so as to restrict such party from enforcing his rights on the expiry of a specified period, such agreement would become void to that extent.

The Supreme Court held that the amendments made in the year 1997 were not declaratory but were substantive changes to the law and therefore applied only prospectively and not retrospectively.

The Supreme Court after analyzing various judgments also determined that limiting the period to make a claim against a guarantee is different from fixing a time period within which a claim can be lodged.  Where a claim is not lodged within the time period prescribed, no claim can be made thereafter.  However, if a claim is made within the time prescribed and no payment is made against the claim, the claimant is entitled to sue within the limitation period.  In view of the fact that no time restriction was envisaged in the clauses providing for invocation, the issue of Section 28 having any application did not arise.

However, in passing, the Supreme Court made an observation with regard to the amendments brought about to Section 28 of the Act with effect from 18.01.2013.

The amendment to Section 28 was by insertion of Exception 3 which permitted banks and financial institutions to limit the period to make a claim up to one year by incorporation of an appropriate clause in the contract.

The effect of this Exception is to limit the period provided under the Limitation Act from three years to one year in the case of banks and financial institutions which issue a guarantee.

However, the Supreme Court whilst dealing with this issue appears to have made a rather wide statement (obiter as it is) which has created significant confusion amongst banks and financial institutions:

“It may only be noticed, in passing, that Parliament has to a large extent redressed any grievance that may arise qua bank guarantees in particular, by adding an exception (iii) by an amendment made to Section 28 in 2012 with effect from 18.1.2013.  Since we are not directly concerned with this amendment, suffice it to say that stipulations like the present would pass muster after 2013 if the specified period is not less than one year from the date of occurring or non-occurring of a specified event for extinguishment or discharge of a party from liability.”

As innocuous as this statement appears, some of the expressions create confusion.  This paragraph uses the expression “stipulations like the present”. The stipulation in the IndusInd case was the extended period of three months for invocation of the bank guarantee after the expiry of the guarantee. This extended period of three months was a contractual understanding between the guarantor and the beneficiary.  Therefore the statement that “stipulations like the present” were wholly irrelevant in the scheme of Section 28 or Exception III to Section 28 of the Contract Act.

The Supreme Court then states that such stipulations would pass muster after 2013 if the specified period is not less than one year from the date of occurring of a specified event for extinguishment or discharge of a party from liability.  This statement adds further to the confusion.

Stipulations in the IndusInd case was for extending the period to make a claim before the Bank and not a claim before a court of law. This statement has resulted in a scenario where Banks have now taken a view that the judgment requires banks to provide for a claim period of one year instead of the period of three months which was provided for in the IndusInd Bank case.

The only issue which is relevant from the point of view of Section 28 is the period of limitation to pursue a claim in Court.  The normal period of limitation under the Limitation Act, 1963 is three years.  The limitation to make a claim in Court can be limited to a period of one year by including a clause in the guarantee.  The time period during which a claim can be made by invoking the bank guarantee is simply a matter of contract and is not governed by any law including Section 28 of the Contract Act.

To summarise:

1. Section 28 of the Contract Act renders void any clause in a contract which may restrict absolutely the right of any party to enforce his rights under or in respect of a contract by the usual legal proceedings or which limits the time to enforce his rights;
2. Section 28 also renders void any clause in a contract which extinguishes the right of any part or discharges any party from liability upon expiry of any specified period.
3. Section 28 does not in any way affect the right of a party to prescribe a time period within which a claim should be made before it and to not be liable if a claim is not made within that time limit. To take an example, a warranty clause in a contract of sale of goods may have certain time limits during which the right to make a claim arises.  If a claim is not made within that time, the right to make a claim for breach of warranty is lost.  If a claim is made and not honoured, then the party is entitled to a period of three years to sue for enforcement of the right.  If this is impermissible, then all warranties provided for goods would be extended for a period as prescribed in the Limitation Act, 1963. 
4. Exception III to Section 28 only acts as an exception and therefore cannot be read over and beyond the scope of Section 28 itself. The right to make a claim before an ordinary tribunal can be limited by virtue of the Exception.  The discharge of the right also occurs after the period of one year if so provided.  This is, of course, subject to the overarching requirement that the claim under the guarantee has been made within the time specified in the guarantee or the right to make the claim has arisen during the period of the guarantee.

Given this obvious confusion that has arisen, it is best to overlook the obiter dictum of the Supreme Court in the IndusInd case and examine the legal position concerning Section 28 de hors the said observations.

The author is a Senior Advocate of the Karnataka High Court.