Banker customer relationships Banker as surety (guarantees)

By T.G.PAUL MA,LLB,MBA,ACS,CAIIB Member of faculty Federal Bank

Banks may stipulate that the borrower should furnish guarantee of other persons for sanctioning any loan Eg: Personal Guarantee of Directors for loan to the companies. In such cases bank is the beneficiary
U/s 128 of the Contract Act the liability of the guarantor is co extensive with that of the Principal debtor Guarantor is liable only for what the principal is liable and not more than that.

Liability of the guarantor crystallizes when the principal debtor defaults Guarantors liability is determined by revocation of guarantee by him or by his death , insolvency etc. Here banker has to take care of the application of Claytons rule Banks normally takes continuous guarantee so that the liability extends to all transactions within the guaranteed limit and time,.
Right of subrogation (Section 140) On payment of the dues of the principal debtor the guarantor Is entitled to all right of the creditor against the principal debtor Limitation against the guarantor begin when a demand is made on the guarantor to pay the debt.

The guarantees executed by banks comprise both performance guarantees and financial guarantees and deferred payment . The guarantees are structured according to the terms of agreement, viz., security, maturity and purpose.
As regards maturity, as a rule, banks should guarantee shorter maturities and leave longer maturities to be guaranteed by other institutions. No bank guarantee should normally have a maturity of more than 10 years. Section 20 of the Banking Regulation Act, 1949 prohibits banks from granting loans or advances to any of their directors or any firm or company in which any of their directors is a partner or guarantor.

Financial guarantee is issued in lieu of monetary obligations. For example, a contractor wants to bid for a tender for Rs.50 lakhs for the construction of a building for a Government Department and the earnest money specified to be deposited is Rs.50,000/-. The Department accepts bank guarantee for Rs.50,000/- instead of the earnest money. This bank guarantee is a financial guarantee. Another example is the guarantees issued at the request of customers favouring Customs in respect of payment of customs duty by the customer. Performance guarantee is issued in respect of performance of a contract or obligation. Even though these guarantees are for performance, in such cases, in the event of non-performance of the obligations as per the terms of the contract, the bank assumes under the guarantee, only monetary liability upto specified amount, and for a specified period and not due performance of the contract like construction of a building or supply of materials etc. (Indirectly such guarantees are Financial Guarantees).

The period of the guarantee can be extended on the same terms and conditions at the request of the borrower and co-obligants, if any on whose behalf the guarantee is issued. Letter of request from the borrower for extension of the guarantee and copy of the extension letter from the Bank to the beneficiary should be kept in the document file. The signature of the borrower should be obtained in the copy of the extension letter.

The following clause is incorporated in the guarantee / Letter of extension of period of guarantee as the concluding clause. "Notwithstanding anything herein contained, our liability under this guarantee shall: be limited to a sum of Rs..........(Rupees..........only) be completely discharged and all your rights under the guarantee shall stand extinguished if no claim or demand is made upon us in writing and received by us on or before ............". The guarantee does not contain any clause(s) contrary to the contents of the above limitation clause. No obligation other than making payment of the guarantee amount under the terms of the guarantee is undertaken.

Restrictions on guarantees of inter-company deposits/loans Banks should not execute guarantees covering intercompany deposits/loans thereby guaranteeing refund of deposits/loans accepted by NBFC/firms from other NBFC/firms.

The Supreme Court had observed [U.P. Co-operative Federation Private Ltd. Versus Singh Consultants and Engineers Private Ltd. (1988 IC SSC 174)] that the commitments of the banks must be honoured, free from interference by the courts.

While drafting / vetting a BG ensure that the terms are very clear And no inconsistence clauses are there. A not withstanding clause at the end is a must. The extent of the liability should be clear. The validity period should be specific. Period for invocation can also be given if needed. If not invoked within the validity period bank stands discharged should be mentioned Payment has to be made if invocation is proper. On demand without demur the bank has to pay the money if invoked.