Law Offices of
Hampshire House
11944 Mayfield,
Voice: (310) 207-0180
E-mail: bob@townsend.net
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BANK GUARANTEES IN A 7 MINUTE NUTSHELL
(And The Frauds That Go With Them)
By
Attorney at Law
Now Available!
Robert Townsend’s new book:
Lawyers’
Guide: Advising Clients on High Yield
Investment Programs and Ponzi Schemes
Price: $37.25
What are bank
guarantees?
Banks
guarantees are written obligations of the issuing bank to pay a sum on to a
beneficiary on behalf of their customer in the event that the customer himself
does not pay the beneficiary. It is
important to note that these bank guarantees apply only whenever the issuing
bank's guarantee is not contingent on the existence, validity and
enforceability of its customer’s obligation; this is called an “abstract”
guarantee (i.e. the bank’s obligation is to pay regardless of any disputes
between its customer and the beneficiary).
The issuance of bank guarantees is a private transaction and does not
result in the issuance of any publicly tradable instruments.
What are the two types of
bank guarantees?
There are two
types of bank guarantees:
(1)
direct bank guarantees that have the issuing bank guarantee
one’s of its customer’s (called “Obligor”) obligations to a third party (called
“beneficiary); and
(2)
indirect bank guarantees that are issued in favor of a second
bank which has issued a guarantee on behalf of the of the original’s bank’s
customer. With an indirect guarantee, a second bank (usually a foreign bank with
head office in the beneficiary's country of domicile) is involved.
For what
purposes are bank guarantees customarily issued?
(1)
Bid Bond (tender bond)
a.
These are
primarily used in the export business for project tenders. They are short term
guarantees.
b.
Its purpose is to
secure any claims by the party inviting the tender on the tenderer in the event
of withdrawal of the bid before its expiry date or if the bid is modified
unilaterally. It is also used if the tenderer, upon being awarded the contract,
refuses to sign the contract or provide further guarantees on request.
c.
The guarantee
amount is generally 1% to 5% of the value of the contract.
(2)
Advance
Payment Guarantees
a.
These are used
not only in the import-export business but also in domestic commercial business,
trade and industry.
b.
In the event that
a seller has failed to meet its contractual delivery obligations in full, the
purpose is to secure any claims by the buyer on the seller for reimbursement of
the buyer's advance payment on the contract price before delivery of the goods
(or advance payment of the full contract price). The amount of the guarantee is the amount of
the installment or advance payment.
(3)
Performance
Bond Guarantee
a.
This is used to
secure any claims by the buyer on a seller arising from default in delivery or
performance of the terms of a contract (e.g. construction, assembly,
execution). It is used in import-export
businesses as well as in domestic commercial business, trade and industry.
b.
The guarantee
amount is generally 5% to 20% of the value of the contract. The terms of the guarantee is until the
contract has been fulfilled.
(4)
Bank
Guarantee for Warranty Obligations
a.
The application
of this type of bank guarantee is in the import-export business and in domestic
commercial business, trade and industry, where it is more often a surety. Its purpose is to secure any claims by the
buyer on the seller due to possible defects appearing after delivery.
b.
The general
amount of the guarantee is 5% to 20% of the value of the contract, and the terms
depend on the custom of the particular business.
c.
In the
construction trade, the guarantee for warranty obligation in the form of a
simple guarantee or a joint and several guarantee is known as a building (or
works) contractor's guarantee. It can also be used in the export business as a
"retention bond" (substitute for payment retention, often 5% to 10%
of the value of the contract).
(5)
Payment
Guarantees
a.
These are used in
the import-export business or in any circumstance where payment of an
obligation needs to be guaranteed. It is
used to secure any claims by the seller on the buyer for payment of the
contract price by the agreed date. The payment guarantee is often used instead
of a documentary credit – upon delivery against «open account».
b.
The amount of the
guarantee is the contract price or a part of it.
(6)
Guarantee
Securing Credit Line
a.
The use of this
guarantee is to secure any claims by the lender on the borrower due to a credit
(loan, etc.) not being repaid in accordance with the terms of the lending
contract.
b.
The amount of the
guarantee is the amount of the credit or loan, and it usually includes a margin
to cover accrued interest and incidental expenses.
c.
The term of the
guarantee is until the expiration date of the loan plus a few days (e.g. 15 days).
d.
These are often
abstract guarantees in favor of a foreign or domestic lending bank.
(7)
Letter of
Indemnity for Missing Bill of Lading
a.
This guarantee is
specifically used for importers when the bill of lading is missing. Its purpose is to secure any claims by the
shipping line/shipping company on (i) the buyer resulting from the goods
arriving from overseas being released without the original bill of lading being
presented (e.g. due to postal delays or even loss) or (ii) the supplier due to
issuance of a replacement bill of lading (original misplaced or lost).
b.
The term is often
unlimited or until the original bill of lading or release document from the
beneficiary is presented.
c.
In practice the
wording of the guarantee is frequently stipulated by the ship owner and must be
sent directly by the debtor, with a counter-guarantee from the bank to the
shipping line.
Are bank
guarantees transferable?
(1) Assignment
of Bank Guarantee Proceeds. The
beneficiary can assign the proceeds of a bank guarantee. But this assignment does not assign the
rights of the beneficiary as “drawer” on the bank guarantee, and only the
beneficiary may exercise the “drawer” rights and present the demand for payment
under the terms of the bank guarantee unless the terms of the guarantee provide
otherwise. This means that the assignee
may receive the proceeds of the guarantee, but in order to obtain those
proceeds, the beneficiary must make the demand for payment. This means that the beneficiary can sell by assignment
at discount the benefits of the guarantee.
An assignment of proceeds requires notice to the issuing bank of this
action; otherwise the issuing bank would pay the beneficiary rather than the
assignee.
(2) Transfer
of Bank Guarantees. Bank guarantees
can be transferred to a third party ONLY with the written consent of the
issuing bank AND the beneficiary.
Are bank
guarantees the subject of trading?
(1) No Public Market. There is no public market for the trading of
bank guarantees. Beware! Fraudsters or naïve brokers are always
erroneously representing that there is a public market for the trading of bank
guarantees (and standby letters of credit).
This is not to be confused with the trading of other bank issued
instruments such as medium term notes, etc.
Bank guarantees can only be transferred or the proceeds assigned in
private transactions (See above).
(2) No
CUSIP or ISIN Numbering. Bank
guarantees are not trading securities, trading debt instruments,
or trading investment funds, and therefore are not subject to the
settlement procedures offered through Eruoclear or DTC and most other
settlement firms (and not Bloomberg).
Obviously, therefore, they also are not issued CUSIP or ISIN numbers for
trading purposes. However, Euroclear may
accept such bank guarantees for “safekeeping” purposes only, and it is not
assigned an ISN or CUSIP number (though it may have a number for identification
purposes). So one has to be careful in
understanding the particular legal relationship of a bank guarantee to
Euroclear or other settlement entities, especially as to issues of
authenticity. A bank guarantee may appear on the “screen”, but not for
trading. It is also important to note,
that a bank guarantee held in safekeeping does not serve to authenticate the
instrument. Anything can be the
subject of a safe keeping situation.
Mixing a metaphor, you can get a safe keeping receipt for a ham
sandwich.
Is there
fraud associated with bank guarantees?
(1) There
are many fraudulent bank guarantees; i.e. they are NOT issued by the bank
that is represented as the issuer. The
authenticity should always be checked (See Paragraph (4) below for important
warning). The fake financial instrument
may have a face value of anything from $5 million to $600 million or even
billions of dollars (or other currencies), and they usually give the appearance
of being tied to a major international bank.
The scheme involves investors being persuaded to buy these Bank
Guarantees after being offered discounts of over 40%. The investor would then look forward to
redeeming the full face value on maturity (e.g. one year's time), thereby
securing a healthy profit. Of
course no profit is forthcoming; the investor only suffers the loss of the
price paid for the bogus instruments.
Banks do not issue guarantees for this type of proposition. Bank Guarantees are NOT investment
products. Bank guarantees are issued by
banks to cover the liability of its customer to a third party that the bank
agrees to repay. Sometimes fraudsters
use the discounted Bank Guarantee as bait to secure an advance fee (e.g. 1% of
the Guarantee's face value). The advance fee is represented to pay for alleged
due diligence and administration procedures, but is merely pocketed by the
perpetrators resulting in a fraud loss to the investor.
(2) Fraudulent
Leasing of bank guarantees. Leasing
of bank guarantees for an upfront fee is invariably a fraud. These bank guarantees can either be
legitimate or bogus, so checking out the authenticity in the long run is not
really important (See Warning above on going to the bank to check authenticity
of bank guarantees!). The problem is
that after paying an upfront fee there is nothing in the real world that the
lessee can do with a leased guarantee, and the lessor knows it; i.e. the lessor
knows that the bank guarantee will never be called upon. The lessor does this by making the terms of
the lease such that the bank guarantees can never be called up. The lease may provide that the leased
guarantee may not be used as collateral without the consent of the lessor
(which is never given); thus it may not be borrowed against. Or the lease may provide a time limit for use
by the lessee that the lessor knows cannot be met (e.g. See (3) below “leasing
for HYIP). An important warning to
potential lessees is that if one leases a bank guarantee for “credit
enhancement” and the bank guarantee cannot be called upon by the lessee, then
any credit or loan issued to the lessee is based on a bank fraud
committed by the lessee on the lending bank unless the lessee
fully discloses to the lending bank the non-callability element of the bank
guarantee. At that point, the lending
bank will not consider the bank guarantee as a “credit enhancer”, so the whole
idea does not work. Leasing is a usually
a bad idea.
It is, however, important to note that this author has been involved in
situations where a bank guarantee is leased as part of a “financing for
investment” structure; however, the instrument is always “at risk”, though
there are several legal techniques for substantially diminishing the risk (but
not eliminating the risk) of the guarantee to be called upon for payment. The remaining risks are worth the rewards the
owner of the bank guarantee receives for its involvement.
(3) Leasing
for HYIP’s. There is the leasing of
bank guarantees that are issued by legitimate banks and with callable terms for
the purpose of investing in HYIP’s; however, the short term of the lease of the
guarantee is such that the lessee cannot possibly perform (or never perform) within
the time limits of the guarantee. Thus,
the lessee does not timely perform and the lessor pockets a large fee without
risk to the instrument. An example of
this situation is where a party agrees to lease a bank guarantee with the
agreement that the lessee will place the guarantee in a performing high yield
investment program approved by lessor.
The lessee cannot find a performing HYIP within the time limit, because
such HYIP’s do not exist. If you wish to
read more about High Yield Investment Programs (i.e. HYIP’s), see “The Mysterious World of Private Securities Trading” or purchase the book: “Lawyer’s Guide: Advising Clients On High
Yield Investment Programs and Ponzi Schemes”.
(4) Funding
Projects With Bank Guarantees Fraud.
One scenario begins like this when the fraudster says to the victim: “If
you will find a bank that will give you a commitment letter to loan you
the funds for your project if you can provide your bank with a bank
guarantee from another bank that the fraudster will arrange, then you will have
your project funded. The fraudster often
requires an upfront fee of 3% of the face amount of the bank guarantee, and I
will arrange the bank guarantee”. The
upfront payment is paid. The
pre-condition of the fraudster having to arrange the bank guarantee is for the
victim to provide a written commitment letter from a bank to loan against the
guarantee. Most of the time this loan
commitment cannot be obtained, because the lending bank will not commit to a
loan until it sees the bank guarantee in place and authenticated. Upfront fee is lost!
RULE ONE: In order for a bank to issue a bank guarantee
for $100 million, someone must FIRST provide collateral to that bank in the
amount of $100 million+ before the bank will issue it. If someone is providing you with the bank
guarantee, you must ask the issuing bank if it authentic…which usually means
you are asking if anyone provided the collateral of $100 million to inspire the
bank to issue the BG. Consequently, if
you need $100 million and you have to get a bank guarantee for $100 million,
then you have to have $100 million to get the bank to issue the bank guarantee
for $100 million. So, you see, the bank
guarantee does not do any good in helping you to fund your project. If you had $100 million, you would not need
the bank guarantee.
RULE TWO: Banks are not venture capitalist. They do not invest in projects by issuing
bank guarantees without collateral, because if they did so, and you borrowed
against the BG and did not repay the money, they would have lost the money
because the invested in your project as a venture capitalist which they are
not.
RULE THREE: Do not confuse a bank guarantee with a bank
commitment letter.
RULE FOUR: Do not waste your time trying to fund
projects by looking for a bank guarantee or standby letter of credit. They will do you no good, because they will
be issued in a fraudulent manner that will require you to obtain the funds you
need elsewhere to secure any draw-down on the bank guarantee or standby. The only fellow you want to talk to about
funding who says he has a bank guarantee is the fellow who provided the
collateral to the bank to get the bank to issue the bank guarantee.
(5) Another
Project Funding Fraud Where The Fraudster Provides The Commitment Letter. The fraudster posing as a lender says to the
victim that he will fund the victim’s project if the victim can provide a bank
guarantee to secure the loan. The victim
pays the fraudster a “Commitment Fee” for the commitment letter to make the
loan. The victim now tries to obtain a
bank guarantee. The victim cannot get a
bank guarantee, because in order to have a bank guarantee issued, the victim
must deposit with the issuing bank (or have on deposit) at least the face
amount of the bank guarantee he is asking for which is the nearly the same
amount of money he needs to complete his project. That is, the victim must have the money he
needs to do the project and give it to the bank to have it issue a bank
guarantee before he can get the bank guarantee. This is not much help in moving the project
forward! The victims don’t understand
that if banks were to issue bank guarantees to fund projects without such a
collateral deposit, the bank would basically be in the role of a venture
capital investor, and banks are NOT venture capital investors. Here is a typical
example of a fraudulent scheme. Jack
wants to build a resort in
(6) Checking
authenticity of bank guarantees. The
ICC states: “Anyone offered an investment opportunity supported by a financial
instrument can have it checked out by the CCB for a nominal cost. Call +44(0) 208 591 3000 or e-mail ccb@icc-ccs.org.uk for details.” Big warning! What one (other than a very careful and
knowledgeable attorney) must NOT due is to walk into a bank (including branch
offices) with a bank guarantee (or standby letter of credit) to check on its
authenticity. There is a high
probability (a) the instrument is fraudulent, and (b) therefore one will be
arrested “on the spot”, and that probability substantially increases if
one is a minority; e.g. African-American, Hispanic, from the
(7) Bank
Guarantees From Offshore Small Banks.
Usually bank guarantees from tax haven banks (unless an affiliate of a
major bank) have little or no value.
Often there is talk about having these bank guarantees “confirmed” (i.e.
accept liability for the instrument) by a major bank, but in reality, this does
not happen for the most part. This is
particularly true with
How does one
collect on a bank guarantee?
The
terms of the bank guarantee itself will advise the beneficiary on the precise
terms that must be followed for presentment of the demand and the collection
thereof. These terms usually must be precisely
followed. Read the instrument
carefully!
How does the
bank handle a dispute?
Usually
absent visible obvious fraud, the bank will pay according to the terms of bank
guarantee without regard to looking at the actual performance by the
beneficiary of the underlying agreement.
If the obligor (bank’s customer) feels that the bank should not pay
because of non-performance or fraud by the beneficiary, then he should sue the
beneficiary and interplead the bank seeking an injunction to prevent the bank
from paying. The bank will stand on the
sidelines until a court tells it what to do.
Sample of Bank
Guarantee (Payment Guarantee)
Here is a sample of a bank
guarantee in hard copy form. However, it
is important to note that most of the bank guarantees utilized today are sent
electronically from bank to bank and thus are in an “electronic” format.
(Bank Letterhead with Bank Address)
____________Payment
Guarantee Number
Name of Beneficiary
Address Date________________
Amount $100,000.00
One Hundred Thousand Dollars
(USD)
We have been informed that you concluded on December
10, 2002 a contract No. 111444 with ABC Inc. for sale and delivery of a rat
shelter at a total price of $1,000,000.00.
According to this contract, payment of the goods supplied, up to
$100,000.00 (10% of the total price) has to be secured by a bank guarantee.
This being stated, we XYZ
Bank, 555 A. Street, Zurich, Switzerland, irrespective of the validity and the
legal effects of the above mentioned contract and waiving all rights of
objection and defense arising wherefrom, hereby irrevocably undertake to pay to
you, upon you first demand, any amount up to the above mentioned maximum
amount, upon receipt of your duly signed request for payment stating that
·
You
have supplied the company ABC Inc. with the goods ordered, in conformity with
the terms of the contract, and
·
You
have not received payment from ABC Inc. at the due date, in the amount claimed
under this guarantee.
For
the purposes of identification, your written request for payment has to be
presented through the intermediary of a first rate bank confirming that the
signatures thereon are legally binding upon you.
Your claim is also acceptable if transmitted to us
in full by duly encoded telex/SWIFT through a first rate bank confirming that
your original claim has been sent to us by registered mail and that the
signatures thereon are legally binding upon you.
Our guarantee is valid until December 31, 2004,
and expires in full and automatically, should your
written request for payment or telex/SWIFT not be in our possession at our
above address on or before that date, regardless of such date being a banking
day or not.
Our guarantee will be reduced by each payment made
by us as a result of a claim.
This guarantee is governed by Swiss law, place of
jurisdiction and performance is
XYZ
Bank.
Compare to Standby Letters of Credit
For information on standby letters of credit see “Standby Letters of Credit in a Nutshell”.
Bank Guarantees and High Yield Investment Programs (HYIP’s)
Sometimes
bank guarantees are purported to be involved in High Yield Investment
Programs. Information on High Yield
Investment Programs is available at http://www.hyip-bull.com/
Questions on bank guarantees.
The initial telephone consultation is $500
payable by PayPal. Address payment to bob@townsend.net at PayPal.com
Now Available!
Robert Townsend’s new book:
Lawyers’
Guide: Advising Clients on High Yield
Investment Programs and Ponzi Schemes
Price: $37.25 :
CONTACTS:
Law
Offices of
Hampshire
House
11944 Mayfield,
Voice: (310) 207-0180
Fax: (310) 388-5690
E-mail: bob@townsend.net
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