Letter of Guarantee (LG, BG)
A Letter of Guarantee is provided by banks and other credit and financial institutions upon the borrower’s (principal’s) request. It is a written obligation to pay a sum of money to the principal’s creditor (beneficiary) in accordance with the conditions of the obligation given by the guarantor, following the beneficiary providing a written demand for its payment. The principal pays to the guarantor a fee for issuing the Letter of Guarantee. A Letter of Guarantee may not be recalled by the guarantor and assigned to another party, unless stipulated otherwise.
As a general rule a Letter of Guarantee is irrevocable because it cannot be recalled by the guarantor issuing it. The beneficiary’s rights cannot be assigned under a Letter of Guarantee, as the demand of the beneficiary to the guarantor may not be assigned to another party.
For our clients, we issue Letters of Guarantee – independent obligations in relation to the beneficiary to pay a certain amount against the beneficiary’s written demand, with a statement about non-fulfillment by the beneficiary’s counter part of its contractual obligations.
As with a Letter of Credit, a Letter of Guarantee is the bank’s obligation to pay against documents provided, independent of the contract, however the essence of a Letter of Guarantee is ensuring fulfillment of obligations, i.e. payment under a Letter of Guarantee occurs in case of non-fulfillment of contractual obligations.
As a Letter of Guarantee is an instrument being totally independent from a contract, the bank receiving a demand under a Letter of Guarantee shall be obliged to make payment independently of the real state of affairs with the contractor fulfilling its obligations.
Letters of Guarantee (in case of import of goods, works, and services) are issued to secure more favourable conditions of supply.
Possessing a Letter of Guarantee, the beneficiary (seller) may provide to the principal (buyer) a supplier’s credit (grace), increase the sum or period of grace, or provide an additional discount for products purchased etc.
The beneficiary (seller) is aware that the risk of the principal’s (buyer’s) non-payment for the goods supplied (works performed, services rendered etc.) is already covered by the Letter of Guarantee.
For the buyer, a Letter of Guarantee is an advantage due to its low price and possibility to receive additional commercial benefits from the seller.
A Letter of Guarantee is a very flexible and convenient financial instrument: if an agreement is reached with the seller regarding the use of a Letter of Guarantee, and the buyer is provided with a grace period for payment, the buyer may plan its purchases and account settlement with the seller, provided that the amount of the buyer’s debt to the seller does not exceed the amount of the Letter of Guarantee.
To receive payment under a Letter of Guarantee, the seller has to provide to the issuing bank a written letter of application in free form about the buyer not fulfilling its contractual obligations.
Sometimes copies of outstanding invoices and/or transport documents confirming shipment of goods to the buyer’s address are attached to the letter of application. The authenticity of the seller’s letter of application has to be confirmed by the bank it is served at.
A Letter of Guarantee is governed by the laws of the country in which it is issued. Therefore foreign suppliers ask to provide a Letter of Guarantee to be governed by the legislation of the country of their location. This is not always convenient for the buyer because it is necessary to involve a third bank located in the seller’s country, for issuing a Letter of Guarantee. In this case, our company offers to issue an irrevocable Standby Letter of Credit (analogue of a Letter of Guarantee), which is governed by the UCPURR (Uniform Customs and Practice for Documentary Credits) of the International Chamber of Commerce.
Main forms and types of Letters of Guarantees:
Letters of Guarantee are very diverse and flexible documentary instruments allowing reduction of not only the payment risk, but other risks as well, for instance the risk of contract non-fulfillment, of breach of guarantee and tender obligations.
We issue the following types of Letters of Guarantee:
1. Guarantee of payment obligations – guarantee of security of the buyer’s obligations to pay the agreed sum under a contract.
2. Guarantee of advance payment – guarantee of security of the seller’s obligations to return the advance payment transferred to it by the buyer under a contract.
3. Guarantee of contract fulfillment – guarantee opened to secure proper fulfillment of a contract (supply of goods of the agreed quality and scope within the established timing etc.). Such a guarantee is usually issued for 5%-20% of the contract fee.
4. Tender guarantee – guarantee of securing fulfillment by a tender participant of its tender obligations. As a rule, tender obligations lie in signing a contract of the established form and in provision of guarantee of contract fulfillment (issued, as a rule, for 1% - 5% of the contract fee).
5. Guarantee of loan return – bank’s guarantee in favour of the creditor, securing the borrower’s obligation to return the loan given to it by the creditor.
6. Reverse export guarantee – guarantee of securing the obligations of the party performing duty-free import of equipment to the territory of a country, with obligation of its export in a certain time (for instance, for demonstration at an exhibition etc.).
7. Guarantee of investment obligations – guarantee securing fulfillment by the investor of its investment obligations. As a rule, it is required as one of the conditions for participation in a competition for purchasing stock.
8. Usually, Letters of Guarantee are issued for 1 (one) year and 1 (one) month.
A Letter of Guarantee will be issued via SWIFT МТ760.
All confirmations and notifications are done only via SWIFT.
Attractiveness of the Letter of Guarantee:
1. Security of the interests of contract partners in diverse fields of activity.
2. No detraction of cash resources from circulation.
3. Possibility to receive from contract partners a commodity credit secured by the Letter of Guarantee.
4. Being a nominal payment obligation, a Letter of Guarantee is a cheaper product compared to a loan or factoring.