Legal & Regulatory Aspects of Banking - Bank Guarantees Unit - 11 : Bank Guarantees In commercial transactions , bank's customers are sometimes required to give a bank guarantee. This is generally an alternative to keeping cash as a security deposit . The third party who seeks the guarantee, not being aware of the customer's financial standing , prefers a bank guarantee.
BANK GUARANTEES: There should first be a commitment on the part of the customer to fulfill certain obligations to a third party. This should be contractual or legal as imposed by Law. The commitment is guaranteed by a bank and if the customer fails to honour his commitment the banker pays the amount , it has promised to pay .
Various Types of Bank Guarantees: 1) Financial Guarantee 2) Performance Guarantee 3) Deferred Payment Guarantee
Issuance of Bank Guarantee : Precautions to be taken i) Amount Guaranteed ii) Period of Guarantee
Payment Under Bank Guarantee - Precautions to be taken i) Proper Invocation of Guarantee ii) No Injunction Prohibiting Payment
Guarantee is defined in section 126 of Indian Contract Act. There are three parties to a contract of guarantee namely principal debtor, creditor and surety.
The liability under guarantee is a contingent liability and surety is liable on default by the principal debtor.
Once there is a default, the liability of the surety is co extensive with the principal debtor. That is he is equally liable as principal debtor.
When a guarantor makes payment on being called by the creditor, he becomes entitled to all rights and remedies which creditor had against the principal debtor. This right of the surety is called Right of Subrogation.
When guarantee is issued for a single transaction it is called specific guarantee and when it isissued for series of transactions it is called continuing guarantee.
Deferred payment guarantee is issued when the applicant purchases machine etc on instalment basis.
Deferred payment Guarantee is just like financial guarantee.
The difference between Deferred payment guarantee and term loan is due to outlay of funds.
Various Types of Bank Guarantees
Financial Guarantee: These are guarantees issued by banks on behalf of the customers, in lieu of the customer being required to deposit cash security or earnest money.
Performance Guarantee: These are guarantees issued by banks on behalf of its customers whereby the bank assures a third party that the customer will perform the contract entered into by the customer as per the conditions stipulated in the contract, failing which bank will compensate the third party up to which the amount specified in the guarantee.
Deferred Payment Guarantee: Under this type of the guarantee, the banker guarantees payment of installments over a period of time. This type of the guarantee is required when the customer on credit purchases goods/machinery and payment is to be made in installments on specified dates. A deferred payment guarantee constitutes an undertaking on the part of the bank to make payment of deferred installments to the seller (beneficiary) on due dates in the event of default by the customer (buyer). Statutory Guarantee: These are guarantees issued by banks favoring Courts and other statutory authorities guaranteeing that the customer will honor his commitments imposed on under law, failing which bank will compensate to the extent of the amount guaranteed. Issuance of Bank Guarantee – Precautions to be taken The liability of the bank under a guarantee depends on two fundamental criteria’s, the amount guaranteed and the period of the guarantee. Amount Guaranteed Period of Guaranteed Claim period in a guarantee: The claim period is usually few months more than the validity period of the guarantee. If a validity period, then the beneficiary can at least of invoke the same on the next day. Difference between Indemnity and Guarantee
Contract of IndemnityContract of Guarantee There are 2 parties There are 3 parties (Debtor, Creditor/Beneficiary, Surety) Risk is contingent Liability is subsisting The Indemnifier is required to make good the loss as soon as it occurs The Surety’s liability is secondary and the principal debtor is primarily liable . There are only two parties to a contract of indemnity There are at least three parties in the contract of Guarantee An indemnity is for the reimbursement of a loss Guarantee is only security to the creditor