BACKGROUND

The (Indian) Parliament has recently caused an amendment to Section 28 of the Indian Contract Act, 1872 (Contract Act) which hitherto struck down provisions of a contract eliminating right to enforce after a stipulated period. The amendment brings the following exception to the statute book:

“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 new provision, as many would point out, now enables a bank or financial institution to limit the time within which a guarantee must be invoked by a beneficiary, in order for it to be honoured. Given that time limitation clauses are not unique to bank guarantees; this new exception raises a concern as to the enforceability of limitation provisions found in other contracts.

ANALYSIS

The genesis of the current amendment has its origin in almost a decade old concern from banks about open ended guarantees and to carry such guarantee commitments for long periods as outstanding obligations. Such concerns apparently arose following an amendment to Section 28 in 1997 which introduced the below provision:

“[Every Agreement], which extinguishes the rights of any party thereto under, 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 that extent”

Although the 1997 amendment was clearly concerned with ‘enforcement of a right’ and not with ‘exercise of a right’, the provision was interpreted to restrict contractual freedom of stipulating the manner of exercise of rights under a contract and making of raising claims thereunder. Admittedly, the 1997 amendments were inspired by the 97th Report of the Law Commission of India (India’s apex legislation review panel) which not only clamped down on contracts squeezing time periods for moving a court for their enforcement but also expressly sought to strike down contracts which provided time bound conditions precedent for exercise of rights. The Law Commission writing the 97th report argued that parties to a contract should not be allowed to prescribe a method which extinguishes the rights of a party to make a claim under the contract and while doing so, the Law Commission was conscious that their recommendation would run contrary to the basic rule that parties to a contract should be free to decide exercise of their substantive rights. Yet, the Law Commission found it necessary to interfere with the freedom of contract on the ground that unequal bargaining power of contracting parties could bring about unfair prescription on extinction of rights.

The law makers responding to the 97th Report after a long gap of 13 years after its publication (the 97th report was written in 1984) appeared less enthusiastic. The 1997 amendment was brought in at a time when India had embraced globalization and while bringing in the amendment, the lawmakers chose to leave out parts of the amendment originally suggested by the Law Commission: Illustratively, the words in bold in the following clause suggested by the Law Commission were not made part of the 1997 amendment:

“[Every contract]… which extinguishes the right of any party thereto under or in respect of any contract on the expiry of a specified period or on failure to make a claim or to institute a legal proceeding within a specified period…[is void to that extent]”

Clearly, the law makers in 1997 did not wish to strike down contracts which provided extinguishment of right upon failure to raise a claim in accordance with the contract. It also sought to only regulate those contracts where the right of enforcement (or in other words, right to move a court of law) was extinguished after a specified period – a narrower position than what the law commission sought to adopt.

Did Section 28 as it stood before the recent amendment restrict a bank’s ability to stipulate a disclaimer clause in a bank guarantee that ousted its liability unless a notice of claim was received by a particular date? The answer should be in negative as the 1997 amendment did not deal with extinguishment of a right for failure to make a claim to the counterparty of a contract within a prescribed date. Assuming a bank rejected such a claim, theoretically, the beneficiary could still move a court for enforcement of his rights. A court facing such an aggrieved beneficiary could, of course, offer no relief for he failed to follow a condition for making the claim under the guarantee. It, however, seems that the legislature thought differently about the fate of such an action and therefore the recent amendment was introduced.  It remains to be seen whether as a result of the amendment, banks now write tighter disclaimers expressly restricting a beneficiary from approaching a court for it may be possible to even restrict the right to enforce unless an action is brought by a particular outer date.

CONCLUSION

In a way, this move to provide additional comfort for banks could be problematic from other perspectives. For starters, the exception does not only apply to a guarantee but applies to any contract of a bank making a provision for guarantee. Perhaps unintended but a consequence of the new amendment is that a bank may now be able to disclaim liability with respect to an entire agreement so long as such an agreement envisage a guarantee (regardless of the guarantor). Apart from obvious constitutional concerns arising with such an approach, the amendment raises doubts about enforceability of limitation provisions found in other contracts. Illustratively, limitation of warranty claims is an important feature of a share purchase contract. Similarly, in many construction contracts, limitation clauses are built requiring the owner of a project to bring a claim within stipulated time. The move to amend Section 28 would indicate that so far as the law makers are concerned, such limitation provisions are to fall because they do not enjoy protection of the recent amendment.