The time limit for raising any dispute or claim by the beneficiary in case of guarantee contracts is generally 3 years from breach of contract. Section 28 of Contract Act prohibits the parties to an agreement to substitute their own periods of limitation in place of the periods laid in the Act. However, the third exception to Banking Laws (Amendment) Act 2012 brings following exception to the statute book:

“This section shall not render illegal if a contract in writing by which any bank or financial institutions 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”.

The above-mentioned exception to the banking law provisions enables banks and financial institutions to limit the validity period of the guarantee. The beneficiary of the guarantee shall invoke the guarantee as per clause of the bank guarantee in order to honour his/her claim.

Indian Banks’ Association (IBA) format of limitation clause:

All commercial banks apply following limitation clause standardised by IBA as a concluding Para of the guarantee. This is to avoid ambiguity if any in the body of the guarantee agreement in respect of bank’s liability under the guarantee and its validity period.

“Notwithstanding anything contained herein: (i) Our liability under this guarantee shall not exceed Rs…….(Amount) (ii) This bank guarantee shall be valid up to…….(date of expiry of the guarantee)  (iii) We are liable to pay the guarantee amount or any part thereof under the bank guarantee only and only if you serve upon us a written claim or demand on or before………………………………….(date of expiry of guarantee or date of expiry of claim period if any claim period is provided in the guarantee agreement to invoke the guarantee after date of expiry of guarantee)”.

The above standard exposure and time-limit clause of IBA neither extinguishes rights nor prescribes a period within which any suit has to be filed. However, it clearly makes a distinction between the creation of an enforceable right and the extinguishment of such right, satisfying provisions of section 28 of Contract Act, as well as the third exception to Banking Laws (Amendment) Act 2012.

Invocation of Guarantee:

A bank is obliged to honour any legitimate claim within the validity period/claim period of the guarantee. If the invocation is in order and there is no court order prohibiting the payment, the bank is required to honour payment to the beneficiary. Before making the payment to the beneficiary, normally concerned bank informs the applicant about the invocation of the guarantee and ask him to arrange for funds for payment of claim amount.

Cancellation of a Guarantee:

The beneficiary of the guarantee shall invoke the BG on or before the expiry date of the guarantee. The bank is discharged from its liability if no claim is received by it on or before validity period mentioned in the guarantee. When an original Guarantee issued by the bank, not returned to the bank for cancellation after the expiry of guarantee, the procedure for cancellation of expired guarantee adopted by the banks is that a registered notice is sent to the beneficiary of the guarantee to return the original guarantee immediately. If no reply is received or original guarantee is not surrendered for cancellation, the guarantee can be cancelled by the bank after waiting for a reasonable time.

CONCLUSION:

The banks are expected to credit the bank guarantee amount to the beneficiary’s account without any demur. In case of any deviation, the beneficiary can take the bank to court for enforcing the terms of the guarantee. The beneficiary can also invoke the jurisdiction of the RBI to make the bank fall in line.