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Bank Guarantees Text


Notice
This note form is provided for general informational purposes. Before you utilize any legal form you find on the Internet, you should have it reviewed by a lawyer in your jurisdiction to be sure that it meets your legal needs, and will be held valid by a court in the jurisdiction where you reside.
NOT LEGAL ADVICE! This is not intended to be legal advice; it is information and opinion only. Do NOT rely on this information as legal advice. You must first see your own attorney and apply the facts of your particular situation to the law of your state and country. Do not engage in any area of the subject of this article without first seeing an attorney.

1.- What are bank guarantees?
2.- What are the two types of bank guarantees?
3.- For what purposes are bank guarantees customarily issued?
4.- Are bank guarantees transferable?
5.- Are bank guarantees the subject of trading?
6.- Is there fraud associated with bank guarantees?
7.- How does one collect on a bank guarantee?
8.- How does the bank handle a dispute?
9.- Sample of Bank Guarantee (Payment Guarantee)

1.- What are bank guarantees?

  • Banks guarantees are written obligations of the issuing bank to pay a sum to a beneficiary on behalf of their customer in the event that the customer himself does not pay the beneficiary.
  • It is important to note that these bank guarantees apply only whenever the issuing bank's guarantee is not contingent on the existence, validity and enforceability of it's customer's obligation; this is called an “abstract” guarantee (i.e. the bank's obligation is to pay regardless of any disputes between its customer and the beneficiary).
  • The issuance of bank guarantees is a private transaction and does not result in the issuance of any publicly tradable instruments.
  • Today bank guarantees are transmitted electronically on a bank-to-bank basis. So one must be very concerned if presented with a hard copy of a bank guarantee; it is likely a fraudulent instrument. This is not to preclude pro forma writings of bank guarantees where the parties agree on the terms, and the applicant takes these terms to the bank and has the bank incorporate them into the electronic bank guarantee. There is a pro forma bank guarantee below.

2.- What are the two types of bank guarantees?

There are two types of bank guarantees:

  • Direct bank guarantees that have the issuing bank guarantee one's of its customer's (called “Obligor”) obligations to a third party (called “beneficiary); and
  • Indirect bank guarantees that are issued in favor of a second bank which has issued a guarantee on behalf of the of the original's bank's customer. With an indirect guarantee, a second bank (usually a foreign bank with head office in the beneficiary's country of domicile) is involved.

3.- For what purposes are bank guarantees customarily issued?

a. Bid Bond (tender bond)

  • These are primarily used in the export business for project tenders. They are short term guarantees.
  • It's purpose is to secure any claims by the party inviting the tender on the tenderer in the event of withdrawal of the bid before its expiry date or if the bid is modified unilaterally. It is also used if the tenderer, upon being awarded the contract, refuses to sign the contract or provide further guarantees on request.
  • The guarantee amount is generally 1% to 5% of the value of the contract.

b. Advance Payment Guarantees

  • These are used not only in the import-export business but also in domestic commercial business, trade and industry.
  • In the event that a seller has failed to meet its contractual delivery obligations in full, the purpose is to secure any claims by the buyer on the seller for reimbursement of the buyer's advance payment on the contract price before delivery of the goods (or advance payment of the full contract price). The amount of the guarantee is the amount of the installment or advance payment.

c. Performance Bond Guarantee

  • This is used to secure any claims by the buyer on a seller arising from default in delivery or performance of the terms of a contract (e.g. construction, assembly, execution). It is used in import-export businesses as well as in domestic commercial business, trade and industry.
  • The guarantee amount is generally 5% to 20% of the value of the contract. The terms of the guarantee is until the contract has been fulfilled.

d. Bank Guarantee for Warranty Obligations

  • The application of this type of bank guarantee is in the import-export business and in domestic commercial business, trade and industry, where it is more often a surety. Its purpose is to secure any claims by the buyer on the seller due to possible defects appearing after delivery.
  • The general amount of the guarantee is 5% to 20% of the value of the contract, and the terms depend on the custom of the particular business.
  • In the construction trade, the guarantee for warranty obligation in the form of a simple guarantee or a joint and several guarantee is known as a building (or works) contractor's guarantee. It can also be used in the export business as a "retention bond" (substitute for payment retention, often 5% to 10% of the value of the contract).

e. Payment Guarantees

  • These are used in the import-export business or in any circumstance where payment of an obligation needs to be guaranteed. It is used to secure any claims by the seller on the buyer for payment of the contract price by the agreed date. The payment guarantee is often used instead of a documentary credit – upon delivery against “open account”.
  • The amount of the guarantee is the contract price or a part of it.

f. Guarantee Securing Credit Line

  • The use of this guarantee is to secure any claims by the lender on the borrower due to a credit (loan, etc.) not being repaid in accordance with the terms of the lending contract.
  • The amount of the guarantee is the amount of the credit or loan, and it usually includes a margin to cover accrued interest and incidental expenses.
  • The term of the guarantee is until the expiration date of the loan plus a few days (e.g. 15 days).
  • These are often abstract guarantees in favor of a foreign or domestic lending bank.

g. Letter of Indemnity for Missing Bill of Lading

  • This guarantee is specifically used for importers when the bill of lading is missing. Its purpose is to secure any claims by the shipping line/shipping company on (i) the buyer resulting from the goods arriving from overseas being released without the original bill of lading being presented (e.g. due to postal delays or even loss) or (ii) the supplier due to issuance of a replacement bill of lading (original misplaced or lost).
  • The term is often unlimited or until the original bill of lading or release document from the beneficiary is presented.
  • In practice the wording of the guarantee is frequently stipulated by the ship owner and must be sent directly by the debtor, with a counter-guarantee from the bank to the shipping line.

4.- Are bank guarantees transferable?

a. Assignment of Bank Guarantee Proceeds.
The beneficiary can assign the proceeds of a bank guarantee. But this assignment does not assign the rights of the beneficiary as “drawer” on the bank guarantee, and only the beneficiary may exercise the “drawer” rights and present the demand for payment under the terms of the bank guarantee unless the terms of the guarantee provide otherwise. This means that the assignee may receive the proceeds of the guarantee, but in order to obtain those proceeds, the beneficiary must make the demand for payment. This means that the beneficiary can transfer by assignment at discount the benefits of the guarantee. An assignment of proceeds requires notice to the issuing bank of this action; otherwise the issuing bank would pay the beneficiary rather than the assignee.

b. Transfer of Bank Guarantees.
Bank guarantees can be transferred to a third party ONLY with the written consent of the issuing bank AND the beneficiary.

5.- Are bank guarantees the subject of trading?

a. No Public Market.

  • There is no public market for the trading of bank guarantees.
  • Beware! Fraudsters or naïve brokers are always erroneously representing that there is a public market for the trading of bank guarantees (and standby letters of credit).
  • This is not to be confused with the trading of other bank issued instruments. There are genuine markets in medium term notes (MTN's), in bonds, notes and other credit instruments of various kinds. Also, there are valid markets in equity instruments of many varieties.
  • But there is not a legal market for “bank guarantees”. Bank guarantees can only be transferred or the proceeds assigned in private transactions (See above).

b. No CUSIP or ISIN Numbering.

  • Bank guarantees are not trading securities, trading debt instruments, or trading investment funds, and therefore are not subject to the settlement procedures offered through Euroclear or DTC and most other settlement firms.
  • Obviously, therefore, they also are not issued CUSIP or ISIN numbers for trading purposes.
  • However, Euroclear may accept such bank guarantees for “safekeeping” purposes only. So one has to be careful in understanding the particular legal relationship of a bank guarantee to Euroclear or other settlement entities, especially as to issues of authenticity.
  • A bank guarantee held in safekeeping does not serve to authenticate the instrument . Anything can be the subject of a safe keeping situation. Mixing a metaphor, you can get a safe keeping receipt for a ham sandwich.

6.- Is there fraud associated with bank guarantees?

a. There are many fraudulent bank guarantees. i.e. they are NOT issued by the bank that is represented as the issuer.

  • The authenticity should always be checked (See Paragraph (4) below for important warning).
  • The fake financial instrument may have a face value of anything from $5 million to $600 million or even billions of dollars (or other currencies), and they usually give the appearance of being tied to a major international bank.
  • The scheme involves investors being persuaded to buy these Bank Guarantees after being offered discounts of over 40%. The investor would then look forward to redeeming the full face value on maturity (e.g. one year's time), thereby securing a healthy profit . Of course no profit is forthcoming; the investor only suffers the loss of the price paid for the bogus instruments.
  • Banks do not issue guarantees for this type of proposition. Bank Guarantees are NOT investment products. Bank guarantees are issued by banks to cover the liability of its customer to a third party that the bank agrees to pay.
  • Sometimes fraudsters use the discounted Bank Guarantee as bait to secure an advance fee (e.g. 1% of the Guarantee's face value). The advance fee is represented to pay for alleged due diligence and administration procedures, but is merely pocketed by the perpetrators resulting in a fraud loss to the investor.

b. Fraudulent Leasing of bank guarantees. Leasing of bank guarantees for an upfront fee is invariably a fraud.

  • These bank guarantees can either be legitimate or bogus, so checking out the authenticity in the long run is not really important (See Warning above on going to the bank to check authenticity of bank guarantees!).
  • The problem is that after paying an upfront fee there is nothing in the real world that the lessee can do with a leased guarantee, and the lessor knows it; i.e. the lessor knows that the bank guarantee will never be called upon. The lessor does this by making the terms of the lease such that the bank guarantees can never be called up. The lease may provide that the leased guarantee may not be used as collateral without the consent of the lessor (which is never given); thus it may not be borrowed against.
  • Or the lease may provide a time limit for use by the lessee that the lessor knows cannot be met (e.g. See (3) below “leasing for HYIP).
  • An important warning to potential lessees is that if one leases a bank guarantee for “credit enhancement” and the bank guarantee cannot be called upon by the lessee, then any credit or loan issued to the lessee is based on a bank fraud committed by the lessee on the lending bank unless the lessee fully discloses to the lending bank the non-callability element of the bank guarantee. This is a felony . Of course, after such full disclosure, the lending bank will not consider the bank guarantee as a “credit enhancer”, so the whole idea does not work. Leasing is a usually a bad idea.

NOTE: It is, however, important to note that this author has been involved in situations where a bank guarantee is leased as part of a “financing for investment” structure; however, the instrument is always “at risk”, though there are several legal techniques for substantially diminishing the risk (but not eliminating the risk) of the guarantee to be called upon for payment. The remaining risks are worth the rewards the owner of the bank guarantee receives for its involvement.

c. Leasing for HYIP .

  • There is the leasing of bank guarantees that are issued by legitimate banks and with callable terms; however, the short term of the lease of the guarantee is such that the lessee cannot possibly perform (or never perform) within the time limits of the guarantee. Thus, the lessee does not timely perform and the lessor pockets a large fee.
  • An example of this situation is where a party agrees to lease a bank guarantee with the agreement that the lessee will place the guarantee in a performing high yield investment program approved by lessor. The lessee cannot find a performing HYIP within the time limit, because such HYIP's do not exist.

d. Checking authenticity of bank guarantees

  • The ICC states: “Anyone offered an investment opportunity supported by a financial instrument can have it checked out by the CCB for a nominal cost. Call +44(0) 208 591 3000 or e-mail This e-mail address is being protected from spambots. You need JavaScript enabled to view it for details.”
  • Big warning! What one (other than a very careful and knowledgeable attorney) must NOT due is to walk into a bank (including branch offices) with a bank guarantee (or standby letter of credit) to check on its authenticity. There is a high probability (a) the instrument is fraudulent, and (b) therefore one will be arrested “on the spot”, and that probability substantially increases if one is a minority; e.g. African-American, Hispanic, from the Mideast , etc.

e. Bank Guarantees From Small Offshore Banks

  • Usually bank guarantees from offshore tax haven banks (unless an affiliate of a major bank) have little or no value.
  • Often there is talk about having these bank guarantees “confirmed” (i.e. accept liability for the instrument) by a major bank, but in reality, this does not happen for the most part. This is particularly true with U.S. banks, as under the Patriot Act in essence they cannot do business with these small offshore banks.

f. Funding Projects Using Bank Guarantees and Standby Letters of Credit

  • A provider of a bank guarantee or standby letter of credit agrees to provide you one of these instruments from which you can borrow the funds to finance a project. The provider requires a fee; e.g. 1% up front and 7% on Closing. There is a often great charade of due diligence done by the provider to make sure that your project is financially feasible so that he or his lender will be comfortable that the project will generate income so that the loan you make against the guarantee instrument can be repaid and his instrument not called upon for payment.
  • This is all nonsense! It isn't going to happen! In order for the provider to have his bank issue a bank guarantee or standby letter of credit, he must put up collateral that at least equals the face amount of the guarantee instrument or have credit that satisfies the bank that if the instrument is called upon the provider can pay the full face amount of the guarantee instrument plus interest and fees. He must risk the money you borrow against his guarantee instrument for a fee of for example 7% of that amount.
  • So the provider has to put up as much collateral with the bank as you need to do your project, and then when the guarantee instrument is issued by the bank, you borrow the greatest amount that a bank will lend against the guarantee instrument, and the provider is exposed to liability for the full amount of your borrowing, principal and interest, if you don't pay back the loan.
  • Now, does it make any business or economic sense for the provider to expose the amount borrowed against the guarantee instrument for a fee that is maybe 5% of his total exposure? No one would do this just for a fee. It makes no sense and that is why it is a fraud…and the provider knows it is a fraud.
  • Closing Day . If the provider doesn't just take your front money and run, there will be a Closing Day ostensibly to “close” the transaction and give you your guarantee instrument (at which time you will have to pay more money). Here is what will happen on Closing Day; the provider will do one of the following: (a) not show up for the closing, (b) Make an excuse to continue the date of closing (often finding something wrong with your package that is not being accepted by a third party with high authority), (c) deliver a forged instrument, (d) deliver an instrument that is drawn on a far lesser bank than was agreed upon [sometimes a fictitious bank], (d) deliver an instrument where the terms and conditions of the instrument have been changed so that it is impossible to obtain a loan against it (though you may not realize it at the closing). There have been many victims who have paid money for instruments that have no loan value whatsoever. Also, see Warning on checking authenticity of instruments. It is also important to note that with rare exception these instruments are electronically created and delivered in bank-to-bank transactions.
  • So do not pay money or waste your time on financing through these types of guarantee instruments. It is a fraud! Bank guarantee or standby letter of credit, the scam is the same.
  • Please note, that this fraud label may not apply to situations where the provider is a joint venture partner and is prepared to take the full exposure on the guarantee instrument as his contribution to the joint venture. BUT in this situation, there should be no requirement of an “up-front” fee for use of the instrument . The provider may also do a legitimate deal if he receives acceptable collateral to collect against in the event of default; e.g. a lien on assets. But be careful here too! He may require the collateral as part of the scam.

7.- How does one collect on a bank guarantee?

The terms of the bank guarantee itself will advise the beneficiary of the precise terms that must be followed for presentment of the demand for payment and the collection thereof. These terms usually must be precisely followed. Read the instrument carefully!

8.- How does the bank handle a dispute?

Usually absent visible obvious fraud, the bank will pay according to the terms of bank guarantee without regard to looking at the actual performance by the beneficiary of the underlying agreement. If the obligor (bank's customer) feels that the bank should not pay because of non-performance or fraud by the beneficiary, then he should sue the beneficiary and interplead the bank seeking an injunction to prevent the bank from paying. The bank will stand on the sidelines until a court tells it what to do. The bank doesn't care how long the dispute takes, because it is holding and using the money for its own profits. Like insurance companies and large law firms, the banks have a license to steal, and this is what they do…this is their primary business. So they like a good dispute that is taken to court.

9.- Sample of Bank Guarantee (Payment Guarantee)

Today bank guarantees are usually issued by wire transfer from the issuing bank to the bank advising the beneficiary (“advising bank”); however, in certain business situations the bank guarantee is issued in hard copy form directly to the beneficiary.

(Name of Issuing Bank with Bank Coordinates)

 

_____________________

Payment Guarantee Number

Name of Beneficiary

Address

 
Date________________  
Amount $100,000.00

One Hundred Thousand Dollars (USD)

 
   
We have been informed that you concluded on December 10, 2002 a contract No. 111444 with ABC Inc. for sale and delivery of a rat shelter at a total price of $1,000,000.00. According to this contract, payment of the goods supplied, up to $100,000.00 (10% of the total price) has to be secured by a bank guarantee.

We XYZ Bank, 555 A . Street, Zurich, Switzerland, irrespective of the validity and the legal effects of the above mentioned contract and waiving all rights of objection and defense arising wherefrom, hereby irrevocably undertake to pay to you, upon you first demand, any amount up to the above mentioned maximum amount, upon receipt of your duly signed request for payment stating that

  • You have supplied the company ABC Inc. with the goods ordered, in conformity with the terms of the contract, and
  • You have not received payment from ABC Inc. at the due date, in the amount claimed under this guarantee.

For the purposes of identification, your written request for payment has to be presented through the intermediary of a first rate bank confirming that the signatures thereon are legally binding upon you.

Your claim is also acceptable if transmitted to us in full by duly encoded telex/SWIFT through a first rate bank confirming that your original claim has been sent to us by registered mail and that the signatures thereon are legally binding upon you.

Our guarantee is valid until December 31, 20__,

and expires in full and automatically, should your written request for payment or telex/SWIFT not be in our possession at our above address on or before that date, regardless of such date being a banking day or not.

Our guarantee will be reduced by each payment made by us as a result of a claim.

This guarantee is governed by Swiss law, place of jurisdiction and performance is Switzerland .

XYZ Bank.

 

 
Wednesday, 30 July 2014
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