Letter of Guarantee
A written undertaking issued by a bank at the request of its customer, the applicant, whereby the bank undertakes to pay a specified or determinable amount to the beneficiary upon the beneficiary's first written demand during the period specified in the guarantee, and without regard to any objection, as a security for the performance of an obligation owed by the applicant towards the beneficiary.
The Parties
1. The Applicant
The bank’s customer who requests the bank to issue a letter of guarantee in favor of the beneficiary.
2. The Guarantor Bank
The bank that issues the letter of guarantee and thereby undertakes to pay a specified or determinable amount to the beneficiary.
3. The Beneficiary
The party in whose favor the letter of guarantee is issued and who is entitled to demand payment from the bank during the validity period of the guarantee.
The Importance
1. For the Beneficiary:
Obtaining a firm undertaking from a person of sound financial standing, namely the bank, to pay the amount of the guarantee upon the beneficiary's demand, without regard to any objection from the applicant customer.
2. For the Applicant Customer:
Achieving significant benefit as it enables the customer to invest the amount that would otherwise have been paid as security. Moreover, the commission paid to the bank for issuing the letter of guarantee is lower than the interest rate the customer would incur if they borrowed the amount of the cash security from the bank.
3. For the Issuing Bank:
The bank receives a fee for issuing the letter of guarantee. Additionally, the customer is usually obligated to provide the bank with a cash amount as cover for the guarantee in the form of a cash deposit, which the bank retains until the expiry of the guarantee, and which the bank may utilize. Furthermore, the bank does not pay any amount upon issuing the guarantee and may not pay at all despite its issuance until the expiry date, unless the beneficiary demands payment under the guarantee. For this reason, it is said that in this transaction the bank does not lend the customer an immediate sum of money, but rather lends them its signature.
The Main Objective
A Guarantee and Indemnity Instrument (Risk Mitigation):
It is used as a security instrument to cover the risk of the customer’s default or breach of his obligations.
Its purpose is also to facilitate participation in tenders, auctions, and commercial practices.
Scope of Use
It is used in domestic projects (Construction Contracts, Supply Contracts, Tenders and Bids).
Required Documents
A written demand from the beneficiary stating that the other party has breached the contractual terms.
Types
1) Bid Bond (or Provisional/Tender Guarantee): It is submitted in government tenders and auctions related to construction, outfitting, and supply to ensure the seriousness of the bid and to prevent the bidder from withdrawing. It is usually of a short duration.
2) Performance Bond (or Final Guarantee): It is submitted upon the award of the tender to ensure the proper execution of the contract and compliance with the specifications.
3) Advance Payment Guarantee: It guarantees the buyer’s recovery of funds paid in advance to commence the work.
4) Unsecured (Clean/Uncovered) Guarantee: If the client enjoys financial creditworthiness and a good reputation with the bank, the Letter of Guarantee is issued without collateral (security), i.e., unsecured or uncovered.
Term/Period of Validity
It is the period during which the beneficiary may claim payment of the guarantee amount from the issuing bank. The law does not prescribe a specific duration for a bank guarantee; therefore, the duration is subject to the agreement between the customer and the bank. The parties may agree to the automatic renewal of such period for an additional term or terms. If they do not so agree, the bank may not renew the validity period of the guarantee except with the customer's consent, and it shall not produce legal effect against the beneficiary except with his consent.
Legal Nature
A disagreement arose in jurisprudence regarding the determination of its legal nature. The source of this disagreement stems from jurisprudence's attempt to ground this letter in the general rules of civil law, despite the inherent differences between those rules and banking operations—differences originating from the fact that banking operations are established on commercial customs and usages.
One opinion considers the letter of guarantee to be a contract of suretyship (guarantee) issued by the bank for the benefit of the customer; a second view regards it as an imperfect delegation (assignation); while a third considers it a form of stipulation for the benefit of a third party.
In Terms of Revocability
The sole party entitled to cancel the bank guarantee is the beneficiary only, and not the applicant for the issuance of the bank guarantee.
In Terms of Governing Rules
It is governed by the Tenders and Contract Execution Law, the Commercial Law concluded between the two parties, and the banks' implementation of the Central Bank's instructions regulating dealings with bank guarantees.