Bank Guarantees (BGs) -Types & Use of Bank Guarantees

Bank Guarantee is an instrument issued by the Bank in which the Bank agrees to give guarantee against the non-performance of some action of a party. The amount of guarantee is called the ‘guarantee amount’. Usually, the Bank Guarantee is for a specified amount, which is a percentage of the total money required for the contract. The guarantee is issued upon receipt of a request from ‘applicant’ for some purpose/transaction in favour of a ‘Beneficiary’. The ‘issuing bank’ pays the guarantee amount to the ‘beneficiary’ of the guarantee upon receipt of the ‘claim’ from the beneficiary. This is called ‘invocation’ of the Guarantee.

Types of Bank Guarantees:

Bank Guarantees (BGs) are broadly classified into Performance and Financial BGs

Performance Guarantee are the ones by which the issuing bank, also known as the Guarantor, guarantees the ability of the applicant to perform a contract, to the satisfaction of the beneficiary.

Financial Guarantees are used to secure a financial commitment such as a loan, a security deposit, etc. These are issued on behalf of brokers, in lieu of the security deposit that needs to be paid at the time of becoming a member of the exchange. For example, guarantees of margin money for stock exchanges.

Other types of BGs are as Follows

  • Bid Bond Guarantee
  • ¬†Advance payment Guarantee
  • Guaranty for warranty obligation
  • Payment Guarantee/Loan Guarantee
  • Deferred payment Guarantee
  • Shipping Guarantee
  • Trade Credit Guarantee

Difference between a Bank Guarantee and a Usual Guarantee

  • A bank guarantee is not directly governed by Sec. 126 whereas a usual guarantee is governed by Sec. 126 of the Indian Contract Act, 1872.
  • A bank guarantee is a contract involving two parties i.e. the bank and the beneficiary whereas An ordinary guarantee is a tri-partite (3 parties) agreement involving the surety, the debtor and the creditor
  • The bank guarantee is independent of the main contract where as in an ordinary guarantee, the contract between the surety and the creditor arises as a subsidiary to the contract between the creditor and the principal debtor.
  • Bank guarantees generally have a time limit within which they are functional where as an ordinary guarantee does not have any time limit before which the debt has to be claimed.

Use of Bank Guarantee 

A bank guarantee might be used when a buyer obtains goods from a seller and runs into cash difficulties and can’t pay the seller. The bank guarantee would pay an agreed-upon sum to the seller. Similarly, if the supplier was unable to provide the goods, the bank would then pay the purchaser the agreed-upon sum. We could say that, the bank guarantee acts as a safety measure for the opposing party in the transaction.