- A bank guarantee is defined as a guarantee given by the bank to a third person, to pay him a certain amount on the behalf of the bank’s customer on the customer failing to fulfill any contractual or legal obligations towards the third person.
TYPES OF BANK GUARANTEES
- Financial Guarantee- These are issued to the customers dealing with Government departments in situations where customer is required to deposit a cash security as a part of the contract. In case the customer is not awarded with the contract, then the government departments invoke the guarantee & collect the money from the banks.
- Performance Guarantee- These are the Guarantees issued by the bank on the behalf of its customer & assure that the customer will perform the contract entered, failing which the bank will compensate the third party up to the amount specified in the guarantee.
- Deferred Payment Guarantee- Under this guarantee, the banker guarantees payment of installments spread over the period. It is required where goods & machinery are purchased by a customer on long-term credit & payments are made in installments. A deferred payment guarantee constitutes an undertaking on the part of the bank to make payments of deferred installments to the seller on the due dates in the event of default by the bank’s customer.
- Bank guarantees are independent commitments taken by the banks on behalf of their customers. The bank has to honour his commitment on a guarantee irrespective of the disputes between the beneficiary & the debtor.
- The liability of the bank is not dependent on the underlying contract except in case of frauds.
ISSUANCE OF BANK GUARANTEE-PRECAUTIONS TO BE TAKEN
- The liability of a bank under a guarantee depends on two factors- Amount Guaranteed & Period of Guarantee.
- Amount Guaranteed- while finalizing the amount, the bank must ensure guarantee to pay amount inclusive of all taxes, interests, charges & other levies.
- Period of Guarantee- Banks always specify the period for which the guarantee exists. The period up to which the guarantee is valid is called Validity period. The period up to which claim can be honored to the party in case of default occurs is called Claim period.
- Claim period in a guarantee- In a guarantee, it is necessary to provide for a period slightly longer than the validity period, for the beneficiary to make a claim. The claim period must be at least 15-30 days after the validity period.
- Before issuing any guarantee to customer, bank should take counter guarantee-cum-indemnity by the customer to recover the guarantee amount in case of default. The value of the counter guarantee depends on the financial standings of the person/company.
- Before making any payment, a banker has to ensure that the invocation of the guarantee has been properly made, failing which he may not have any recourse against the debtor.
The invocation has to satisfy the following conditions-
- The invocation is within validity period.
- The invocation amount is not more than the guaranteed amount.
- The authority invoking the guarantee is competent or empowered to invoke the guarantee.
- The banker should see that no order of injunction has been passed by any court of law prohibiting the bank from making payment. In case, an banker makes payment, in spite of there being an order by a competent court in which the bank is a party, then bank will be answerable for contempt of court.