Bank Guarantee

In international trade, it is difficult for the buyer to accurately assess the professional ability and financial position of a supplier or seller. The situation is worst when both parties are domiciled in different countries. The buyer therefore, quite rightly, demands that the seller’s ability to perform be secured and for this purpose a Bank Guarantee (BG) is arranged. In general, the use of the BG as an instrument for securing payment is restricted in international trade to non-payment guarantees used for the “open account” mode of payment.

A BG may be defined as the "irrevocable obligation of a bank to pay a sum of money in the event of non-performance of a contract by a third party". Similar to Letter of Credit, the guarantee is a separate obligation independent of the principal debt or the contractual relationship between the creditor and the principal debtor. Under the terms of the guarantee, the bank has to pay on first demand provided that the conditions contained in the guarantee are fulfilled. Guarantees are, as a rule, subject to the laws of the country of the issuing bank. Meaning to say, when a BG is issued by a bank in Malaysia, it is governed by the Malaysian laws. Under Swiss law, the parties are free to determine the contents and form of a guarantee. Generally, the contents of a BG more or less is standardized to suit to the issuing bank’s laws. However, minor adjustment is permissible subject to approval of the issuing bank. Issues or clauses not provided for would be adjudicated on basis of Article 111 of the Swiss Code of Obligations.

There are few example of related guarantees for securing performance or payment namely, the ‘simple’ guarantee (Swiss Code of Obligations, Art 495) and the ‘Joint and several’ guarantee (Swiss Code of Obligations, Art 496); by the contract of guarantee, the guarantor is obligated to make payment if the principal debtor becomes insolvent and goes bankrupt. The contract of guarantee presupposes a valid principal debt and also become void if the principal debt ceases to exist. In Switzerland, contracts of simple and/or joint and several guarantees are used almost exclusively for securing claims of domestic creditors.

The confirm payment order (Swiss Code of Obligations, Art 468); As in case of the guarantees, the irrevocable confirmed payment order includes an irrevocable, not accessory obligation to pay. Payments under this instrument can be subject to the fulfillment of the special conditions of this order. The documentary credit is an important case of application of the irrevocable, confirmed payment order.

As in the case of the documentary credit and the documentary collection, the International Chamber of Commerce in Paris has issued ‘Uniform Rules for Contract Guarantees’. But these guidelines issued in 1978 have not been generally accepted.

Red Clause Credit

The purpose of red clause in a documentary credit is to enable the beneficiary to obtain pre-shipment advances from the advising or confirming bank, at the expense of the beneficiary, but under the responsibility of the issuing bank. This red clause is so termed because it is usually printed in red on the credit to draw attention to this special feature of the credit terms.

Red clause has been used traditionally, in certain countries where goods, such as wool, cotton, meat, rubber etc, need to be purchased by a beneficiary who requires advances in order to pay for goods either directly or at auctions. Under the terms of the credit, an intermediary bank is authorized by the issuing bank to make advances to the beneficiary so that he may pay in this way. When in due course the goods are shipped and complying shipping documents presented, the proceeds are used to liquidate the pre-shipment advances, proportionate interest being taken or claimed.

Advances are usually made in local currency to avoid any fluctuation in exchange rates between the time of the advance and the time payment or negotiation is effected. If the credit is expressed in a currency other than local currency, it should stipulate for whose account any exchange difference will be.

If a red clause credit is available for negotiation rather than payment, it need not be restricted to the intermediary bank responsible for providing the advances as long as the eventual proceeds of the credit are made available to that bank. There are two main types of red clause:

1. The unsecured or clean red clause, under which the advances are authorized against the beneficiary’s statement that they are required to pay for pre-shipped goods.

2. The secured or documentary red clause, under which advances are made against presentation of warehouse receipts or similar documents together with the beneficiary’s undertaking to deliver the bill of lading and/or other documents required upon shipment (The warehouse receipts are usually returned to the beneficiary in trust so that he may then obtain the bill of lading). Here, the beneficiary may also be required to insure the goods while they are in store.

In the event of subsequent default by the beneficiary, including failure to present documents in compliance with the terms and conditions of the credit, the intermediary bank has the right to claim refund of its advances, together with interest and any other charges, from the issuing bank.

There is a third type of clause which may be used, the ‘receipt and undertaking’ or ‘invoice and undertaking’ clause, which differs from both the above in that the intermediary bank makes advances against the beneficiary’s receipt or invoice together with his undertaking to refund the advance in the event of failure to present complying documents under the credit.Advances under the ‘receipt and undertaking’ clause are not normally made from the intermediary bank’s own fund but against immediate reimbursement from the issuing bank, with the beneficiary being responsible to the issuing bank in the event of default.

Clean red clause:
"As the accredited may have to pay for the wool before shipment, kindly grant him advances to enable him to make such payments agaisnt his statement that the money is required for the purpose of the aforesaid. We accept responsibility for the repayment of anticipatory advances granted by you within the credit limits."

Documentary red clause:
"As the accredited may have to pay for the goods before shipment please grant him advances for the purpose of making such payments against Warehouse Receipts or other documents evidencing the right to claim possession of the goods and the undertaking to deliver the relative Bills of Lading in due course. Such Warehouse Receipt or other documents may be entrusted to the accredited in exchange for his acknowledgement that the documents are held by him as trustee for you and as your agent to obtain for you in exchange the relative Bill of Lading. The goods, whilst in the warehouse pending shipment are to be insured by......................... . We accept responsibility for the repayment of anticipatory advances granted by you within the credot limits."

Invoicing and undertaking clause:
"As the accredited will have to pay for the goods, processing and ancillary charges before shipment, negotiation may be made to the beneficiary against invoices evidencing firstly cost of goods and/or processing and ancillary charges and the beneficiary's undertaking to produce the relative shipping documents in due course. We accept responsibility for meeting such payments under the terms of the credit."

Revolving Letter of Credit

A revolving credit (RC) is one that is available for an amount that remains constant for a given period of time so that whenever it is drawn upon, it becomes available again for the full amount, either immediately or as soon as advice is received from the issuing bank that earlier presentations are acceptable to them. Alternatively, it may be made available for a reducing sum during a given period of time, to become automatically available again for the original sum at the end of the period. If the renewal of amount is not automatic but subject to reinstatement instructions after each drawing, it is not strictly a true RC but rather one of fixed amount which has to be increased by means of amendment.

RC may be renewable as to amount and time as follows:

· RC may be available for up to, say USD10,000 at any one time, and as soon as a drawing is made the amount drawn immediately becomes available gain. Often there is no limit to the number of drawings that may be made of up to USD10,000 each, except perhaps a qualification as to how much may be drawn per day; such RC continues to be drawn upon and reinstated until it expires.

· RC may be available for up to USD10,000 per week or per month. The amount is automatically available each week or month irrespective of whether any sum has been drawn during the previous week or month. This can be on a cumulative or non-cumulative basis, cumulative being more common, i.e. un-utilized amounts are carried forward and added to the total amount available for the following week or month.

RCs that revolve around amount, as in the first example, are rarely confirmed since it is virtually impossible to establish the total liability that may be incurred during the life of the RC. RCs that revolve around time (example 2) are more likely to bear confirmation since the overall amount of liability is ascertainable.

RCs should not be confused with LCs available by instalments. If an LC has an overall limit as to amount and validity and permits specified drawings or quantities of goods to be shipped at appointed periods of time during that validity, it is an LC that is available by instalments and as such is subject to UCP 600 article 32, “if a drawing or shipment by instalments within given periods is stipulated in the credit and any instalment is not drawn or shipped within the period allowed for that instalment, the credit ceases to be available for that and any subsequent instalment.”

Shipping Guarantee: Part 2

In international trade, banks deal with documents and not with physical goods although these documents represent goods and movement of goods. The regulatory and commercial requirements of international trade have resulted in the use of many and varied documents. It is not unusual to see exports department and imports department staff of banks buried under huge mass of documents. You will appreciate that due to this inherent characteristic of international trade shipping documents through delays, losses in the mail and bureaucratic procedures may arrive after the goods have reached their destination. Non-arrival of shipping documents may result in the importer facing a loss should he not be able to take delivery of goods and sell them especially if they are perishable goods. To assist the importer to take delivery of the goods a Shipping Guarantee (SG) is issued in favour of the carrier of the goods.

In general, SGs only relate to bills of lading that have been delayed, lost, mislaid, stolen or destroyed.

SG is an indemnity given by the consignee to which the bank jointly indemnifies the carrier of goods so that the consignee so named can take delivery of the goods without production of the relevant bills of lading. The consignee and the bank jointly undertake to indemnify the carrier against all liabilities relating to the delivery and undertake to surrender the bill of lading duly endorsed to the carrier on receipt of it.

On receipt of notice of arrival of ship bearing the goods, the consignee will ascertain whether the bank has received the relevant shipping documents, particularly the bill of lading. If the shipping documents are not on hand, the consignee will then request the bank to issue a SG.

The normal prudent consideration for a banking facility is applied. If the consignee is someone who is not known to the bank or who has had minimal dealings with the bank, a deposit varying in amount up to the full invoice value of the imports normally required by the bank. This deposit is commonly known as a margin and provides the requisite security should the consignee turn out to be someone who is not entitled to the goods. A counter indemnity is also taken whereby the consignee undertakes to indemnify the bank against all losses, damages and expenses in relation to the issue of the SG and at the same time undertake to deliver the bill of lading duly endorsed on receipt or obtain a discharge of the bank’s liability under the indemnity. Having satisfied that all precautions have been taken the bank will then issue the SG and forward it to the carrier or his representative for the goods to be released.

On receipt of the shipping documents, the bank will extract the bill of lading and after having obtained the required endorsements forward it to the carrier to redeem the SG.

Commercial Invoice

Commercial Invoice is a bill for the goods shipped to the buyer. It is the accounting document for seller’s claim on the buyer for goods sold to the buyer. Commercial Invoice would normally contain the following information:

1. Names and addresses of the buyer and the seller
2. Date of invoice, sale contract or firm order, reference number, date and etc
3. Unit prices, if any, final sum claimed, shipment terms
4. Settlement terms viz sight, tenor, DA/DP and etc
5. Shipping marks and numbers
6. Weight/quantity of the goods
7. Name of the vessel, port of embarkation etc

In addition to these particulars, the following details are generally given in the commercial invoice to facilitate customs clearance in the importing country:

1. Country of origin of the goods
2. Ports of loading and discharge
3. Details of freight and insurance charges (where applicable)
4. Commissions payable to an agent
5. Seller’s certification under signature certifying value of goods and relevant particulars to be correct

When an invoice is to be tendered under terms of the LC, care must be taken to comply with the following requirement:

1. Invoice – made out to the seller – beneficiary (exception to transferable LC)
2. Must be addressed to the opener or such other party as specified in the LC
3. Description of goods must exactly correspond with description in the LC
4. Quantity must agree with that stated in the LC – subject to tolerance limits permitted under UCP
5. Price and price basis must be specified and agree with the LC terms
6. Signed, if expressly stated in the LC
7. Identifying marks, numbers, gross/net weight, number of packages etc agree with all other

8. relevant documents e.g. BL, insurance etc
9. Only permitted items of costs included
10. License number etc specified when stipulated
11. Amount should not exceed LC amount subject to the provision of UCP

There are variations of invoices which are used for various purposes either as a substitute or along with commercial invoice. Such widely used documents are:

1. Certified Invoice
2. Legalized Invoice
3. Combined Certificate of value and origin
4. Visaed invoice

Standby LC and Principle of Autonomy

The traditional LC for import and export transaction is issued to provide the exporter with a guarantee of payment when performance has occurred by submitting documents in accordance with the terms and conditions of the LC. However, the standby LC (SBLC) for import and export transaction is issued to provide the exporter with a guarantee which is only activated in the case of non-performance of another pre-arranged activity. The development of SBLC took place in the United States where the banks do not have the power to issue performance bonds and first demand guarantee.

SBLC can be issued in lieu of performance guarantee in construction contracts, as a guarantee to loan repayment or as a guarantee to a seller as a back-up to some other pre-arranged method of finance. In transactions involving the manufacturing and the sale of goods, SBLC can also be used to secure payment of the price; the payment of liquidated damages for faulty performance; and to cover a deposit repayable in the event of the non-performance of the underlying contract. Losses which could be incurred in a take-over of a company and arising from the non-payment of a promissory note, the payment of rental and the payment of an amount can be, likewise, secured by SBLC.

The beneficiary can usually draw under the SBLC on the basis of providing a certificate or statement that a specific agreement has not been complied with. Given that specified documentation is presented, the bank called upon will be required to pay, regardless as to whether or not the applicant of the LC considers he has performed. Just as in the case of commercial LCs, the payment of a SBLC is subject to the tender of a fully complying set of documents by beneficiary.

The autonomy of a SBLC leads to certain problems. As the bank’s undertaking frequently assumes the form of a promise to accept a bill of exchange accompanied by a default certificate or statement, the beneficiary, who executes the two documents, is in a position to abuse the rights conferred on him.

For example, in the case of Intraworld Industries Inc vs Girard Trust Bank, a SBLC was issued by a bank in order to cover annual rentals due under a lease of a hotel. Payment was to be effected against the beneficiaries’ sight draft, accompanied by their written statement confirming the non-payment of the rent. As the account party (the lessee) mismanaged the hotel to such an extent as to seriously damage its international reputation, the beneficiaries cancelled the lease. They made a demand under the SBLC in order to recover an amount of liquidated damages due under the terms of the lease in lieu of rent.

The account party brought an action for an injunction to restrain the bank from paying. He alleged that the beneficiaries’ demand for fraudulent because it did not involved a genuine claim for rent, as represented in the default notice, but a “stipulated penalty”. Dismissing this action, the Supreme Court of Pennsylvania observed that the circumstances which would justify the granting of an injunction were limited to situations of fraud in which the “wrongdoing” of the beneficiary had vitiated the entire transaction.

In another case, Bossier Bank & Trust Company vs Union Planters National Bank, the Circuit Court of Appeals emphasized that an injunction could be granted only if the alleged fraud related to the relationship between the issuing bank and the beneficiary and not the underlying contract between the beneficiary and the account party.

Shipping Guarantee

Shipping Guarantees are issued by banks to enable importing customers to effect clearance of goods in circumstances where the bill of lading covering the cargo has not come forward or may be missing. In doing so, the bank incurs liability in respect of the goods. Also, of course, it may involve loss of control of the goods, the documents for which the bank has been entrusted to handle.

Shipping guarantees are only issued in respect of missing bill of lading where the guarantees relate to documents which are definitely expected to come forward through the bank. In the absence of already approved credit facilities under which a shipping guarantee may be issued, all applications for shipping guarantees are subject to a credit appraisal of the applicant. Where the standing of an applicant does not justify clean credit facilities, a cash margin (normally 100%) is taken. In all cases, it is essential that banks satisfy themselves from appropriate and reliable documentation regarding the value of the cargo prior to the issue of the guarantee. Shipping guarantees may not be issued in respect of cargo under lien to another bank.

Upon clearance of goods, the guarantee must be returned to the issuing bank for cancellation. It should not remain outstanding for more than one month from the date of its issuance. It is customary, where bank would initiate an enquiry into the reason for its non-return immediately after expiry date of the guarantee.