Guarantee and Indemnity for Loan/Credit

Generally loans and advances are made against tangible securities. When a customer has no tangible security to offer or when the security offered is inadequate, a guarantee is demanded by the banker.

A guarantee is a promise by a third person to the lender for the present or future debt of the borrower. The person who gives the guarantee is called a surety or guarantor. The person to whom the guarantee is given is called creditor or beneficiary. The person in respect of whose default the guarantee is given is called the principal debtor.

Example: P lends Tk. 5000/- to Q and R promises to P that if Q does not pay the money R will do so. This is a contract of guarantee. Here Q is the principal debtor, P is the creditor or beneficiary, and R is the guarantor or surety.

Section 126 of the contract Act, 1872 defines a contract of guarantee as,” a contract to perform the promise or discharge the liability of a third person in case of his default.”

Essential Features of Contract of Guarantee

i) The essential feature of a contract of guarantee is that the guarantor is liable when the principal debtor fails to repay the debt. The liability of the principal debtor is primary and that of guarantor is secondary.

ii) A guarantee may be either oral or written. Banks, however, do not accept oral guarantees. The contract must be in writing and should satisfy all legal requirements as to signature, stamp duty etc.

iii) A guarantee may be either (a) specific guarantee or (b) a continuing guarantee. A specific guarantee covers a single transaction. It comes to an end when the specific promise is fulfilled. The continuing guarantee is applicable to a series of transactions. The surety can fix up a limit on his liability as to time or amount of guarantee when the guarantee is a continuing one. For example, X enters into cash credit arrangement with Modern bank for a credit limit of Tk.50,000/-. Y stands as guarantor for this amount for a period of one year. Under this arrangement, X can undertake any number of transactions subject to the amount and time specified.

iv) The party must be competent to enter into contract.

v) Minor’s guarantee is not allowed but if any major gives guarantee in favor of minor, the guarantor becomes principal debtor.

vi) Credit worthiness of the guarantor is to be considered before obtaining guarantee.

vii) As per contract, the guarantee must be supported by lawful consideration.

viii) The contract must be entered into with free consent.

ix) A guarantee obtained under misrepresentation, fraud and undue influence is void able.

Indemnity

A contract of indemnity is defined as ‘a contract by which one party promises to save the other from the loss caused to him by the conduct of the promise himself or by the conduct of any other person. The person who makes such promise is called the ‘indemnifier’ and the other person is called the ‘indemnified’ or ‘beneficiary’. For example, X who has lost a fixed deposit receipt issued by modern bank may claim the amount by furnishing an indemnity bond. By this act, X promises to reimburse the bank any loss that may be caused to it for paying the amount without the receipt.

Banks and letters of indemnity

Banks may obtain the letters of indemnity in the following situations;

1. Loss of term deposit receipt: The bank is not entitled to withhold payment of the money if a deposit receipt is lost or destroyed. The depositor is asked to sign a letter of indemnity duly stamped when the payment is made or duplicate is issued.

2. Issue of duplicate draft: In case of issuing a duplicate draft in lieu of the original reported lost, the banker should immediately notify the office on which the draft is drawn and enquire whether it is outstanding. A stamped letter of indemnity should be taken, on receipt of nonpayment advice from the drawee branch. The letter of indemnity should be signed by the purchaser and by two sureties’ good for the amount of the draft.

3. Loss of traveler’s cheque: In case the purchaser of a traveler’s cheque claims refund of the value of the cheque reported lost, the request should be entertained by the selling branch of the bank only when the cheque had not been endorsed before it was lost and a letter of indemnity is obtained from the purchaser. The letter contains special stipulation that the cheque was unendorsed at the time of lost.

4. Loss of safe custody receipts: In case of a customer losing a safe custody receipt, he has to give a stamped indemnity letter before he is given delivery of a duplicate receipt of articles kept with the bank for safe custody.

5. Loss of gift cheque: In the event of loss of gift cheque, a duplicate may be issued obtaining a letter of indemnity from the concerned person as follows:

a) Where the gift cheque was in possession of the purchaser, at the time of its loss or where it has been lost in the course of postal transit, the banker should issue a duplicate cheque after obtaining a stamped letter of indemnity from the purchaser.

b) Where the name of the payee had been inserted in the cheque and it was lost while in the actual possession of the payee, the issuing branch, after verifying from the concerned purchaser and obtaining a stamped letter of indemnity from him with sureties, issue a duplicate cheque.

Distinction between Guarantee and Indemnity:

1. Number of parties: In case of guarantee there are three parties- the principal debtor, the creditor and the surety. A contract of guarantee requires the concurrence of the three parties. In case of indemnity there are only two parties- indemnified and indemnifier.

2. Number of contracts; In case of guarantee there are two contracts, one between the principal debtor and the creditor and the second between the surety and the creditor. On the other hand, in a contract of indemnity, there is only one contract between the indemnifier and the beneficiary.

3. Request: In a contract of guarantee, the guarantor undertakes his obligation at the request, express or implied, of the principal debtor; no such request is necessary in respect of an indemnity.

4. Nature of liability: In a contract of guarantee the liability of the principal debtor is primary and that of surety is secondary. The person giving an indemnity is primarily and independently liable.

5. Purpose of contracts: A contract of guarantee is to provide necessary security to the creditor against the loan but a contract of indemnity is made for reimbursement of loss.

6. Right of parties: The surety has the right to recover from the principal debtor the amount paid by him under the contract of guarantee, the indemnifier cannot claim reimbursement from anybody else.

7. Nature of risk: The surety agrees to discharge the existing liability of the principal debtor. So it is a subsisting risk. The indemnifier promises to save the indemnified against risk of loss happening in future. So it is a contingent risk.

Rights of Guarantor

1. Right to revoke continuing guarantee

2. Right of subrogation

3. Right to claim indemnity

4. Right to know the extent of his liability

5. Right against co-sureties

Discharge of Surety

1. Death of the surety

2. Discharge on variation of terms

3. Discharge by release of the principle debtor

4. Discharge by composition

5. Discharge by creditors’ acts or omissions

6. Loss of security

Precautions to be observed in taking Guarantee

1. Ascertain the solvency and integrity of the guarantor

2. The capacity to contract

3. Banker not to approach a guarantor

4. Type of guarantee

5. Execution of contract of guarantee

6. Explanation of the clauses in the form

7. No duty to inform voluntarily

8. Joint and several liabilities

9. Periodical confirmation

10. Death, lunacy and insolvency of the principal debtor

11. Death, insolvency or insanity of the guarantor

Types of Bank Guarantee

1. Performance guarantee

2. Guarantee for Earnest money i.e.; Bid Bond, especially for International Tender.

3. Advance Payment Guarantee

4. Shipping Guarantee

5. Custom & Exercise Guarantee