A guide to bank guarantees

The provision of a bank guarantee is often a contractual requirement and, therefore, part of the negotiation process between you and your customer. The terms of these guarantees must be acceptable to all parties, mainly to the bank you ask to be your guarantor. Prior to agreeing to a particular guarantee, you must check with your bank that the form of words to be used does not contain unclear or unacceptable conditions which would make the guarantee unworkable or expose you to undue risk.
Why is a guarantee required?
The beneficiary wishes to be secured against the risk of the issuer not fulfilling contractual or other obligations in respect of the underline transaction, contract or order.
Guarantee criteria
The most important criteria are the amount payable, the expiry date and the terms of payment.
Where the guarantee is to cover payment of interest in addition to the principal amount, the interest rate and the period covered must be clearly defined.
The expiry date may be a fixed date or a specified event such as delivery of goods.
Where payment is to be made under specified documents, details of the documents must be defined in the guarantee.
Bank facilities
The issuance of a bank guarantee is subject to prior agreement of a banking facility covering the amount and the period of the guarantee. The approvals of such facilities by the bank often depend on providing of security.
The role of the bank
The bank is obliged to pay according to the terms and conditions set out in its guarantee which is a legal undertaking completely independent of the contract between the issuer and the beneficiary. No other investigation is required.
Types of guarantee
  1. Bid Bonds or Tender Guarantees
  2. Performance Guarantees (this replaces the tender guarantee if the tender is accepted)
  3. Advance Payment Guarantee
  4. Retention Monies Guarantee
  5. Facility Guarantee (to support banking facilities with a local bank when engaged in an overseas contract)
Unconditional and conditional guarantees
Unconditional guarantees can usually be called at the sole discretion of the beneficiary. Whilst all bank guarantees are payable on demand, some are conditional upon the presentation of documents to substantiate the demand by the beneficiary. Asking for documentary evidence provides a reasonable measure of protection to the issuer.
A bank guarantee, as with any commitment provided by a bank, requires the allocation of part of the bank’s capital, often for a long period of time. A commission charge in respect of the utilization of that capital is payable (usually quarterly in advance) over the life of the guarantee.
Extend or pay
Where guarantees are issued by a correspondent bank overseas, especially where local law is applied, it is not uncommon to receive ‘extend or pay’ requests on or before the expiry date of the guarantee. This is a mechanism for ensuring that the issuer agrees to a request from the beneficiary to extend the expiry date of the guarantee. However, such demands must conform to the terms and conditions of the guarantee before they can be met.
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