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Is Your Bank Guarantee Worth the Paper it’s Written On?

The contract has been signed, the $1 million has been paid and a Bank Guarantee has been issued to secure repayment. Nothing further to do…you are protected! Or are you?

Bank Guarantees may not be as iron clad as you think!

Picture three years later, when the other party defaults and the Bank Guarantee is called upon, only for you to find out:

-          that the defaulting party had returned the originals to the bank and the Guarantee has been cancelled; or

-          the Guarantee has expired; or

-          the bank refuses to honour the Guarantee because it contains incorrect details.

Does a Bank Guarantee provide a false sense of security, or are there ways to ensure its enforceability?

Which bank is providing the Guarantee?

Australian entities generally should only accept a Bank Guarantee from an Australian Trading Bank, i.e. a bank with an Australian banking licence. It is important to note that foreign banks can hold an Australian Banking licence. Therefore it is prudent to ensure that the Guarantee is provided by a bank that has a ‘physical’ presence in Australia (as detailed below this is for practical reasons as the original guarantee needs to be produced for payment).

Are all details/references in the Guarantee correct?

It is imperative that the details contained in the Guarantee are correct and unambiguous. In relation to party details, ensure correct spelling of names and the correct ABN or ACN is stated. Correctly state the amount (including any GST amount) to be guaranteed. Further, it is crucial that the Guarantee contains the right references to the contract under which the Guarantee is to be provided i.e. ensure that the parties to the contract are the same as those specified in the Guarantee.  

Errors in any of these details could result in the bank refusing to pay out on the Guarantee.

Does the Guarantee have an expiry date?

Preferably there should be no expiry date. You should also check that the issuing bank does not have a policy whereby its guarantees need to be renewed yearly.

The best position is to have a Guarantee which will continue until notification has been received from the beneficiary that the security is no longer needed.

If there is to be an expiry date, check that it covers the duration of contract (preferably a minimum of 3 months after expiry of the contract). In the alternative, include in the contract a reinstatement clause, requiring the provider to issue, prior to expiry/cancellation, a replacement Guarantee.

Put in place internal reminders so that, before it’s too late, you can call on the replacement Guarantee or renew the Guarantee. Further, it is advisable to set up regular compliance checks to ensure that the Guarantee is valid and the amount of security it provides is sufficient.

Is the contract clause adequate?

The clause in the contract relating to the Guarantee needs to provide an adequate level of protection. Therefore, the clause must clearly identify the circumstances which give rise to an entitlement to call upon the Bank Guarantee. It is important to remember that this entitlement will be strictly construed in accordance with the wording contained in the contract.

Accordingly, this entitlement should be unfettered and unqualified – such that the beneficiary can call on the Guarantee, without giving notice, in its absolute discretion and in whatever circumstances they see fit. An entitlement requiring ‘reasonableness’ could even affect a beneficiary’s right to call on the Guarantee.

Who holds the original?

As Guarantees are treated as cash, banks will only pay on provision of the original document. It is imperative that if you are the beneficiary of the Guarantee you hold the original. To be enforceable, Guarantees must be an original that has been executed by the issuing bank.

So…

Next time you are provided with a Guarantee as security use the above check list to mitigate the risks of your Guarantee being cancelled or the bank refusing to pay.

Rachel Schaffer

21 March 2017