What is the time limit for enforcement of a bank guarantee?

(The law of limitation applicable to a general guarantee and the guarantee issued by banks and financial institutions are different. This article explains the law of limitation explicitly applicable to bank guarantees, invocation and cancellation of bank guarantees)

The law of limitation of time means the time-limit for different suits within which an aggrieved person can approach the court to obtain a decree against the principal debtor and surety. The different time limit or period of limitation is prescribed in the Schedule to the Limitation Act, 1963, for different types of suits, appeals or applications. The suit filed, appeal preferred and application made after the expiry of time-limit is struck by the law of limitation and same will not be admitted by the court as evidence for breach of contract.

Time-limit for enforcement of bank guarantees:

The time limit for raising any dispute or claim by the beneficiary in case of guarantee contracts is generally 3 years from the breach of contract. The 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.

IBA format of limitation clause:

All commercial banks apply the 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 banks 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.

Related articles:

(i)What is the time limit for bank guarantees issued in favour of Government Departments?

(ii) Major types of bank guarantees

(iii) Circumstances that may discharge Guarantor from all liabilities

(iv) How to compute limitation period for personal guarantees

Disclaimer:

This article should not be construed as a professional advice under any circumstance. It is clarified to the readers that the contents provided in this write-up are intended for general information only and cannot be relied upon for real-time professional facts. Readers are advised to refer relevant provisions of law and also to take qualified professional’s advice before applying or accepting any of the points mentioned above. The author or the website accepts no responsibility whatsoever caused by the use of any information provided in this article and shall not be liable for any losses, claims or damages which may arise because of the contents of this post.