What is a bank guarantee? Examining different bank guarantee and its fair rules
International trading have its own particular rules and regulations. Private persons and legal persons in international trade as Intra-border trade will require issue and use a variety of bank guarantees under terms and conditions. Therefore, these guarantees that are subjected to exclusive laws and regulations play an important role in promoting international trade so in this article from Sindbad we are going to introduce different bank guarantees and their types.
What is a bank guarantee?
According to provided definitions, the bank guarantee is indeed a contract concluded at the request of the guarantor between bank guarantor and beneficiary. According to this grantee, the bank undertakes to pay some amount money to the beneficiary in response to his written request after fulfilling the terms of the guarantee and during maturity unconditionally and irrevocably.
Different types of guarantees in terms of confidence level for beneficiary
As mentioned earlier, there are many types of bank guarantees and we are going to discuss more about them in the following parts.
Conditional guarantee, subordinate or contractual
Conditional, subordinate or contractual guarantee is a subsidiary and secondary commitment of power to a creditor. This guarantee is depended on the validity of the principal debtor's commitment (initial commitment) and is limited to the terms and condition of that commitment. Therefore, If the principal and initial debt are lost for any reason (including payment), this commitment (conditional commitment) will also be invalid.
Independent guarantee, unconditional or on demand
Independent guarantee (on demand) is a basic and primary commitment (not dependent on another commitment) to its beneficiary. In this condition, even if the commitment of the main undertaker to the beneficiary of guarantee is lost for any reason, guarantor will still be committed. He will pay with the first request and without protest and defense.
Different types of guarantees in terms of procedure of issue
Bank guarantees are divided into two categories, direct and indirect; whether they are directly issued by the bank in favor of the beneficiary or issued by intermediary bank.
In this kind of guarantee, after receiving issuance request of guarantee from the main debtor, the bank issues its guarantee directly to the beneficiary. Currently, direct guarantee issued by foreign banks are only allowed for contracts in the applicant's currency.
In some cases, the beneficiary of guarantee requests the issuance of a guarantee through a specific bank or a bank in his country. In this case, the first guarantor bank which is called also as ordering bank issues a mutual guarantee in favor of intended bank, it means the second bank and furthermore gives the second bank the order of original guarantee’s issuance. Obviously, in case of acceptance of the mutual guarantee by the recipient bank, that bank try to issue the guarantee, otherwise it will declare its refusal of request of correction in communicated text to ordering bank.
The first guarantee which is between two banks is called mutual guarantee and the second guarantee issued by the second bank is called guarantee. Generally, direct guarantee is used in domestic transaction and indirect guarantee is used in international transactions.
Possible risks of direct guarantees for the beneficiary
Compared to indirect guarantees, direct guarantees can have different risks for beneficiary under special conditions. Some of the most important risks are as follows:
- The beneficiary is not aware of the authenticity of the signature and guarantee, credit rating of foreign banks, and Agents' authorized maximum.
- Inaccessibility of beneficiary to fast communication devices such as Swift, will increase the possibility of delays in sending requests, receiving relevant responses, and the loss of regulated opportunities in guarantee.
- According to current sanctions, regarding the demand for dollar, buyer’s ignorance of cash collection channels which are between agent banks increase the possibility of not receiving or delay in receiving funds.
- Beneficiary’s lack of knowledge of common tariffs of broker banks will increase the probability of paying more fee than international rates.
- Lack of familiarity with various texts of broker banks and their related legal aspects increases the risk of the direct guarantees.
- If there is any obstacle such as non-payment rule by jurisdictions of guarantor’s country, the beneficiary incurs heavy legal costs and other travel, negotiation and consultation expanses.
Claiming the amount of the guarantee
The beneficiary of the guarantee can claim the entire amount or part of the guarantee amount. In this regard, the review of the beneficiary's request to the bank includes the following:
- Signature review; the authenticity of the signature and the identity of the claimant must be established.
- The way of claiming; generally, claiming must be written /encrypted telex / Swift / encrypted Swift or custom letter with confirmation of the authenticity of the signature requested by a bank.
- Limitation of claiming; payment claiming must be made by the end of the guarantee period at a bank branch listed under the terms of the guarantee. The beneficiary is responsible for any delay in claiming amount.
Expiration of the guarantee
Regardless of whether the guarantee document has been returned to the issuing bank or not, the guarantee will be expired, if the beneficiary don’t ask for payment till the due date stated in guarantee.
- Paying the guarantee amount: when the beneficiary claims the amount and that amount is paid back totally, the guarantee will be expired.
- Cancelation before deadline: formal cancelation of guarantee before deadline by the beneficiary.
Sending and notifying of the guarantee
In order to verify its authenticity, the guarantee can be notified and sent to the beneficiary by a bank in his country. For this purpose, usually the guarantor bank transmits the text of the guarantee to the local bank by Swift or encrypted telex. And the mentioned bank which has no responsibility about above direct guarantee except authenticating the message, delivers it to the beneficiary.
Types of currency guarantees from thematic points of view
Company’s guarantee in Tender / auction
Companies, organizations and institutions usually tend to buy or sell their properties through tenders and auctions. To carry out their projects with providing their required services, they operate tenders. Persons participating in the tender and with the auction are required to give the employer a guarantee which can be confiscated in favor of the employer if the obligation is not fulfilled.
Proper work commitment guarantee
This type of guarantee is issued for on time commitments of the debtor against the beneficiary.
To start operation, for equipping the workshop or complete the equipment, the employer usually pays a percentage of the contract amount to the contractor as a prepayment to take a guarantee. The more the operation progress, the employer will reduce that amount.
Deduction refund guarantee
To ensure the accuracy of the work, the employer deducted 10 percent of the status statement as assurance of good performance. The employer keeps that amount in his account which can be returned at the request of contractor and by in exchange for a bank guarantee. This guarantee which is issued by the bank at the request of contractor in favor of employer is called deduction refund guarantee.
If the owners of imported goods can’t pay for the relevant customs' duties in cash must give bank guarantee equivalent to their cash to clearance their goods. These guarantees are issued for a certain period of time, for example, 6 months, 9 months, etc., or as installments. If the costumes guarantees are not deposit in the due time, they will be subjected to late payment damages.
Payment commitment guarantee
Payment commitment guarantee in another type of bank guarantee. These types of guarantees are issued by the bank in order to accept the payment of the debt on the specified receipt.
The law of guarantees
The bank guarantee is subject to the laws of the country where the bank issuing the guarantee is located. Though, if the parties to the guarantee agreement agree, they can rule the law of the third country with the agreement of the banks that are related to the guarantee. Also, probable disputes between the guarantor and the beneficiary will be resolved by the competent courts of the country issuing the guarantee, if the guarantee is not specified otherwise. This suggests that the legal status of each warranty should be carefully considered and studied as appropriate.
Required terms and conditions to issuing guarantee for legal persons
- Presenting the image of the company's articles of association + the latest changes of the board members + authorized signatures and the location and center of the company in the official newspaper
- Requesting the issuance of a guarantee with the company's authorized signature and stamp including beneficiary’s letter or the contract concluded with the beneficiary stipulating the type, amount and the period of the guarantee.
- Providing complete identification of board members, picture of the tender documents (in terms of guarantees for participation in the tender), picture of the contract with work referring announcement, related subject of contract specifications and how to pay (about good performance and prepayment guarantee)
- Having an account and appropriate account turnover as far as possible, not having returned checks and deferred facilities of applicant and guarantor and customer validation
- Determining the amount of cash deposit of guarantee, amount of guarantee, types, assurance and amount of the deposits, contractors, guarantor and guarantee due date
The last word
According to the great importance of international trade and business in world’s states quo, the bank guarantees play significant role. The guarantees are classified in different types and each one has its own features and uses.
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