Letter of Guarantee and Indemnity Bid Bond and Performance Advance Payment Guarantee, Foreign Guarantee etc.
Letter of Guarantee and Indemnity Bid Bond
Definition:
The guarantee has been defined very clearly in various statutes of law in various parts of the world; however, the substance of all these definitions is the same.
The contract of Guarantee has been defined under section 126 of the contract Act which reads:
“A contract of guarantee is a contract to perform the promise or discharge the liability of a third person in case of his default.”
In the course of normal trading, the customer may need a guarantee to be given by the bank to support a trading transaction or bank may take guarantee as security against the advance.
Guarantee may be of two kinds. They are:
- Guarantees taken by a bank as security against its advance.
- Guarantees required by customers from banks in the course of their normal trading.
Kinds of Guarantee
A guarantee may be either a Specific Guarantee or a continuing Guarantee.
DIFFERENT TYPES OF GUARANTEES ISSUD BY BANKS.
In the ordinary course of business, the customer may request a banker to support a trading transaction by giving a guarantee or an indemnity to a third party. As a service to the customers, bankers issue guarantees and indemnities of various types on customers behalf on third parties. By this, the bank undertakes a contingent liability on behalf of its customer.
The following are the basic principles to be borne in mind by bankers at the time of considering a proposal for issuing Guarantee or indemnity on behalf of clients.
- The customer, on whose behalf the guarantee will be executed, must be a man of character and integrity and he must be creditworthy. An up-to-date credit report on customers should be obtained.
- The Guarantee should relate to the normal business of the customer.
- Clauses of guarantee must be precise and clean.
- The guarantee must be for a certain fixed amount and the period of its validity must be limited and fixed.
- The customer is to execute a duly stamped counter – guarantee or counter – indemnity to the bank providing inter alias that he will indemnify the bank against all consequences and authorizes the bank to charge all payments to his account. The counter guarantee is returned to the banks duly discharged from the beneficiary, the counter-guarantee will remain in force, sometimes, banks require tangible security in support of counter-guarantee, care must be taken to see that terms of the guarantee are always covered by the terms of counter-guarantee.
- As soon as the guarantee period is over, the signed guarantee bond should be called back duly canceled by the beneficiary.
The following types of the guarantee are generally issued by the bank on behalf of its constituents.
- Tender Guarantee or Bid Bond
- Performance Guarantee
- Shipping Guarantee
- Investment Bank Guarantee
- Customs and Excise Guarantee
- Guarantee on account of foreign correspondent
- Deferred Payment Guarantee
Expiry of Guarantee: The guarantee is considered expired in the following two situations:
- The guarantor has received no claim on or before the expiry date or within the last date for claim.
- The satisfaction of all concerned.
- Nevertheless, a tender guarantee or bid bond expires under the following three conditions.
- When the tender or bid bond has been accepted by the beneficiary and the principal has signed the contract.
- When the contract to which it relates has been awarded to another tenderer.
- When the beneficiary expressly declares that he does not intend to place a contract.
Return of Guarantee: The original documents of guarantee should be returned to the guarantor when it is no more valid in accordance with the terms and conditions under which it was drawn.
Claim of Guarantee: Claim under a guarantee or indemnity should be made in writing. It may be communicated through mail, cable, telegram or telex within the validity period.
However, the claims must be supported with the documents which prove that the principal has defaulted or failed to fulfill his contractual obligation; hence, the cause of action has arisen.
Accounting procedure
Liability vouchers: As soon as the guarantee is issued, the bank accepts a liability which should be recovered for reflection in their books of accounts in the following manner.
DR: Customer’s Liability on the letter of Guarantee (L/G)
CR: Bank’s Liability on the letter of Guarantee (L/G)
On the expiry of the validity date of guarantee, notice should be given for the return of guarantee is stamped ‘Cancelled’ and kept in the file.
Types of Guarantee that are generally issued by the bank:
Bid-boud/Security deposit: This is also called tender or bid guarantee and is generally sought for 2 percent to 5 percent of the contract amount. In case of default of the tender at whose request the guarantee is extended, the beneficiary may encash the same.
- Performance Guarantee: Guarantees which are extended in consideration of specific performance guarantees are given to Government or Corporation on behalf of contractors undertaking to make payment of the contract or supplying goods as per contract.
- Shipping Guarantee: Banks give guarantee/indemnity to shipping companies for release of goods in the absence of shipping documents, in case of goods arrive before receipt of such documents by the consignee and are incurring demurrage or original shipping documents have been lost after retirement from bank.
- Customs Guarantee: This guarantee is issued in favor of customs authority on account of customs duties/excise duties on imported goods and machinery or export commodities on behalf of clients.
- Investment Bank Guarantee: While approving a loan by Bangladesh Shilpa Bank, Bangladesh Shilpa Rin Sangstha and Bangladesh Small and Cottage Industries Corporation etc. to a project they conduct a thorough survey and arrive at a certain figure, which in their opinion, is necessary to run the project efficiently. They allow loan only to a certain extent, usually foreign exchange component for import of machinery etc. requiring the proposed borrower to invest the remaining amount. If the amount already invested in the project is less than what should be the contribution of proposed borrower or where he is not in a position to invest the amount immediately, they require a bank guarantee confirming that the customer would be in a position to invest the required amount in the project out of his own resources within a certain period, and on his failure to do so, the bank will provide the fund.
- Guarantee on account of foreign correspondent: This type of guarantee is required to be issued by the bank at the request, and on behalf of the client of foreign correspondents, in favor of beneficiaries in Bangladesh in the form of Bid/Earnest money guarantee or performance bonds. Foreign Bank’s counter-guarantee is held for each guarantee issued.
- Deferred Payment Guarantee: Importers of capital goods like plants and machinery, turn-key projects, etc., may find it difficult to pay the full price of goods or documents immediately on their receipt. Therefore, the suppliers of capital goods extend deferred payment credit terms, provided the buyer can provide acceptable security.
“Deferred payment guarantee” issued by a well-reputed bank is one of the acceptable securities to the suppliers. Under the “deferred payment guarantee” total payment to be made against the deal is spread over a number of years. This document guarantees payment of the full price together with the agreed interest thereon in pre-determined installments or undertakes to accept bills drawn to cover each prescribed installment together with interest due for the period, in case the importer defaults to pay the installments as and when they fall due.
The text of the deferred payment guarantee is generally provided by the foreign supplier; however, the issuing bank must ensure that the validity period of the guarantee does not exceed the useful life of the imported capital goods.
Precautions in taking Guarantees:
i) The guarantor should be highly credit-worthy. The value of a guarantee depends upon the ability of a guarantor to pay the debt immediately when called upon to do so. Utmost care must, therefore, be exercised in accepting a particular as a guarantor.
ii)Reports on the financial position of the guarantor must be periodically collected. The value of the guarantee has to be maintained throughout the currency of the advance.
iii) The banker should not approach any person to give a guarantee for advance to a borrower. It is for the borrower to arrange for a guarantee and the request to the guarantor in this behalf has to be made by the borrower.
iv) The guarantee should always be taken on the bank’s approved form.
v) The signature of all proposed guarantors must be obtained in presence of an officer of the bank on the guarantee from before the advance is initiated.
vi) Periodical confirmation of the guarantee should be obtained from the guarantor separately along with balance confirmation duly signed by the borrower to avoid the guarantee agreement becoming time-barred.
vii) On the dearth, insolvency or lunacy of the principal debtor, or the guarantor, or on receipt of a notice of determination from the guarantor, the account should be broken to avoid the operation of the rule in Clayton’s case.
Claim of Guarantee
In case the guarantee is presented for encashment and balance of customer’s account including cash margin held is sufficient to cover the amount of guarantee, the same should be paid by pay order to the debit of customer’s account. If the balance is not sufficient the customer should be asked to deposit the amount of shortfall immediately, and in case of his failure, the bank must pay the claim by forced loan in borrower’s account.
Before settlement of a claim under guarantee furnished by the bank, it must be ensured that the claim is justified as per terms of the guarantee. The customer shall also be informed as usual before the settlement of the claim.
Letter of Guarantee and Indemnity Bid Bond
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Letter of Guarantee and Indemnity Bid Bond