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Are bank guarantees really guaranteed? Print E-mail
Tuesday, 29 May 2018

Tan: Bank guarantees are usually irrevocable and can be called on demand.
Tan: Bank guarantees are usually irrevocable and can be called on demand.

PETALING JAYA: In commercial transactions, bank guarantees add credence and validity to contracts.

Because a bank is involved in a bank guarantee, the document carries weight and largely gives an added sense of security.

However when bank guarantees are subject to disputes, the matter not only raises question on the terms of commercial contracts but also the validity of bank guarantees as the bastion of security in the corporate world.

A seasoned investment banker said that there should not be any ambiguity in bank guarantees.

“When there is a call on the bank guarantee, the bank has to honour it. That is the fundamentals of bank guarantee. It’s quite simple. The bank has the funds and done its own due diligence even before issuing the bank guarantee,” said the banker.

In commercial transactions, bank guarantees are viewed as among the most secure forms of validation of certainty in payment.

“It serves as a promise from a financial institution that it will stand guarantor on behalf of its customer, or the applicant of the bank guarantee.

“It is as good as the money in the bank if something goes wrong,” said the investment banker.

Disputes lawyer John Mathew echoed the view of the investment banker on the strength of bank guarantees.

He said the confidence and strength of the security is enhanced in transactions where there is a bank guarantee.

“It reduces the element of uncertainty as there is greater chance that the party whose performance is secured by a bank guarantee will perform, failing which the bank guarantee may be called upon.

“It is also unlikely that there would be an issue of insufficient funds when dealing with a bank,” he said.

However, despite having a bank guarantee backing a commercial transaction, there are rare instances where the beneficiary may not be able to access the funds in the event of disputes.

Which raises the question of whether bank guarantees, are really guaranteed?

And if bank guarantees can be disputed to prevent the beneficiary from accessing the funds, does this put a dent on the value of a bank guarantees?

Senior corporate lawyer Datuk Roger Tan said bank guarantees are usually irrevocable and can be called on demand.

This, he said, meant that the bank must release the promised amount when called by the beneficiary, regardless of any protests by its client.

“As long as the demand is made within the stipulated period, the bank must pay on demand notwithstanding any protestation made by the customer,” he said.

The investment banker said that disputes on bank guarantees were another matter and handled on a different platform.

“It’s similar to a share financing agreement between investors and investment banks. The shares are sold immediately without questions asked. Any dispute is settled later,” said the investment banker.

A share financing arrangement is where investors take loans using the shares of listed companies listed as collateral. When the stock market falls and value of the collateral declines, the shares are immediately sold with little notice to the investor.

“The investment bank gives the investors a few days to top up the collateral by either putting money or more shares.

“If it does not happen within the few days, the shares are immediately sold,” said the investment banker.

“If there is a dispute, it is something that is settled by the courts. But there is no ambiguity on the exercise to sell the shares that are held as collateral,” said the investment banker.

However there is a view that clients can stop banks from making payments on bank guarantees. This arises when conditions of the contract and terms of agreement are not clear.

Mathew said disputes relating to bank guarantees usually happen when the party which procured the bank guarantee seeks an injunction to stop the beneficiary of the bank guarantee from calling on the guarantee or from receiving the funds.

The applicant for the injunction may do this by claiming that the beneficiary of the bank guarantee was acting “fraudulently or unconscionably” in calling on or making a demand on the bank guarantee.

For example, in the event a contractor is tasked with constructing a building, and delivers on time, but the other party is unsatisfied with the quality of work – and decides to call on the bank guarantee provided by the contractor.

The contractor may then take the position that any call on the bank guarantee is unreasonable and unconscionable, and seek injunctive relief from the court.

“Much depends on the terms and conditions of the guarantee,” said Mathew.

“To ensure that it is secure, the bank guarantee must be drafted in a way that it can be called on demand and the payment obligation is ‘unconditional, irrevocable and despite protestation’ by the bank or the applicant,” he said.

Banks, he added, will typically pay the promised amount as their reputations are at stake.

However, if an injunction has been sought and obtained, the bank will have to abide by the court order.

“Beneficiaries will want the bank guarantee to be as airtight and clear as possible to ensure that payment will be made on demand.

“The other party, however, will usually want some leeway to safeguard its interest and ensure that there is no unfair calling of the guarantee,” he says.

Tan however felt that the bank’s obligation to pay continued and cannot be released or exonerated.

“You have to recognise the paramountcy of the bank guarantee. Otherwise, it loses its value,” he said.

Injunctions sought by the applicant to prevent a bank from paying out the proceeds, he said, can be set aside on ground that the bank guarantee is “on-demand”.

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