31132115 bank-guarantee

INTRODUCTION
 A contract of guarantee is defined as ‘a contract
to perform the liability of a third person in case of
default’. The parties to the contract of guarantee
are:
a. Applicant : The principal debtor : The person at whose
request the guarantee is executed.
b. Beneficiary : The person to whom the guarantee is given
and who can enforce it in case of default.
c. Guarantor : The person who undertakes to discharge the
obligations of the applicant in case of his default.

 Thus, a contract of guarantee is a collateral
contract, consequential to a main contract
between the applicant and the beneficiary.

PURPOSE OF Bank Guarantee (BG)
 BGs may generally be issued for the following
purposes:
a. In lieu of Security Deposits / Earnest Money Deposits
for participating in tenders.
b. Mobilisation advance or advance money before
commencement of the project by the contractor and
for money to be received in various stages like plant
layout, design / drawings in project finance.
c. In respect of raw material supplies or for advances by
the buyers.
d. In respect of due performance of specific contracts by
the borrowers and for obtaining full payment of the
bills.

PURPOSE OF BG
e. Performance guarantee for warranty period on
completion of contract which would enable the
supplier to realise the proceeds without waiting for the
warranty period to be over.
f. To allow the units to draw funds from time to time
from the concerned indentors against past execution
of contracts, etc.
g. Bid bonds on behalf of exporters.
h. Export performance guarantees on behalf of
exporters favouring the Customs Department under
EPCG Scheme.

GUIDELINES ON CONDUCT OF BG
BUSINESS
 Banks should, as a general rule, limit themselves
to the provision of Financial Guarantees and
exercise due caution with regard to Performance
Guarantee business.
 The subtle difference between the two types of
guarantees is that under a Financial Guarantee,
a bank guarantees the customer’s (applicant’s)
financial worth, creditworthiness and his capacity
to take up financial risks.
 In a Performance Guarantee, the bank’s
guarantee obligations relate to the performance
related obligations of the applicant (customer).

BUSINESS
 While issuing Financial Guarantees, Banks
should satisfy themselves that customers would
be in a position to reimburse the Bank in case
the Bank is required to make the payment under
the guarantee.
 In case of Performance Guarantee, Banks
should exercise due caution and have sufficient
experience with the customer to satisfy
themselves that the customer has the necessary
experience, capacity, expertise and means to
perform the obligations under the contract and
no default is likely to occur.

BUSINESS
 Banks should not normally issue guarantees
valid for more than 18 months. For BGs of more
than 18 months, prior approval is required
 No Bank Guarantee should normally have a
maturity of more than 10 years. BG beyond
maturity of 10 years may be considered against
100% cash margin with prior approval

BUSINESS
 Banks should normally refrain from issuing
guarantees on behalf of customers who enjoy
other credit facilities not with them but with other
banks.
 Unsecured guarantees, where furnished by
exception, should individually be for a short
period and for relatively small amounts.
 All DPGs should ordinarily be secured.

APPRAISAL OF BG LIMIT
 Banks should appraise the proposals for
guarantees with the same diligence as in the
case of Fund Based Limits. They may also
obtain adequate cover by way of margin and
security so as to prevent default on payments
when guarantees are invoked.
 Whenever an application for the issue of BG (or
sanction of a regular BG Limit as part of WC
Limits) is received, Banks should examine and
satisfy themselves thoroughly about the following
aspects:

APPRAISAL OF BG LIMIT
a. The need for the BG and whether it is related to the
applicant’s normal trade / business.
b. Whether the requirement is one-time or on a regular basis.
c. The nature of BG, i.e., Financial or Performance.
d. Applicant’s financial strength / capacity (through an analysis
of his financial statements, Cash & Funds Flow position and
opinion reports) to meet the liability / obligation under the BG
in case of invocation.
e. Past record of the applicant in respect of BGs issued earlier,
e.g., instances of invocation of BGs, the reasons thereof, the
customers’ response to the invocation, etc.
f. Present outstanding on account of BGs already issued.
g. Margin
h. Collateral security offered.

ASSESSMENT OF BG LIMIT

Assessment of BG Limit

MARGINS
 Following are some of the factors to be kept in
view by the Banks while determining the margins
required:
a. Cash margins provide a cushion against invocation.
Margin money may be in the form of Fixed Deposit.
b. The margin to be stipulated would depend on the
borrower’s means, resources, creditworthiness, security
available, past experience with regard to issue of BGs,
nature of guarantee and the nature of underlying
transactions. If existing borrower, margin on BG may
generally be the same as on Stocks, Receivables, etc.

MARGINS
c. In case of Advance Payment Guarantees, lower
margins may initially be stipulated. Once the advance
is actually received, depending on the amount not
likely to be immediately utilised, higher margins may
be built up by impounding of cash advances.
d. In respect of non-borrower applicants, Bank’s
approach should normally be to obtain full margins.
However, a credit risk can be taken on the applicants
based on the financial indicators, credit worthiness,
security available, etc.
e. 100% margin should ordinarily be retained in respect
of guarantees issued in connection with disputed
Customs / Central Excise duties, unless otherwise
specified in the sanction.

SECURITY
 Apart from the margin, BGs are usually secured
by an extension of the charge on Current Assets
obtained to cover WC facilities.
 Adequate collateral security by way of Equitable
Mortgage or third party guarantee should be
taken depending on the merits of each case.

DOCUMENTS
 Whenever a guarantee is issued and / or
guarantee bond is countersigned by the Bank on
behalf of a constituent, suitable Counter
Guarantee should be obtained from the
constituent.

FORMAT OF BANK GUARANTEES
 BGs should normally be issued on the format
standardised by Indian Banks Association (IBA).
When it is required to be issued on a format
different from the IBA format, as may be
demanded by some of the beneficiary
Government Departments, it should be ensured
that the BG is:
a. For a definite period.
b. For a definite objective enforceable on the happening of a
definite event.
c. For a specific amount.
d. In respect of bona fide trade / commercial transactions.

f. Not stipulating any onerous clause.
g. Not containing any clause for automatic renewal of the BG
on its expiry.

 BGs should be issued with a pre-printed and
numbered standard first page of the guarantee
form, which contains the limitation clause.
 The pre-printed form is to be used for all BGs.
 However, in case of a guarantee favouring a
Govt. Dept. objects to the use of the pre-printed
form, Banks may issue the guarantee on non-
judicial stamp paper.

 The text of the guarantee will appear on the
pages succeeding the printed first page. It
should be ensured that while filling up the first
page of the BG, no separate claim period is
provided.
 The validity period of the guarantee will be stated
inclusive of the claim period.
 Further, each page of the text of the guarantee
enclosed with the pre-printed form should also
mention pre-printed serial number, BG number,
date of issue and amount, etc.

 In all the guarantees issued by the Bank, the
limitation clause suggested by IBA should
invariably be incorporated at the end of the text
as concluding paragraph of the BG.
 “Notwithstanding anything contained herein:
a. Our liability under this BG shall not exceed Rs. ………
(Rupees ………………………… only);
b. This BG shall be valid upto…………..; and
c. We are liable to pay the guaranteed amount or any part
thereof under this BG only and if only if you serve upon us
a written claim or demand on or before ……………. (date
of expiry of guarantee).”

 In case of BGs issued favouring Govt. Depts.,
the above clause should be incorporated in the
Model Bank Guarantee (MBG) form, prescribed
for BGs in favour of Govt. Depts.
 If period of claim is required to be stated
separately, it has to be kept at the minimum. It
should generally not exceed 3 months.
 The BG may be issued on a stamp paper on
which the name of the customer appears as the
purchaser thereof.

AMENDMENT OF BANK GUARANTEE
 There is no provision for amendment of Bank
Guarantees unlike in the case of Letters of
Credit.
 Instead, fresh guarantees need to be issued,
cancelling the earlier ones.

INVOCATION OF BANK GUARANTEE
 The beneficiary of the BG can invoke in writing,
the guarantee any time before the expiry of the
guarantee period. Invocation can be done by
Telex / Telegram / Hand Delivery also followed
by Mail Confirmation.
 Banks should ensure that all valid claims
received by them under BGs issued by them are
settled promptly.
 In the case of any dispute, such honouring, on
invocation, will be done under protest and the
matters of dispute should be pursued separately.

 The Bank’s liability under BG is absolute and
independent and exclusive of any other contract
entered into by the applicant and beneficiary.
 It is, therefore, obligatory on the part of the Bank
to pay to the beneficiary without delay and demur
the amount of BG on its invocation in accordance
with the terms and conditions of the guarantee
deeds.
 It is not necessary for the beneficiary to satisfy
the Bank about the default or the amount of
actual loss suffered by him.

 Delay in honouring the claim immediately may
unnecessarily put the Bank in problems
pertaining to claim of interest, damages and at
times injunction orders from Court.

 Only when the Bank has received an order of
restraint / injunction from a competent /
appropriate Court, the Bank can withhold
payment under the BG. The liability of the Bank
under the BG will continue till the Court case is
decided.

31132115 bank-guarantee

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