Romana, MBA (B&F) 3
Term 2009-2011 Page 1
Letter of guaranteeissuing banks risks and obligations
A guarantee is an undertaking given by a person/bank to be answerable for the debt, default ormiscarriage of another person/bank.A guarantee may be specific or continuing. When the guarantee is specific, the guarantor is answerablefor a particular loan only. In case the guarantee is continuing, the guarantor shall promise to pay wholeor part of transactions carried out by the debtor.
Characteristics of guarantee
The main characteristics of guarantee are as under:-
There are three parties in guarantee:1.
The primary liability to pay the debts falls on the original debtor. The guarantor will pay only theprincipal debtor fails to pay whole or part of agreed debt.
The guarantor is answerable for the loan if the debtor defaults. Guarantor has no interest in thecontract between principal creditor and principal debtor.
Capacity to contract
or firms who are able to make contracts may stand as surety for loans.
Minors and persons of unsound mind are not eligible to enter into contract of guarantee.
Married women have capacity to contract only against their separate estates. The bankhowever should avoid accepting guarantee of married women.
ypes of bank guarantee
addressed to shipping companies requiring the issue of delivery orders inthe absence of original bill of lading.2.
. These are guarantees given by the bank to financial institutions (e.g. IDBP)and companies (the creditors or beneficiary) undertaking to pay the debts of its customer(theprincipal debtors) in the event of the default by the customer.
ender guarantee or bid bonds:
hese are issued by the bank to avoid the deposit of theearnest money by its customers when they tender for contract. The amount is usually 1% to 20%of the contract value and the duration is for very short period until the bids are opened and thecontract awarded. Once the bank issues the bid bond, it is usually committed to supporting theproject by issuing further guarantees such as performance bonds etc.4.
erformance guarantee/performance bond
: These are issued by a bank on behalf of itscustomer who has entered into a contract to supply goods or perform other services and theguarantee compensation in term of money in the event of non performance of such contract. Itis usually for 5% to 10% of the value of the contract and would remain in force throughout theperiod of the contract at a constant amount.5.
dvance payment Guarantee (
). These are issued where a customer receives an advancepayment in respect of the work to be performed or goods to be supplied under a contractundertaken by him and the bank as a guarantor, undertakes to repay the amount or the goods