Bank Guarantee Process in Bangladesh:
The Bank guarantee process in Bangladesh or performance guarantees are very popular and important in the era of mega development projects taking place in Bangladesh. As a result, this article will provide a comprehensive guideline on the concept of bank guarantee as well as the legal rules governing bank guarantees in Bangladesh.
A “contract of guarantee” is a contract to perform a third person’s promise or discharge his liability in the event of his default. The person who gives the guarantee is called the “surety”: the person in respect of whose default the guarantee is given is called the “principal debtor”, and the person to whom the guarantee is given is called the “creditor”. Similarly, when a bank provides any security, that security is referred to as the bank guarantee.
A bank guarantee means that the bank will ensure that the third party’s liabilities are met. In other words, for Bank Guarantee Process in Bangladesh, if the third party fails to meet its obligations, the bank will make up the difference. In summary, a bank guarantee can be defined as described above; however, the meaning of a bank guarantee is much broader than this.
In Bangladesh, the term “bank guarantee” has been defined in a large number of case laws. Nonetheless, in the most recent case, ABB India Limited vs. Power Grid Company of Bangladesh Limited and others of 2020, clear guidelines on bank guarantee issues were provided. As a result, our article will be based on the interpretations of this case, as well as references to other recent bank guarantee cases.
In regards to Bank Guarantee Process in Bangladesh, the term “bank guarantee” has been defined in a large number of case laws. Nonetheless, in the most recent case, ABB India Limited vs. Power Grid Company of Bangladesh Limited and others of 2020, clear guidelines on bank guarantee issues were provided. As a result, our article will be based on the interpretations of this case, as well as references to other recent bank guarantee cases.
How is a Bank Guarantee Created as per Bank Guarantee Process in Bangladesh?
The steps for creating a bank guarantee are summarised below.
(i) The applicant requests that the bank serve as a guarantee for their performance
(ii). The bank then enters into an agreement with the beneficiary at the applicant’s request.
(iii) In the deed of bank guarantee, the bank guarantees to pay the beneficiary a fixed amount specified in the deed of bank guarantee on demand if the applicant fails to perform as per the contract.
Bank Guarantees Explained
A bank guarantee is a promise made by a lending institution to cover a loss if a borrower defaults on a loan. The guarantee allows a company to purchase items that it would not be able to afford otherwise, promoting business growth and entrepreneurship.
Bank guarantees come in various forms, including direct and indirect guarantees. In foreign or domestic business, banks typically use direct guarantees issued directly to the beneficiary. Direct guarantees are used when the bank’s security does not rely on the main obligation’s existence, validity, and enforceability.
Individuals frequently choose direct guarantees for international and cross-border transactions because they are less formal and can be more easily adapted to foreign legal systems and practices.
Indirect guarantees are most common in the export business, particularly when government agencies or public entities are the beneficiaries. Many countries refuse to accept foreign banks and guarantors due to legal concerns or other formalities. With an indirect guarantee, a second bank, typically a foreign bank with a branch in the beneficiary’s country of residence, is used.
Bank Guarantee Examples:
In regards to Bank Guarantee Process in Bangladesh, There are numerous types of bank guarantees due to their general nature:
- A payment guarantee ensures that the purchase price is paid on time.
- An advance payment guarantee serves as collateral for reimbursing the buyer’s advance payment if the seller fails to supply the specified goods per the contract.
- A credit security bond serves as collateral for loan repayment.
- A rental guarantee is used to secure rental agreement payments.
- A confirmed payment order is an irrevocable obligation in which the bank pays the beneficiary a predetermined amount on the client’s behalf on a specific date.
- A performance bond serves as collateral for the buyer’s costs if services or goods are not provided in accordance with the contract.
- A warranty bond acts as collateral to ensure that ordered goods are delivered on time.
Company A, for example, is a new restaurant that wants to spend $3 million on kitchen equipment. Before shipping the equipment to Company A, the equipment vendor requires a bank guarantee to cover payments. Company A asks the lending institution that manages its cash accounts for a guarantee. In essence, the bank cosigns the purchase contract with the vendor.
A bank guarantee program is also available from the World Bank. The World Bank’s project-based loan guarantees protect commercial lenders from payment defaults or failures by governments to meet performance obligations.
Bank Guarantee Types
There are two types of bank guarantees that are commonly used in business:
Financial Security
In most cases, for Bank Guarantee Process in Bangladesh these guarantees are issued in lieu of security deposits. Some contracts may require the buyer to make a financial commitment, such as a security deposit. Instead of depositing the money, the buyer can provide the seller with a financial bank guarantee, which will compensate the seller in the event of a loss.
Performance Warranty
These guarantees are given in exchange for the performance of a contract or obligation. The bank will make good the beneficiary’s loss if there is a default in the performance, non-performance, or short performance of a contract.
For example, A signs a contract with B to complete a specific project, and the contract is backed up by a bank guarantee. If A fails to complete the project on time and does not compensate B for the loss, B may seek compensation from the bank using the bank guarantee.
Considerations before entering into a Bank Guarantee Agreement
When a beneficiary enters into a bank guarantee agreement, it is critical that the following factors are properly considered, particularly when foreign entities obtain bank guarantees from banks outside their home country. The following are the key points to consider:
(i) Bank guarantee agreement terms and conditions
(ii) Terms and conditions relating to the extension of a bank guarantee, such as the process for extending the guarantee period, the number of times it can be extended, and so on (
iv) What documentation is required for a bank guarantee?
(v) The time required for the encashment of a bank guarantee.
(vi). If the bank guarantee agreement contains an arbitration clause. This clause aids in the resolution of any dispute in a timely manner.
(vii). It is also critical to investigate the authenticity and dependability of the bank that will act as the beneficiary’s guarantor.
Bank Guarantee Regulations
According to Bangladeshi case law and Bank Guarantee Process in Bangladesh, the most important thing to remember about bank guarantees is that they are an independent deed of the contract between the bank and the beneficiary, even if the bank enters into the contract at the request of a third party (applicant).
The following are a few key points to remember regarding bank guarantees from the recent case ABB India Limited vs. Power Grid Company of Bangladesh Limited and others of 2020:
(i) A bank guarantee is a legally binding agreement between the bank and the beneficiary.
(ii) The applicant is not a party to the bank guarantee agreement for the Bank Guarantee Process in Bangladesh.
(iii) The bank guarantee agreement is independent and distinct from the beneficiary-applicant agreement (iv). A bank guarantee is an irrevocable undertaking given by a bank to pay an amount in favor of its beneficiary as and when the beneficiary makes a demand on the underlying contract, without regard to any dispute between the applicant and the beneficiary.
(v) Whenever the beneficiary makes a demand to encash the bank guarantee, the bank is obligated to pay the money immediately.
(vi) A guarantor’s undertaking to pay under the guarantee is not subject to any claims or defenses based on any relationship or contract between the third party and the beneficiary.
(vii). As a result, there is no way to prevent its encashment by the bank, let alone a third party. Because the third-party/applicant is not a party to the bank guarantee agreement, this is the case.
(viii) Bank guarantee encashment cannot be barred on the basis of financial loss or business reputation because financial claims can always be resolved in arbitration.
(ix) In a number of cases, the court has extended the bank guarantee period even after it had expired while the court proceedings were in progress. In the case of Loyal Shipping (Pvt.) Ltd. vs. M.V. Anangel Wisdom and others, the court ordered an extension of the bank guarantee even though the request for an extension of the validity of the bank guarantee or for a new bank guarantee was made after the expiry of the previous bank guarantee.
Exceptions to the Bank Guarantee Law
The bank can only stop the encashment of a bank guarantee if a dispute is raised. Only the bank has the authority to file a valid and genuine dispute regarding the encashment of a bank guarantee if-
I the wrong person invokes the bank guarantee’s encashment; or (ii). Any other discrepancy in the bank guarantee is discovered by the bank.
Exception to Bank Guarantee Approved by the Court
In general, no injunction can be granted to prevent the encashment of a bank guarantee. According to ABB India Ltd vs Power Grid Company of Bangladesh Ltd and others (2020), the court has the authority to halt the encashment of a bank guarantee only when-
(i) Clearly fraudulent preparation of the bank guarantee (Himadri Chemicals Industries Limited vs Coal Tar Refining Company (2007) 8 SCC 110). and
(ii) If successful, the encashment will cause irreparable harm that cannot be reimbursed or recovered (U.P. Coop, Federation Ltd vs Singh Consultants and Engineers (P) Ltd (1988) 1 SCC 174).
Our country’s courts will grant injunctions over any civil dispute, such as a bank guarantee, if the applicant can show that there is an arguable case for the applicant and the loss cannot be recovered or reimbursed. Read the reference to the bank guarantee.
Difference between BG & Letter of Credit (LOC)
LOC is a financial document that requires the bank to pay the beneficiary upon completion of certain services as specified by the applicant. LOCs are issued by banks when a buyer requests that his bank pay the seller upon receipt of certain goods or services.
That is, if the buyer encounters cash flow issues or other similar situations and is unable to make an immediate payment to the seller, he will approach his bank and request that payment be made to the seller upon submission of certain documents. It is important to note that a bank guarantee is not the same as a letter of credit, although with both instruments the issuing bank accepts a customer’s liability if the customer defaults.
The bank will later recover the amount paid from the buyer, as well as the applicable charges. In contrast, under BG, the bank is only required to pay the third-party if the applicant fails to pay the third-party or fails to fulfill the contract’s required obligations.
A BG is essentially used to protect a seller from loss or damage caused by the other party’s failure to perform under a contract. LOC is frequently confused with BG because they share some characteristics. When the parties to the transactions do not have established business relationships, they both play an important role in trade financing. However, there are numerous distinctions between LOC and BG.
The following are the primary distinctions between a Letter of Credit (LOC) and a Bank Guarantee (BG):
Major differences between Letter of Credit (LOC) and Bank Guarantee (BG) are as follows:
| Particulars | Letter of Credit (LOC) | Bank Guarantee (BG) in Bank Guarantee Process in Bangladesh |
| Nature | LOC is an obligation accepted by a bank to make payment to a beneficiary if certain services are performed. | BG is an assurance given by the bank to the beneficiary to make the specified payment in case of default by the applicant. |
| Primary liability | Bank retains the primary liability to make the payment and later collects the same from the customer. | The bank assumes to make the payment only when the customer defaults to make payment. |
| Payment | Bank makes the payment to the beneficiary as and when it is due. It need not wait for a default to be made by the customer. | Only when the customer defaults the payment to the beneficiary, the bank makes the payment. |
| Way of working | LOC ensures that the amount will be paid as long as the services are performed as per the agreed terms. | BG assures to compensate for the loss if the applicant does not satisfy the specified conditions. |
| Number of parties involved | There are multiple parties involved here – LOC Issuing bank, its customer, the beneficiary (third party), and advising bank. | There are only three parties involved – banker, its customer, and the beneficiary (third party). |
| Suitability | Generally, this is more appropriate during the import and export of goods and services. | Suits any business or personal transactions. |
| Risk | Bank assumes more risk than the customer. | Customer assumes the primary risk. |
What is a Bank Guarantee?
A bank guarantee is a promise made by a bank to a third party to assume payment risk on behalf of its customers. A bank guarantee is given in the event of a breach of a contractual obligation between the bank and its customers. Such guarantees are commonly used in commercial and personal transactions to protect a third party from financial losses.
This guarantee enables a company to purchase items that it would not be able to afford otherwise, thereby assisting business growth and encouraging entrepreneurial activity.
For example, Xyz company is a newly established textile factory that wishes to purchase fabric raw materials worth BDT.1 crore. Before shipping the raw material to Xyz company, the raw material vendor requires a bank guarantee to cover payments.
The lending institution keeping Xyz company's cash accounts requests and receives a guarantee. In essence, the bank cosigns the purchase contract with the vendor. If Xyz company fails to pay, the vendor can recover the money from the bank.
Similarly, a large furniture manufacturer wishes to enter into an agreement with a small woodshop vendor.
Similarly, a large furniture manufacturer wishes to enter into an agreement with a small woodshop vendor. Before entering into a contract for BDT.50 lakh worth of wood material, the large manufacturer will require the small vendor to provide a bank guarantee. In this case, the beneficiary is a large manufacturer who requires a guarantee before entering into a contract. If the small vendor is unable to deliver the wood material, the large furniture manufacturer can seek reimbursement from the bank.
When is a bank guarantee required?
Bank guarantees are required when there is a shortage of funds or the lack of trust between the two parties.
Is a bank guarantee refundable in Bangladesh?
As soon as the applicant pays his/her dues to the seller within the stipulated time frame, the bank guarantee becomes null and void.
What is the difference between the expiry date and the claim date in a bank guarantee?
The claim date is the date on which a beneficiary claims the benefits of the bank guarantee while the expiry date is the date by which the claim has to be made.
What is the limit of a bank guarantee in Bangladesh?
If a company regularly requires bank guarantees, the bank often issues them the guarantees with a fixed upper amount known as the bank guarantee limit.
Can a bank guarantee be amended in Bangladesh?
Yes, a bank guarantee can be amended. Both, the amount, as well as, the duration can be increased or decreased by sending a formal application of the same to the bank.
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Barristers, Advocates, and lawyers at Tahmidur Rahman Remura Wahid in Gulshan, Dhaka, Bangladesh are extremely experienced in regards to Bank Guarantee Process in Bangladesh: Tahmidur Rahman Remura’s Barristers, Advocates, and Lawyers in Gulshan, Dhaka, Bangladesh are highly experienced in assisting clients through the entire process and legal provisions relating to Bank Guarantee in Bangladesh. Do you require service in regards to Bank Guarantee Process in Bangladesh? Please contact us if you require legal assistance.
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