A guide to bonds and guarantees

In today’s competitive global trading environment, overseas importers are increasingly insistent that UK exporters underpin their contractual obligations by means of Bonds and Guarantees.

A Bond or Guarantee – which can be treated as synonymous for the purposes of this guide – give the importer the security of a financial guarantee in the event of the exporter’s failure to meet the obligations of a contract. It is issued by the guarantor – usually a bank – on behalf of the exporter.

If you, the exporter, fail to deliver the goods or services as described in the contract with the importer, the latter can “call” the Bond and receive financial compensation from the bank. Under a counter indemnity, the bank has recourse to you for the full amount including costs and interest.

Types of Bonds and Guarantees
• Bid or Tender Bonds
• Performance Bonds
• Advance Payment and Progress Payment Guarantees
• Retention Bonds
• Warranty Bonds
• Overdraft Guarantees
• Standby Letters of Credit.

Bonds and Guarantees fall into two classes:

On Demand
This is often the only class of Bond acceptable to an overseas buyer. It can be called at the buyer’s sole discretion without contest, even if called “unfairly”. Banks cannot enter into contractual disputes between trading partners.

A Bond of this class gives greater protection to exporters, as it requires substantiation, e.g. a certificate of award from an independent arbitrator. However, it is unacceptable to many overseas buyers.

Within this two-fold classification are several different forms of Bond or Guarantee. Here are the types you are most likely to encounter:

Bid or Tender Bonds
These are given in support of customers’ tenders for the supply of goods and services, and are required by the beneficiaries as indications that; the bidders are serious in their intent, will not withdraw their tenders before adjudication, will sign contracts if awarded to them and will provide any subsequent bonding. Bid Bonds usually cover 2% to 5% of the value of the tender (so that if the Bond is called, the importer is paid 2% to 5% of the contract value). Bid Bonds frequently remain valid for three months after the bid closure date.

Performance Bonds
These guarantee that if the exporter or contractor fails to carry out the terms of the contract, the importer will be paid a sum in compensation – typically around 10% of the contract price. The Bonds are purely financial guarantees and carry no warranty that the bank will complete the contract if its customer fails to do so. Note that when a tender proves successful, a Performance Bond is usually required.

Advance Payment and Progress Payment Guarantees
These give protection to the buyer who has made an advance or progress payment to the exporter before the contract has been completed. They guarantee that any such amounts are refunded to the buyer if the exporter fails to complete a contract. It is advisable for the Guarantee to contain an operative clause making it effective only upon receipt by the exporter of an advance payment, and a reduction clause so that the Guarantee value is written down as the contract progresses.

Retention Bonds
These enable retention monies, which would otherwise be held by the buyer beyond completion of the contract, to be released early. The guarantee ensures refund to the buyer of released retention monies in the event of subsequent non-performance of equipment supplied. Inclusion of an operative clause is advisable.

Warranty Bonds
These provide a financial guarantee to cover the satisfactory performance of equipment supplied during a specified maintenance or warranty period.

Overdraft Guarantees
These guarantee the borrowing requirements of UK exporters or contractors who need finance in the importer’s country. The Guarantee covers the local bank against the exporter defaulting. Without such security, the local bank would be unwilling to lend monies where the UK exporter is unknown to them.

Standby Credits
An exporter and his customer may arrange that goods will be paid for in an agreed manner after they have been despatched. But if payment in the agreed manner is not forthcoming, the exporter will need another way of getting paid. A Standby Credit can provide this security backup. The importer’s bank issues the Standby Credit, under which the exporter can claim for the amount unpaid simply by (for example) submitting a certificate stating the value of shipments made in respect of which no payment has been received from the importer. Since the Standby Credit becomes active only if the importer fails to perform his obligations, the paperwork required to draw on a Standby Credit is minimal. In the event that the importer does not pay, therefore, Standby Credits provide the exporter with security similar to a bank guarantee. In some marketplaces (e.g. the USA), they are preferred to bank guarantees.

Similarly, Standby Credits can be used to support performance obligations in a trade relationship. For example, they can fulfil the same purpose as a performance guarantee.

Topics: Contracts, Export Process, Getting Started, and Insurance & Risk
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