Sunday, December 12, 2010

BANKING

What is a Bank Guarantee?Bank guarantee
By Suhail Rajani
What is BG ?
A bank guarantee is a commercial instrument in the nature of a contract, intended between two parties, to secure compliance with the contract. It is an off-shoot of the main contract between two parties. In simple terms, a bank guarantee is defined as an accessory contract, whereby the promisor undertakes to be answerable to the promisee for the debt, default or miscarriage of another person, whose primary liability to the promisee must exist or be contemplated.
Bank Guarantees are financial instruments through which a Bank guarantees payment/ liability on behalf of individuals and /or entities to a third party.
In other words, banks agree to indemnify the beneficiary any loss which may arise due to default of another person (customer of the bank)

Performance guarantee
It is a guarantee by which customer of the bank has to complete given work with in a given period. In case he fails to perform, bank has to make payment to the beneficiary.
E.g. Your company has awarded a contract to construct a factory building costing 10 crores with in a period of 12 months. SBI has issued a guarantee favouring company. In case contractor fails to complete the construction with in stipulated period, on demand from your company, SBI will make payment say 50% of value of the contract.
Financial guarantee
It involves settling financial liabilities say tax demand from government,.
A guarantee from a lending institution ensuring that the liabilities of a debtor will be met. In other words, if the debtor fails to settle a debt, the bank will cover it.
A guarantee that enables a buyer to recover an advance payment made under a contract or order if the supplier fails to fulfill its contractual obligations. E.g. importer in India makes advance payment to an exporter in Malaysia for import of Palm oil.

Parties to BG
An guarantee is a tri-partite (3 parties) agreement involving the surety, the debtor and the creditor.
Surety – Bank (Who issues the BG)
Debtor – Beneficiary ( in whose favour BG is issued )
Creditor – Applicant ( on whose behalf BG is issued)


Need for BG
The instances when a bank guarantee may be given are as follows:
A bank guarantee may be given by a buyer to a seller as a guarantee for the future payment. E.g.. Sale of goods.
A bank guarantee may be given by the contractor as a guarantee for any amount advanced. E.g. Government ay grant advance for execution of contracts say construction of bridge/road etc
A bank guarantee (letter of credit), given by an importer to safeguard against governmental policy changes and as a guarantee of due payment. E.g. payment of customs duty.
Since this guarantees is called a bank guarantee as it is provided by a bank or a financial institution.
Why BG ?
Guarantee is required either to secure a debt or a performance. For example if you have borrowed money from some one then a bank can guarantee the lender for repayment of the debt. in the second case if you have taken up some construction work and supply of machinery warranting a good performance or completion within a time limit the bank may give a guarantee for due performance to the party for whom you have undertaken the job.
How do bank guarantees help in commercial contracts?
Liquidity – applicant need not block the money.
Confidence and trust – since bank is acting as intermediary, beneficiary is confidence of compensation in case of default.
Highly useful in international transactions where parties operate in different countries/political system/regulatory environment.
Fee based income for the bank.
Invocation of BG

Invocation means beneficiary asking for payment of money from the bank due to default. Bank on receipt of written confirmation from the beneficiary , has to make payment.
The invocation of a bank guarantee by the beneficiary can be restrained by an injunction under the Civil Procedure Code, 1908, or the Specific Relief Act, 1963. However, the normal considerations, which apply in granting an injunction, will not apply in cases of a bank guarantee. Courts are usually reluctant to grant an injunction against a bank guarantee. If a bank guarantee has to be restrained, it has to satisfy the following conditions:
" Fraud; " Irretrievable injustice or injury.

Can the invocation of a bank guarantee be prevented by initiating arbitration proceedings?
If the bank guarantee is unconditional, arbitration proceedings would in no way affect the enforcement of the guarantee. This is because an unconditional bank guarantee is independent of the main contract which refers disputes to arbitration. However, if the bank guarantee includes a clause to the effect that it could not be invoked prior to the decision of the arbitrators, such a bank guarantee, which is conditional, cannot be invoked and an injunction can be granted.
What is the difference between a bank guarantee and a usual guarantee?
Following are some points of difference between a bank guarantee and a usual guarantee:
A usual guarantee is governed by Sec. 126 of the Indian Contract Act, 1872. A bank guarantee is not directly governed by Sec. 126.
An guarantee is a tri-partite (3 parties) agreement involving the surety, the debtor and the creditor.
In an ordinary guarantee, the contract between the surety and the creditor arises as a subsidiary to the contract between the creditor and the principal debtor. The bank guarantee is independent of the main contract.
An ordinary guarantee does not have any time limit before which the debt has to be claimed. Bank guarantees generally have a specific time within which they are functional.

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