External Guarantees

Letter of guarantee is promise by the bank (guarantor) to compensate financially for any detriment suffered on the basis of non-fulfillment of obligations. When issuing a letter of guarantee, a bank undertakes an own liability towards the beneficiary that a third party (the applicant of the guarantee) will duly perform an obligation resulting from a contractual agreement between the beneficiary and the third party (e.g. payment, delivery of goods, services). If the contractual obligation is not fulfilled, the bank can be held liable for payment of any amount up to the maximum amount, for which the guarantee is issued. The characteristic feature of a letter of guarantee is its abstract nature that means it is a separate commitment which exists independent of the underlying contractual agreement between the party requesting the guarantee and the beneficiary of the guarantee. The guarantor is not allowed to make objections or contestations based on the underlying contract. If the beneficiary of the guarantee raises a claim under the guarantee in accordance with the terms and conditions of the guarantee, the bank is obliged to effect payment of the guaranteed amount.

Letters of guarantee may be issued in Turkish Lira or in other hard currencies, either with or without an expiry date. Letters of guarantee can be issued in various subjects such as purchase of goods, franchising, constructions, custom transactions, court awards and tax issues.

 

Counter-guarantee

Counter-guarantees are usually functioning as bank-to-bank guarantees. If the applicant’s bank is not considered as an acceptable guarantor by the beneficiary and in order to ensure the issuance of the guarantee by another acceptable bank, the applicant’s bank may issue a counter guarantee in favor of another bank that is acceptable to the beneficiary. In that case, applicant’s bank acts as the “counter guarantor” and the bank which is acceptable to the beneficiary and issuing the letter of guarantee is called as “guarantor”. Overall, such transactions are defined as counter-guarantee in banking terminology.

Types of Letter of Guarantee

Performance Bond

This type of guarantee is aimed to secure any claims by the buyer on the seller arising from default in delivery or performance of the terms of the contract (e.g. construction, assembly, execution). In international business, "pay or extend" claims are quite often made under guarantees. This simply extends the validity of the guarantee.

Bid Bond (Tender Bond)

This type of guarantee is aimed 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 – or if the tenderer, upon being awarded the contract, refuses to sign the contract or provide further guarantees on request. These type of bank guarantees are usually issued for short term.

Advance Payment Guarantee

This type of guarantee is aimed 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) – in the event that the seller has failed to meet his or her contractual delivery obligations in full.

Payment Guarantee

This type of guarantee is aimed to secure any claims by the seller on the buyer for payment of the contract price by the agreed date.

Warranty Guarantee

This type of guarantee is aimed to secure any claims by the buyer on the seller due to possible defects appearing after delivery.

Stand-by Letter of Credit

The stand-by letter of credit comes from the banking legislation of the United States, which forbids US credit institutions from assuming guarantee obligations vis-à-vis third parties. To circumvent this rule, the US banks created the stand-by letter of credit, which is based on the "Uniform Customs and Practice for Documentary Credits (UCP 600)". Like the guarantee, the stand-by letter of credit is of an abstract nature, i.e. legally separated from the underlying transaction. In the case of a stand-by letter of credit, the documents stipulated in the claim must be submitted within the specified period. These documents should show that the client (exporter) has not met or insufficiently fulfilled his or her performance obligations or the debtor has not met a payment on time. The stand-by basically fulfils the same purpose as a guarantee: it is payable upon first demand and without objections or defenses on the basis of the underlying transaction. It is up to the beneficiary to decide whether a stand-by may be given. On 1 January 1999, the ICC introduced the “ISP 98” (International Standby Practices), new guidelines which were drawn up especially for “stand-by letters of credit” business. In practice, however, stand-bys are generally still subject to the “Uniform Customs and Practice for Documentary Credits”, publication no. 600 (UCP 600).