What is Bank Guarantee?A Contract of Guarantee is a contract to perform the promise or discharge of liability of a third person in case of his default. The person who gives the Guarantee is called the ‘surety’, the person in respect of whose default the guarantee is given is called the ‘principal debtor’ and the person to whom the guarantee is given is called the ‘creditor’. The contract of guarantee may be either written or oral”.
Purposes: Contracts of Guarantee are usually entered into (a) to secure the performances of something (b) to secure the honesty & fidelity of someone or (c) to secure someone from injury arising out of some wrong committed by another.
- What are the types of Guarantee?
Guarantee mainly two types: These are (i) Specific guarantee and (ii) Continuing guarantee.
(i) Specific guarantee: Specific guarantee means a guarantee for one specific transaction. In this type the liability of the surety or guarantee extends only to a single transaction. Specific guarantee is used for Bid bond, Performance and shipping guarantee.
Tender or Bid Guarantee:
Government Organizations and Institutions, Corporations, Companies etc. generally invite tenders for completion of their projects, such as road building, construction of bridges, building construction, use of facilities, performance of any service.
Parties bidding for the tender must submit with their bids a guarantee to the beneficiary or issuer of the tender (Government organizations and institutions, Corporations, Companies etc.). This type of Guarantee is known as a “Tender or Bid Guarantee”. It is, generally, sought for 5 per cent to 10 per cent of the contract amount.
After the declaration of the successful bidder(s), the original guarantee, of parties whose bids have not been successful, are returned to the Bank for cancellation. Only the Guarantee of the successful bidder is retained till the signing of the final agreement and submission of another Guarantee under the name of “Good performance of undertaking Guarantee”. In case of default of the successful bidder, at whose request the Guarantee is issued, in entering into the agreement and/ or in submitting a Good performance of undertaking Guarantee, the beneficiary may encash the “Tender or Bid Guarantee’ from the issuing Bank. As such, this type of Guarantee should usually be issued at higher cash margin with collateral security covering the Guarantee amount.
Guarantees, which are issued in consideration of specific performance of contract, are called “Performance Guarantee”. This type of Guarantee would require higher cash margin with collateral security covering the Guarantee amount with power of Attorney to collect bills from the beneficiary (Government organizations and institutions, Corporations, Companies etc.)
This type of Guarantee is issued to ensure the proper and timely performance of undertakings by the successful bidder. The object of this type of Guarantee is the assurance of good performance of undertakings arising from signing of a contract, which is issued at the request of the applicant (the contractor), in favor of the beneficiary (Government organizations and institutions, corporations, Companies etc.), to ensure the performance of the undertakings accepted by the contractor, according to the stipulations of agreement signed.
The submission of this type of guarantee by the contractor is an essential pre-requisite for the signing of the agreement with the beneficiary (Government organizations and institutions, corporations Companies etc.)
Banks give guarantee to shipping companies for release of goods in the absence of shipping documents; in case goods arrive before receipt of such documents by the consignee and are incurring demurrage or original documents have been lost after retirement from the Bank. These guarantees are limited to bill amount or letter of credit value and for period till receipt of original bill of lading. The guarantee is actually signed by the importer in favor of shipping company and countersigned by the Banker. Normally, full value of invoice or letter of credit must be retained as margin for issue of guarantee. Alternatively, the goods may be cleared by Bank and kept in its custody. As soon as the original shipping documents are received, these shall be sent to clearing agents to facilitate return of original guarantee.
(ii) Continuing guarantee: “ A continuing guarantee is that which extends to a series of transactions” – section 129 of the Indian Contract Act – 1872. It is not confined to a single transaction. Surety can fix up a limit on his liability as to time or amount of guarantee, when the guarantee is a continuing one. Continuous guarantee used mainly for custom purpose.
This guarantee is issued in favor of customs authority on account of customs duties on imported goods and machinery or export commodities on behalf of clients.
Sometimes, importers are not in a position to pay in cash, the customs duties to release their imported goods. As such, they need to submit Bank guarantee to the customs for an amount equivalent to the amount of the customs duty.
By issuing the above guarantee, the bank make commitment for payment, and must pay the amount of the guarantee to the customs authority, without any delay, at the fixed maturity or on the dates when the installments fall due.
There are some other types of Guarantee:
Advance Payment Guarantee:
The objective of this type of guarantee is to secure the funds, paid by the beneficiary (Government organizations and institutions, corporations, Companies etc.) to the contractor, before start of the job, or in the process of the job, to strengthen the financial position of the contractor for speeding up the progress of work. The beneficiary will take steps to re-collect the funds paid by encashing the guarantee, in case of the contractor’s failure to meet his commitments. These guarantees are issued by the Bank, in favor of the beneficiary, at the request of the contractor. These are required for a fixed percentage of the total amount of the contract that the beneficiary is expected to pay to the contractor in the form of advance payments. The funds paid, by the beneficiary to the contractor, are deducted from the job position reports at various stages in such a manner that before the last temporary job position report is filled in, the said amount should have been amortized.
According to the general terms of the contract, the amount of the guarantee is also reduce each time upto the amount of the deductions, on the basis of the beneficiaries declaration, and the guarantee is released, with the consent of the beneficiary, at the latest, by the date of the temporary hand-over of the job.
Payment undertaking Guarantee:
This type of guarantee issued by the bank to make payment of dues at fixed maturities, such as the “guarantee to pay taxes”. Normally, this type of guarantee issued against 100% cash security.
Miscellaneous Bank Guarantee:
Besides the various guarantees stated above, applications may be received for the issue of multifarious other types of Bank guarantees for all kinds of jobs. The draft of such guarantees is usually dictated by the beneficiary.