Issuance of Bank Guarantee – Precautions to be taken :

The liability of bank issuing bank guarantee is based on two factors (a) the amount guarantee and (b) the period of guarantee. These two aspects need be mentioned in the guarantee unequivocally. In the absence of clarity of either one or both of these factors, the bank’s liability could become unlimited either in terms of amount or period of guarantee. Banker should necessarily obtain a counter guarantee from his customer on whose behalf he has issued the bank guarantee. In case the banker is required to pay the guarantee amount,he can fall back on the counter guarantee to claim the amount paid by him. We need to know about this a little more in detail as it helps us in dealing with day-to-day matters on bank guarantee as bakers.

Amount of guarantee agreed to be mentioned both in figures and words. While stating the amount, bank should be clear as to whether the amount is inclusive of interest, charges, taxes etc. Bank should mention a certain amount clearly and say that it is the only amount payable irrespective of any other claim. In other words, bank should take care of chances of any loose interpretation at a later stage. When the bank issues performance guarantee, the mention of amount of liability in clear and unambiguous terms becomes all the more important.

The period during which the bank guarantee subsists in called the validity period and the period during which the claim could be preferred in called the claim period. Bank guarantee’s validity period should be specified to exact date, for example. “This guarantee is valid up to 31 December, 2014.” Specific mention about claim period is equally important as, for example, “Claim under this guarantee must be made within 3 months from the validity period and the last date of such claim shall not be later than 31 March 2015.” It is necessary to provide for a period slightly longer than the validity period for the beneficiary to make a claim. The claim period is usually a few months more the validity period of the guarantee. This claim period is a sheer necessity as the debtor could possible commit a default even on the last day of the validity period. Taking in to account the time to communicate the invocation etc., the claim period should at least be 15 to 30 days after the validity period, it may even go up to 3 months.

Prior to amendment of Section 28 of the Indian Contract Act, 1872 most bank guarantees had a standard clause at the end of their guarantee agreement.as per this clause, the beneficiary was required to enforce his claims within a period of three to six months, failing which the banks liability was extinguished and hence the rights of the beneficiary. This clause was necessitated due to the fact that in the absence of it, Government Departments and Municipal Bodies need to file a suit against the bank under a bank guarantee within a period of 30 years after making a claim. The banks would therefore be required to carry forward the liability for a long period and thereby make provisions for the same in their balance sheet. Further more, cash margin and security furnished by the customer would have had to be retained for that long a time. Though this clause was challenged before various High Courts, there was not much relief as Courts held that such clauses are not violate of Section 28 of the Contract Act.

With effect from 1st January, 1987, Section 28 of Indian Contact Act been amended due to which the standard limitation clauses in the bank guarantees by which the banks extinguished their liability have been declared illegal. As such, at present, if a beneficiary were to invoke the guarantee within the claim period, for a default committed by the debtor during the validity period, then in case the bank did not make payment, the beneficiary can sue the bank within the normal period as provided in the Limitation Act, 1963. This period under the Limitation Act is 30 years in case the beneficiary is a Government Department or Municipal Body and 3 years in all other cases.

It is prudent therefore that the bank insists that the bank guarantee be returned after the claim period duly cancelled by the beneficiary or a certificate be obtained from the beneficiary that there is no claim under the guarantee. Till such times, the cash margin and the security of the debtor (customer) have to be retained.

As bank guarantee is a contingent liability, it is always prudent for a banker to secure this contingent liability in case it is enforced. This can be done by obtaining a counter guarantee –cum-indemnity executed by the customer in favour of the bank. The counter guarantee –cum – indemnity should be carefully drafted to ensure that in case the bank were to make payment on behalf of the customer, then the customer in turn should not only make good the amounts paid by the bank to the creditor but also any expenses connected therewith including costs of attorney, any interest on delayed payment, taxes and other levies. It is to take care of all the payments that the counter guarantee also includes an indemnity aspect. The counter guarantee should also include a clause that it would remain in force till the guarantee given by the bank subsists viz., till the bank is duly discharged by the beneficiary or a certificate to this effect is issued by the beneficiary.

Though a counter guarantee-cum-indemnity is taken as a security for every guarantee issued by the bank, its values would depend on the financial standing of the person/company giving the counter guarantee. As such, it is preferable that keeping in mind the financial worth of the counter guarantor, necessary security in the form of fixed deposits, mortgage etc. be obtained or the existing charge of the debtor be also extended to cover the guarantee.