Types of Performance Guarantees
Performance guarantee is the agreement between a client and a contractor to assure the client to perform the contractor’s obligation as per agreement.
In this respect, the Bank gives an undertaking to its client that contractor will do their job as per agreement. If the contractor fails to perform his duties as per contract, the bank will pay the damage up to the guaranteed amount. This guarantee might include a clause to protect the client against the losses incurred if the contractor fails to perform.
There are different types of guarantees that a bank will offer to its clients and parties. Following two types of Guarantees are very familiar and commonly used in the corporate field. These two are:
Advance Payment Guarantee
Advance taken from the buyer is a very common practice in today’s business. In this respect, the bank provides a guarantee to the buyer that the money given by him to the seller against advance payment to deliver the required goods. If the seller fails to comply with the requirements mentioned in the sale agreement, the seller will be liable to back the amount to the buyer. The Bank offered the guarantee to back the advance payment for non-compliance with the conditions.
This guarantee is also referred to as the “Bid Bond” guarantee. Both in International Tender and Local Tender, this guarantee is used where a contractor/supplier is obliged to comply with the conditions as mentioned in the agreement.
Types of Financial Guarantees
A financial guarantee is a contractual promise made by a bank, insurance company, or other entity to guarantee payment of a debt obligation of another party such as a company. Essentially, a financial guarantee is a type of warranty attached to a debt. Individuals may also provide financial guarantees, such as when a parent co-signs a loan for their child.
- Individual financial guarantees
Financial guarantees provided by individuals occur all the time. Parents with good, established credit may become a guarantor of debt by co-signing a loan agreement or rental agreement for one of their children who lacks an established credit history or has a poor credit rating.
- Bond guarantees
Many bonds issued by companies are supported with a financial guarantee of the bond’s payments to investors by an insurance company. In such cases, the insurance company may provide either a full or partial guarantee of the bond payments due.
- Financial guarantees from companies
Public or private companies commonly provide financial guarantees for their subsidiary companies. The parent company of a subsidiary typically has more extensive financial resources than the subsidiary company does. Therefore, if the subsidiary is seeking a large loan, the lender may require the parent company to act as a guarantor of the loan.
The lender may simply require a contractual obligation by the parent company to cover the debt repayment if necessary, or it may require that the parent company pledge assets as collateral for the loan. A company involved in a joint venture may also act as a guarantor of a debt obligation if it is financially much larger and financially sound than its partner in the joint venture.
- Bank financial guarantees
Banks frequently provide a wide variety of financial guarantees for their clients. One of the most commonly issued types of bank guarantees is a guarantee of payment to a seller by a buyer. Such a guarantee is often used in the case of large international transactions. As the seller may not lack sufficient knowledge about the buyer, they may require a guarantee of payment from the buyer’s bank.
The buyer’s bank may, in turn, require the buyer to deposit the necessary funds for the purchase with the bank. A bank may also provide what is known as a performance or warranty bond that essentially guarantees that the goods provided to a buyer are as promised and delivered as agreed by contract with the seller.
Banks also sometimes provide an advance payment guarantee, which is a promise to refund any advance payment on goods made by a buyer in the event that the seller fails to deliver the goods.
Assessment of Bank Guarantee Limit
Bank Guarantee a promise made by the bank to any third person to undertake the payment risk on behalf of its customers. Bank guarantee is given on a contractual obligation between the bank and its customers. Such guarantees are widely used in business and personal transactions to protect the third party from financial losses. This guarantee helps a company to purchase things that it ordinarily could not, thus helping business grow and promoting entrepreneurial activity.
The advantages are:
- Bank guarantee reduces the financial risk involved in the business transaction.
- Due to low risk, it encourages the seller/beneficiaries to expand their business on a credit basis.
- Banks generally charge low fees for guarantees, which is beneficial to even small-scale business.
- When banks analyse and certify the financial stability of the business, its credibility increases and this, in turn, increase business opportunities.
- Mostly, the guarantee requires fewer documents and is processed quickly by the banks (if all the documents are submitted).
Features of a Valid Guarantee
- The period until which the guarantee holds is clearly specified
- The guarantee issuance is always for a specific amount
- The purpose of the guarantee is very clear.
- The guarantee is valid for a particular period of time.
- The grace period allowed to enforce guarantee rights is also stated in the guarantee
- Guarantee clearly states the events under which it is enforceable.
Period of Claim under Guarantee
“Exception 3; Saving of a guarantee agreement of a bank or a financial institution: This section shall not render illegal a contract in writing by which any bank or financial institution stipulate a term in a guarantee or any agreement making a provision for guarantee for extinguishment of the rights or discharge of any party thereto from any liability under or in respect of such guarantee or agreement on the expiry of a specified period which is not less than one year from the date of occurring or non-occurring of a specified event for extinguishment or discharge of such party from the said liability.”
That said, the banks have often been stipulating a claim period of one year, or in some instances of less than one year.