INTRODUCTION A contract of guarantee is defined as ‘a contract to perform the liability of a third person in case of default’. The parties to the contract of guarantee are: a. Applicant : The principal debtor : The person at whose request the guarantee is executed. b. Beneficiary : The person to whom the guarantee is given and who can enforce it in case of default. c. Guarantor : The person who undertakes to discharge the obligations of the applicant in case of his default. Thus, a contract of guarantee is a collateral contract, consequential to a main contract between the applicant and the beneficiary.
PURPOSE OF Bank Guarantee (BG) BGs may generally be issued for the following purposes: a. In lieu of Security Deposits / Earnest Money Deposits for participating in tenders. b. Mobilisation advance or advance money before commencement of the project by the contractor and for money to be received in various stages like plant layout, design / drawings in project finance. c. In respect of raw material supplies or for advances by the buyers. d. In respect of due performance of specific contracts by the borrowers and for obtaining full payment of the bills.
PURPOSE OF BGe. Performance guarantee for warranty period on completion of contract which would enable the supplier to realise the proceeds without waiting for the warranty period to be over.f. To allow the units to draw funds from time to time from the concerned indentors against past execution of contracts, etc.g. Bid bonds on behalf of exporters.h. Export performance guarantees on behalf of exporters favouring the Customs Department under EPCG Scheme.
GUIDELINES ON CONDUCT OF BG BUSINESS Banks should, as a general rule, limit themselves to the provision of Financial Guarantees and exercise due caution with regard to Performance Guarantee business. The subtle difference between the two types of guarantees is that under a Financial Guarantee, a bank guarantees the customer’s (applicant’s) financial worth, creditworthiness and his capacity to take up financial risks. In a Performance Guarantee, the bank’s guarantee obligations relate to the performance related obligations of the applicant (customer).
GUIDELINES ON CONDUCT OF BG BUSINESS While issuing Financial Guarantees, Banks should satisfy themselves that customers would be in a position to reimburse the Bank in case the Bank is required to make the payment under the guarantee. In case of Performance Guarantee, Banks should exercise due caution and have sufficient experience with the customer to satisfy themselves that the customer has the necessary experience, capacity, expertise and means to perform the obligations under the contract and no default is likely to occur.
GUIDELINES ON CONDUCT OF BG BUSINESS Banks should not normally issue guarantees valid for more than 18 months. For BGs of more than 18 months, prior approval is required No Bank Guarantee should normally have a maturity of more than 10 years. BG beyond maturity of 10 years may be considered against 100% cash margin with prior approval
GUIDELINES ON CONDUCT OF BG BUSINESS Banks should normally refrain from issuing guarantees on behalf of customers who enjoy other credit facilities not with them but with other banks. Unsecured guarantees, where furnished by exception, should individually be for a short period and for relatively small amounts. All DPGs should ordinarily be secured.
APPRAISAL OF BG LIMIT Banks should appraise the proposals for guarantees with the same diligence as in the case of Fund Based Limits. They may also obtain adequate cover by way of margin and security so as to prevent default on payments when guarantees are invoked. Whenever an application for the issue of BG (or sanction of a regular BG Limit as part of WC Limits) is received, Banks should examine and satisfy themselves thoroughly about the following aspects:
APPRAISAL OF BG LIMITa. The need for the BG and whether it is related to the applicant’s normal trade / business.b. Whether the requirement is one-time or on a regular basis.c. The nature of BG, i.e., Financial or Performance.d. Applicant’s financial strength / capacity (through an analysis of his financial statements, Cash & Funds Flow position and opinion reports) to meet the liability / obligation under the BG in case of invocation.e. Past record of the applicant in respect of BGs issued earlier, e.g., instances of invocation of BGs, the reasons thereof, the customers’ response to the invocation, etc.f. Present outstanding on account of BGs already issued.g. Marginh. Collateral security offered.
MARGINS Following are some of the factors to be kept in view by the Banks while determining the margins required: a. Cash margins provide a cushion against invocation. Margin money may be in the form of Fixed Deposit. b. The margin to be stipulated would depend on the borrower’s means, resources, creditworthiness, security available, past experience with regard to issue of BGs, nature of guarantee and the nature of underlying transactions. If existing borrower, margin on BG may generally be the same as on Stocks, Receivables, etc.
MARGINSc. In case of Advance Payment Guarantees, lower margins may initially be stipulated. Once the advance is actually received, depending on the amount not likely to be immediately utilised, higher margins may be built up by impounding of cash advances.d. In respect of non-borrower applicants, Bank’s approach should normally be to obtain full margins. However, a credit risk can be taken on the applicants based on the financial indicators, credit worthiness, security available, etc.e. 100% margin should ordinarily be retained in respect of guarantees issued in connection with disputed Customs / Central Excise duties, unless otherwise specified in the sanction.
SECURITY Apart from the margin, BGs are usually secured by an extension of the charge on Current Assets obtained to cover WC facilities. Adequate collateral security by way of Equitable Mortgage or third party guarantee should be taken depending on the merits of each case.
DOCUMENTS Whenever a guarantee is issued and / or guarantee bond is countersigned by the Bank on behalf of a constituent, suitable Counter Guarantee should be obtained from the constituent.
FORMAT OF BANK GUARANTEES BGs should normally be issued on the format standardised by Indian Banks Association (IBA). When it is required to be issued on a format different from the IBA format, as may be demanded by some of the beneficiary Government Departments, it should be ensured that the BG is: a. For a definite period. b. For a definite objective enforceable on the happening of a definite event. c. For a specific amount. d. In respect of bona fide trade / commercial transactions.
FORMAT OF BANK GUARANTEES f. Not stipulating any onerous clause. g. Not containing any clause for automatic renewal of the BG on its expiry. BGs should be issued with a pre-printed and numbered standard first page of the guarantee form, which contains the limitation clause. The pre-printed form is to be used for all BGs. However, in case of a guarantee favouring a Govt. Dept. objects to the use of the pre-printed form, Banks may issue the guarantee on non- judicial stamp paper.
FORMAT OF BANK GUARANTEES The text of the guarantee will appear on the pages succeeding the printed first page. It should be ensured that while filling up the first page of the BG, no separate claim period is provided. The validity period of the guarantee will be stated inclusive of the claim period. Further, each page of the text of the guarantee enclosed with the pre-printed form should also mention pre-printed serial number, BG number, date of issue and amount, etc.
FORMAT OF BANK GUARANTEES In all the guarantees issued by the Bank, the limitation clause suggested by IBA should invariably be incorporated at the end of the text as concluding paragraph of the BG. “Notwithstanding anything contained herein: a. Our liability under this BG shall not exceed Rs. ……… (Rupees ………………………… only); b. This BG shall be valid upto…………..; and c. We are liable to pay the guaranteed amount or any part thereof under this BG only and if only if you serve upon us a written claim or demand on or before ……………. (date of expiry of guarantee).”
FORMAT OF BANK GUARANTEES In case of BGs issued favouring Govt. Depts., the above clause should be incorporated in the Model Bank Guarantee (MBG) form, prescribed for BGs in favour of Govt. Depts. If period of claim is required to be stated separately, it has to be kept at the minimum. It should generally not exceed 3 months. The BG may be issued on a stamp paper on which the name of the customer appears as the purchaser thereof.
AMENDMENT OF BANK GUARANTEE There is no provision for amendment of Bank Guarantees unlike in the case of Letters of Credit. Instead, fresh guarantees need to be issued, cancelling the earlier ones.
INVOCATION OF BANK GUARANTEE The beneficiary of the BG can invoke in writing, the guarantee any time before the expiry of the guarantee period. Invocation can be done by Telex / Telegram / Hand Delivery also followed by Mail Confirmation. Banks should ensure that all valid claims received by them under BGs issued by them are settled promptly. In the case of any dispute, such honouring, on invocation, will be done under protest and the matters of dispute should be pursued separately.
INVOCATION OF BANK GUARANTEE The Bank’s liability under BG is absolute and independent and exclusive of any other contract entered into by the applicant and beneficiary. It is, therefore, obligatory on the part of the Bank to pay to the beneficiary without delay and demur the amount of BG on its invocation in accordance with the terms and conditions of the guarantee deeds. It is not necessary for the beneficiary to satisfy the Bank about the default or the amount of actual loss suffered by him.
INVOCATION OF BANK GUARANTEE Delay in honouring the claim immediately may unnecessarily put the Bank in problems pertaining to claim of interest, damages and at times injunction orders from Court.
INVOCATION OF BANK GUARANTEE Only when the Bank has received an order of restraint / injunction from a competent / appropriate Court, the Bank can withhold payment under the BG. The liability of the Bank under the BG will continue till the Court case is decided.