NOTE ON BANK GUARANTEE

Introduction:
A Bank Guarantee is an innovative financial instrument whereby, the bank itself stands as a
guarantor for a particular amount and whereby, if the beneficiary of the bank guarantee perceives
that there has been a breach of contract by the other party, he can liquify the bank guarantee and
avail of the amount immediately, without having to undergo the hassles of litigation.
Bank Guarantees are independent contracts that vest the beneficiary/creditor therein with a right
to make a claim against the bank to pay for the loss suffered due to the default committed by a
borrower.
This arrangement is put into motion when a borrower's default under his contract with the
beneficiary occurs within the Validity Period of the BG. The beneficiary makes a written
demand invoking the Bank Guarantee either within the Validity Period, or in cases where a BG
clause provides for a grace period which is called the Claim Period to make such written
demand, then within such Claim Period. The stipulation of a claim period in a bank guarantee is
not compulsory.
In case, the Bank fails to honor its commitment, a creditor/beneficiary has the right to bring an
action against the Bank before appropriate court of law for the enforcement of right under the
BG within a limitation period from the date of default by the bank. This Limitation period is also
called enforcement period.

Applicability of Law:
Whether the Bank Guarantee be enforced after expiry of validity period (or expiry of claim
period)?
A specific Exception i.e., Exception 3 to Section 28 of the ICA was brought in by way of 2013
Amendment which intends to safeguard Bank Guarantee clauses containing a Limitation Period
different from the one prescribed under the Limitation Act.
Exception 3 to Section 28 of the Act reads as follows:
“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.”
This exception and guidance from circulars issued by Indian Bank’s Association (IBA) which
were based on legal opinions obtained by IBA, has enabled banks and Financial Institutions to
limit the claim period upto one year by incorporation of suitable clause in the BGs. Therefore,
banks started a practice of incorporating a minimum claim period of 12 months in the bank
guarantees.
A view is prevalent that if a bank issues a bank guarantee with a claim period of less than 12
months then it will not have the benefit of the said Exception 3. It would stand exposed to the
period of limitation under the Limitation Act, 1963 which would be 3 years in a case when the
Government is the guarantee beneficiary and 3 years when some other party is the guarantee
beneficiary.
The Delhi High Court in the case of Larsen & Toubro Limited vs. Punjab National Bank
[W.P(C)7677/2019], pronounced an important judgement on July 28, 2021 clarifying the
duration of a claim period in a bank guarantee.
This writ petition was filed by Larsen & Toubro (“L&T”) aggrieved by two communications
made by Punjab National Bank (“PNB”) which mandated a claim period of 12 months for its
bank guarantee and the aforementioned circulars. Reiterating IBA’s view, PNB’s communication
also stated that if the claim period stipulated was less than 12 months, a 3-year period as per the
Limitation Act, 1963 would apply.
The Judgement held that:
1. A view that the law mandates to stipulate a claim period of 12 months in the bank guarantee
failing which it shall be void under Section 28 of the Contract Act, is an erroneous view.
2. The said Exception 3 does not deal with the claim period for lodging a claim with the issuing
bank or under bank guarantee.
3. The said Exception 3 deals with a period within which a beneficiary can approach a
court/tribunal to enforce its rights in case of refusal to pay by the guarantor bank.
Therefore, by way of an exception to the section 28 of ICA which declares every agreement in
restraint to legal proceedings as void, the banks can stipulate a term in guarantee and extinguish
the right of creditors or discharge its liability on expiry of a specified period to be less than one
year.