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Forcing minimum claim period of 1 year on bank guarantees wrong, says Delhi HC

In a ruling that will help infrastructure and construction companies, the Delhi High Court said forcing a minimum claim period of 12 months for bank guarantees is wrongful, rejecting interpretations that existing laws rendered shorter claim periods void.

Ruling on a petition filed by engineering conglomerate Larsen & Toubro Ltd against

, a single-judge bench of the High Court observed, “It is clear that respondent No 1 (PNB) is erroneously of the view that they are in law mandated to stipulate a claim period of 12 months in the bank guarantee, failing which the clause shall be void under Section 28 of the Contract Act.”

The court directed the lender to take a relook at such agreements.

“It (Section 28) deals with the right of the creditor to enforce his rights under the bank guarantee, in case of refusal by the guarantor to pay, before an appropriate court or tribunal,” Justice Jayant Nath observed in a 43-page order issued on Wednesday. It does not deal with the claim period – a time within which the beneficiary is entitled to claim the guarantee.

Experts said the ruling will particularly benefit infrastructure and construction companies that need to issue bank guarantees while fulfilling contracts for government bodies and public sector undertakings.

“This decision will have far-reaching consequences because it will give both banks and companies the much-needed flexibility in entering into contracts related to bank guarantees,” said Ashish K Singh, managing partner of law firm Capstone Legal.

Anil Goel, founder and chairman of insolvency professional company AAA Insolvency Professionals, said, “Construction companies bidding for projects should have the flexibility to bank guarantee from banks. Multiple options to get it should help them bid for more projects and save costs substantially.”

L&T, in its petition, argued that PNB’s insistence on a bank guarantee (BG) for 12 months, due to misinterpretation of Section 28, has unnecessarily made the company liable to pay commission charges for such extended BG when the principal contract would be for a much shorter period.

Also, companies have to maintain collateral security – or margin money against which a bank guarantee is issued – for supporting an extended claim period, which affects their capability to do business by entering new contracts, L&T said.

Hemant Kumar, group general counsel of L&T, confirmed the passing of an order by the Delhi High Court but refused to divulge any details.

An email query to PNB remained unanswered as of press time Friday.

L&T had made the Indian Banks’ Association (IBA) and the Reserve Bank of India (RBI) parties in the case.

As per the court order, PNB’s stand is due to letters issued by IBA on December 12, 2018, to its member banks, stating that if a bank issues a claim period of less than one year on top of the guarantee period then such a bank guarantee would not have the benefit of Exception 3 to Section 28 of the Contract Act.

Exception 3, inserted as an amendment to the Act in 2013, allowed lenders to limit the period to make a claim up to one year, down from the minimum of three years provided under the Limitation Act.

BGs are provided on a case to case basis depending on banks and individual clients. The margin money varies, but normally it is about 10-20% of the bank guarantee amount, industry insiders said.

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