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Bank Guarantees

Section 126 of the Indian Contract Act 1872 defines a contract of Guarantee as a a Contract to perform the promise or discharge the liability of a third person in case of his default.

Parties to the Contract

The Beneficiary The Guarantor

Guarantee is a collateral contract, consequential to a main contract between the applicant & beneficiary

The contract of Guarantee is distinctly different from the contract of Indemnity

Sec.124 of the Indian contact Act 1872 defines contract of Indemnity as a contract by which one party promises to save the other from loss suffered by him by the conduct of the promisor himself or by the conduct of any other person

Parties to Indemnity
1. Indemnifier---Person who promises to make good the loss 2. Indemnified---Person whose loss is to be made good

Guarantee 1. 3 parties Applicant,Beneficiary, Guarantor 2. Guarantors liability begins only after default is committed by the principal debtor Indemnity 1. 2 parties Indemnifier Indemnified 2. The Indemnifier may be asked to discharge whenever the indemnified suffers a loss.

Types of Guarantees
Bank Guarantee

Ordinary Guarantee

Deferred Payment Guarantee

Financial Guarantee

Performance Guarantee

What does a Financial Guarantee do?

It guarantees the customers (applicants) financial worth, creditworthiness & his capacity to take up financial risks Liability is reduced to monetary terms

What does a Performance guarantee do?

The Guarantee obligations relate to the technical, managerial, administrative experience & capacity of the customer. Liability is reduced to monetary terms. (Bank is not going to be asked to perform the contract in case of default by the applicant) (only the financial loss on a/c of non performance of the commitment)

Bank guarantees payment of specified amount over a period of time>1 year but less than 10 years

1. For EARNEST performance of MONEY/ machinery/goods TENDERDEPOSIT supplied


2. ISSUED TO Govt.depts for releasing disputed claims money like excise/customs

2. For satisfactory performance of Turnkey projects for a specific period

Appraisal of BG Limit
Single transaction or Regular limit 2. Purpose 3. Need for the BG limit (Related to business) 4. Nature of BG (Financial or Performance) 5. Amount of BG 6. Applicants financial strength/capacity to meet his liability under the BG on invocation (ABS & P/L) 7. Past record (in respect of BGs issued/invoked/paid) 8. Margin 9. Collateral security offered 10. Installed capacity & financial capacity to meet margin on BGs & WC reqd.

BG-Other features
1. Format of the GuaranteeApproved by C.O 2. Period-Normally for 12 monthsInclude 3. 4. 5. 6. 7.

without fail, the Claim(Grace) period Limitation clauseensure before signing Documents to be obtained as per rules MarginStipulated margin to be collected Collateral security3rd party guarantee, Property/stocks/machinery//others Commission to be collected as per rules in force

Discussion on

1. Invocation of guarantee 2. Cancellation of Guarantee 3. Return of Expired Guarantee

Assessment of BG limit Exercise