Life Cycle and Types of Bank Guarantee

Bank Guarantee is an instrument issued by the Banks in which the Bank agrees to stand guarantee against the non-performance of some activity/event of a customer.  The guarantee is issued on receipt of a request from ‘applicant’ for some purpose/transaction in favour of a ‘Beneficiary’.  The guarantee amount will be paid by the ‘issuing bank’ to the ‘beneficiary’ of the guarantee on receipt of the ‘claim’ from the beneficiary i.e., when the guarantee is “Invoked”.

Parties involved in a Bank Guarantee

1.    Applicant: Applicant means the party indicated in the guarantee as having its obligation under the underlying relationship supported by the guarantee. The applicant may or may not be the instructing party.

2.    Beneficiary: Beneficiary means the party in whose favour a guarantee is issued.

3.    Guarantor: Guarantor is the institution that issues the bank guarantee. Guarantor means the party issuing a guarantee, and includes a party acting for its own account.

4.    Instructing Party: Instructing party means the party, other than the counter-guarantor, who gives instructions to issue a guarantee or counter-guarantee and is responsible for indemnifying the guarantor or, in the case of a counter-guarantee, the counter-guarantor. The instructing party may or may not be the applicant.

5.    Advising Party: Advising party means the party that advises the guarantee at the request of the guarantor.

Types of Guarantee:

1.    Deferred payment guarantee: This refers to a bank guarantee or a payment guarantee that is offered to the exporter for a deferred period or for a certain time period. When a buyer purchases capital goods or machinery, the seller will give credit to the buyer when the buyer’s bank gives a guarantee that it will pay the unsettled dues of the buyer to the seller. Under this type of guarantee, payment will be made in installments by the bank for failure in supplying raw materials, machinery or equipment.

2.    Financial guarantee: A financial bank guarantee assures that money will be repaid if the party does not complete a particular project or operation entirely. According to the financial guarantee agreement, when there is a delay in the completion of the project, the bank will make the payment.

3.    Advance payment guarantee: Under this kind of guarantee, an advance payment will be made to the seller. There will also be a guarantee that if the seller fails to deliver the service or product accurately or promptly, the buyer will receive a refund of the payment.

4.    Foreign bank guarantee: A foreign bank guarantee is provided by a bank on behalf of a borrower. This will be offered on behalf of the foreign beneficiary or creditor.

5.    Performance guarantee: Under a performance guarantee, compensation of money will be made by the bank when there is any delay in delivering the performance or operation. Payment will have to be made even if the service is delivered inadequately.

6.    Bid bond guarantee: Under this type of guarantee, there will be a supply bidding procedure. This will be conducted by the contractor for the owner of an infrastructure or industrial project or any kind of operation. The contractor of the project will guarantee that the best bidder or the highest bidder will have the capability and authority to implement a project as per his or her preferences. The bid bond will be given to the owner of the project as a proof of guarantee and the bond will imply that the project will have to be devised according to the bid contract.

Advantage of Guarantee:

1. Guarantee of payment. This type of guarantee is a security of payment obligations of Buyer to Seller.

2. Guarantees of advance payment return. This guarantee represents an obligation of the bank to return advance payment in the event that, after receiving an advance, the Seller does not perform its contractual obligations.

3. Contract execution guarantee. This guarantee is a security of timely delivery of goods or performance of services according to a contract.

4. Tender guarantees. This guarantee plays a role of security in those cases when the Company fails to perform its obligations to tender organization or other party that is stipulated in the order received by winning the tender.

5. Guarantee in favor of the customs authorities. This guarantee is a security of obligation of the company performing import and export operations to the Customs authorities for payment of customs taxes and duties.

6. Guarantees of warranty execution. This guarantee plays a role of security of quality for delivery to the contract terms.

7. Guarantee of credit return. This guarantee is a security for repayment of credit.

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- Sachin Gupta