|As many exporting businesses will be only too aware, it is very common for overseas buyers to insist that a bond or guarantee is provided usually by a bank, as a standard means of securing the terms of the contract and then usually covering the exporter’s performance of their obligations during the period of the contract. In some instances buyers require this form of security to extend through warranty periods usually after goods have been delivered and installed, so the timescales that bonds and guarantees cover can be quite protracted.
Examples of bonds / guarantees that may be required are:
This article covers a number of topical issues raised by a cross section of UK based companies at a series of export finance workshops undertaken in recent months which included the usage of bonds and guarantees . The businesses attending the workshops ranged from SMEs to multinational entities, but most of the issues/challenges that they faced were the same, irrespective of the size or complexities of their businesses.
Issuance procedures/communicating with the guarantor (usually the exporter’s own bank).
The method of actually transmitting the request to arrange the issuance of a bond/guarantee to a company’s own bank, may sound a rather rudimentary issue, but it appears that it is a source of irritation to many companies.
The options for delivery, are unsurprisingly – by mail (with the exporter’s authorised signatures appended), fax (provided that a fax indemnity, as stipulated by the bank, is in place) or by using the bank’s e-delivery system.
Most banks will provide an e-delivery solution, which will allow frequent users of trade products to monitor existing transactions and initiate new trade product items (ie: import letters of credit, bonds and guarantees) on the system. There will be a monthly fee for this service and some banks will only offer the system to their most frequent trade users, with certain usage levels required as a qualification criteria.
A common request is that exporters would like to liaise with their bank by email, but very few banks will allow this. In truth, the banks must ensure that communication between its customers and its trade operational processing centres is entirely secure and currently this security cannot be guaranteed using email. Exporters mentioned that in the short term, it would be helpful if the bank’s e-channel delivery systems were opened up to allow more clients to process and monitor trade transactions in this secure environment. In general terms these e-solutions are very user friendly and well constructed, and eliminate the rather tired and outdated procedures where a customer has to send paper or fax instructions or applications to a bank.
The buyer’s own wording – “where should we obtain advice?”
The actual wording used for a bond/guarantee is an area for negotiation between a seller and a buyer, and in many instances the buyer has a preferred wording which they may quote verbatim in the commercial contract, and insist that this wording is used in the bond/guarantee as issued by the seller’s bank. It is entirely the seller’s commercial decision as to whether they agree to these demands or attempt to negotiate with the buyer, striving to reach some middle ground with perhaps the deletion of any perceived onerous terms or in an ideal scenario, persuading the buyer to accept the seller’s preferred wording. The outcome will vary, but it seems that the buyers usually win, and their wording is often used.
To give most mainstream UK banks some credit, they will provide comment to proposed wording, drawing attention to sections which, in the bank’s opinion require their customer’s due consideration. The banks will provide this service without charge, but in most instances the exporter will agree to the issuance of the bond/guarantee, having taken on board the comments made by the bank before making their own commercial decision based on their interpretation of the risks. It is important to note that the bank is providing some considered thoughts rather than any legal advice or legal opinion, so it is always recommended that independent legal advice is sought, if the exporter is uncertain of the implications of any terms stated in that sample wording.
The banks have been subject to close scrutiny regarding their charging policies for a number of years, and the ensuing years since the 2008 financial crisis has only seen that focus on fees and charges increase. The main charge levied by banks relating to bonds/guarantees is the fee which effectively reflects the risk to the bank for issuing the item for a period of time. This charge will be called a variety of different names according to which bank a customer uses, but “Issuing fee/charge” is common. The actual charge for a small to medium sized business will vary from around 2% p.a – 2.5% p.a, depending on your chosen provider. This fee is almost always payable quarterly in advance. It is interesting that this level of charging has been consistent for over 30 years, but exporters have commented that this charge is not stated in detail on the published tariffs of some banks. In those cases the tariff will often state “This charge is individually priced on a case by case basis” or “subject to arrangement”.
In these cases, it is probable that the bank will price the issuance fee having considered the individual exporter’s financial performance, and then priced their bond/guarantee facility based on that information. This actually seems a much fairer and equitable way of pricing this risk for the customer, rather than a (for example) published 2.2% p.a which every exporter is expected to pay, irrespective of their financial performance and overall business standing. A larger exporting company with higher volume of trade transactions may thus be able to negotiate a more favourable rate than those outlined above.
Some banks charge an extra administration fee of up to £150 in some instances, over and above the afore mentioned issuance fee percentage. Others only charge the percentage, without this additional administration cost. Many banks will charge an annual arrangement fee for providing a bonds/guarantee facility and this is likely to be between 1% – 1.5% of the facility amount.
Cancellation of bonds/guarantees
The issue of obtaining cancellation of liability under a bond/guarantee is without doubt one of the most contentious and emotive areas for exporters. This is, in reality quite a complicated area, as it will depend on a number of variables. These will include whether the item was issued on (for example) UK bank paper or by an overseas correspondent bank, or very importantly which law the guarantee is governed by and whether the original item has been returned by the beneficiary.
The frustration for exporters is that in many instances they consider that they have performed their contractual obligations and their liability under the bond/guarantee should have ended. Concerns revolve around the fact that they will still be incurring their bank’s quarterly issuance/risk fees, possibly with additional overseas correspondent bank fees, and most importantly the impact on their overall bonds/guarantee facility.
All banks will have slightly different procedures but by way of example if the bond/guarantee is issued on UK bank paper, has an expiry date and is expressly stated to be governed by English law cancellation can usually be achieved in the following scenarios*;
· If the expiry date expressly stated, has passed and there is no later date specified for receipt of claims.
· If stated in the item, the last date for receipt of claims as specified, has passed.
· The bond/guarantee has no fixed expiry date but it is stated within the wording that it will expire on the occurrence of an expiry event, provided sufficient evidence has been received that the expiry event has taken place.
· The beneficiary returns the item and confirms cancellation.
· The guarantor receives an authenticated advice from the beneficiary confirming release of liability.
· If the guarantor has received and paid a single or multiple claim – depending on the wording of the item.
If the bond/guarantee has been issued by an overseas correspondent bank, against the instructing bank’s counter indemnity, the decision to cancel liabilities will almost certainly be influenced by the governing law in the overseas country and whether the item is subject to that local jurisdiction. This can be complex and in some countries their law dictates that the original bond/guarantee must be returned by the beneficiary in order for cancellation to be approved, and in other jurisdictions, stated expiry dates are not acknowledged, effectively meaning that claims may be made after those dates.
If a bond/guarantee is issued subject to URDG 758 (Uniform Rules for Demand Guarantees, ICC No.758) then articles 34 and 35 stipulate that the guarantee will be governed by the laws and subject to the jurisdiction of the courts of the country where the guarantor (issuing bank) or instructing party is located. However we understand that currently only a relatively small percentage of bonds/guarantees are issued subject to these relatively recently revised rules (July 2010).
Since the majority of bonds/guarantees are issued by overseas correspondent banks against the instructing bank’s counter indemnities and are not governed by URDG 758, it is essential that exporters ask their banks to confirm their current procedures on cancellation on items issued in this manner. If there is an expiry date stated in the bond/guarantee it is possible that some UK banks will take a more pragmatic view of allowing cancellation, and this could mean significant savings on fees for exporters.
However, for bonds/guarantees which are issued without a fixed expiry date or obvious expiry event, so called “until further notice” items, these will cause cancellation challenges whether the original bond/guarantee is issued on UK bank paper or by an overseas correspondent bank. If the bond/guarantee has been issued on UK bank paper, then in order to achieve cancellation that bank will require either the return of the original instrument from the beneficiary, confirming cancellation or receive authenticated advice from the beneficiary confirming release of liability. If the item has been issued by an overseas correspondent bank the UK instructing bank will need to be in receipt of authenticated advice from that overseas bank that liability under the bond/guarantee may be released.*
In conclusion, most exporters are able to fulfil their contractual obligations under their overseas contracts, and any supporting bonds/guarantees are rarely claimed on by overseas buyers. Many ‘extend or pay’ requests which are received in, are perfectly genuine, usually because a delay has caused a contract to be extended, and the beneficiary is seeking a corresponding extension to the bond/guarantee/s. However, since the vast majority of bonds/guarantees that are issued are simple demand guarantees without the need for the beneficiary to present any independent evidence that the claim is a fair one, the concern that a spurious claim may occur is rarely out of an exporter’s mind.
* these are general terms for cancellation and exporters/applicants must check with their own bank to clarify that bank’s procedures, as there may be some variation amongst banks owing to differing legal opinion and practices.
Find out more about Bonds and Guarantees by arranging training for your key staff: