By a direct pay guarantee I refer to an instrument issued by a bank on behalf of its customer whereby the bank irrevocably and unconditionally undertaks to pay a beneficiary specific amount(s)automatically (no demand required) on specific due date(s). Some guarantees specify the account number of the beneficiary where the payment should be made. These type of guarantees are usually issued in favour of beneficiaries who sell heavy equipment / cars etc. on installments.
My questions to the members are:
1) has any one of them encountered / received request for discounting payments under such guarantees.
2) for its own guarantee(s), would a bank require to take the consent of the applicant(s) to discount the future payment(s) under the guarantee(s)?
3) for the guarantees issued by other banks, should the beneficiary’s bank obtain assignment of benefit of the guarantee accepted by the guarantee issuing bank or assignment of proceeds of the guarantee acknowledged by the issuing bank will suffice.
I know that matters related to assigned guarantees have a lot to do with the governing law but I just wanted to know the practice of other banks without of course any responsibility on the part of any of the members who will share with us their knowledge.
I also know that guarantees are not negotiable instruments and bankers discourage discounting payments under guarantees to avert the industry from giving way to Prime Bank Instrument Frauds.
[edited 11/30/01 11:54:37 AM]
Discounting Payments under Direct Payment Guarantees
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AbdulkaderBazara
- Posts: 256
- Joined: Fri Apr 05, 2019 5:15 pm
Discounting Payments under Direct Payment Guarantees
Regret unable to help as have no experience of such instruments.
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hatemshehab
- Posts: 220
- Joined: Fri Apr 05, 2019 5:19 pm
Discounting Payments under Direct Payment Guarantees
Analysis:
Although I have never encountered such a request but I think discounting of the payments before they are due is a possibility provided that:
1. The wording of the guarantee is studied carefully to make sure that there is no room for any condition or phrase that would suggest or give rise to any dispute between the parties involved.
2. The discounting bank should obtain an assignment of benefits under the payment obligation. This can be done under an irrevocable letter from the beneficiary in favour of the discounting bank. The assignment of benefits will block any rights and duties to the beneficiary under the guarantee in favour of the discounting bank. It will also keep the issuing bank within the circle of the discounting process. The assignment of proceeds will keep the beneficiary’s right to perform under the guarantee, however only proceeds will be the right of the discounting bank.
3. The bank should obtain the negotiable instruments, if any, from the beneficiary endorsed on collection to the order of the discounting bank to collect them from the principal. Alternatively, the instrument itself could be considered as a dead collateral.
4. That the beneficiary is not entitled to cancel amend or otherwise the guarantee in question and that the guarantee will remain in force until the discounting parties releases the issuer of its obligation.
5. It is very important that the discounting bank obtains the express consent of the issuing bank to the assignments of benefits and I would suggest that the discounting bank intentionally refers to the discounting action when seeking the approval of the issuing bank to the assignment. Why? Well my interpretation of such direct payment guarantee is that it is “partially conditional” in the sense that payment under it is implied to be only on due dates and not before, therefore if the beneficiary’s is allowed to get out of the circle of this guarantee and later there is a fraud or a litigation on default on the part of the beneficiary regarding the equipments, the discounting bank may find itself in an unfavorable situation.
6. Proper loan/discounting documentation, as the case may be, should be put in place. It is advisable that the loan or discounting agreement state and refer to the guarantee as a collateral for the loan and not as a financial instrument.
Precautions / Risks to be considered
1. The duty of care on the part of the discounting bank is highly at test in this type of transaction. The bank has to look at the underlying contract, the parties involved, the activities and performance of the beneficiary even if the later is his customer, because in effect the discounting party is in a way releasing the beneficiary from the mandate of the guarantee as discounting will likely to be without recourse to the beneficiary. Although the recourse issue is a contractual one, however the payment with recourse in view of an issuing bank is a different bank from the discounting bank will imply that the issuing bank may not pay.
2. If the discounting bank is the same as the issuing bank then it should know that by issuing the direct pay instrument the beneficiary obtains payment of the paper from the bank that issued it rather than from the corporation. Therefore this makes it clear that payment is being paid from the bank’s assets rather than from the debtor’s. The bank is then faced with the problem of getting reimbursement from the insolvent debtor.
3. It would be prudent not to accept the payment of the direct pay guarantee to be forthcoming into the beneficiary account to avoid any risks in right to set-off or in the event of injunctions.
4. The consent of the guarantor should be obtained in case assignment of benefits is sought before imposing a new contracting party on him “the discounting bank”, since the consequences of this assignment is sever.
5. It might be advisable that the discounting bank in case he is the issuer of the guarantee to seek the principles consent on the assignment of benefits. Otherwise the bank, unilaterally amending the guarantee by accepting another beneficiary different from the one specified in the principal’s instruction form would put the bank’s recourse against the principal in peril. This does not apply to assignment of proceeds.
6. There are different mechanisms that may be applied to prevent payment. In common law jurisdictions, courts are requested to impose an interim injunction. In civil law countries, the procedure is often referred to as interlocutory relief. As an alternative in these countries an application of arrest or attachment may be ordered, although the applicability of this procedure is disputed. An attachment order applies where a debtor is himself owed money by a third party. The money owed to the debtor by the third party is seized by the creditor at the end of the chain. In Saudi Arabia, as far as I know formal injunction procedure does not exist.
Of course this type of facility can be done in two ways: whether to transfer the non-funded commitment into funded commitment on the part of the issuing bank who is now also a discounting bank, or to grant a capital equipment line of finance with repayment installments within two weeks prior to the due date of the installment of the direct pay guarantee or maturing on the same due dates thereof. In the second option, the bank will have no interest exposure, while in the first option the bank will have to build upon this interest of exposure if it decides to discount the payments before they mature. The first option might be more practical and time saving for both parties as the granting of line financing may take additional time than that of required in the second option. The capital equipment line of finance, will mean that the bank will advance the payment of the guarantee well before due dates, therefore the bank has to look for the working investment, the financing needs, the course of activities of the beneficiary. I would anticipate that the line should not exceed 60% of the guarantee value, while the discounted amount under it could go up to 90% of the total value as it could be done by one. Of course all these factors are dependent on the internal policies and procedures of the bank, the risk factors and other things that might come into the picture.
I hope that these brainstormed idea will be of help to Abdulkader.
Although I have never encountered such a request but I think discounting of the payments before they are due is a possibility provided that:
1. The wording of the guarantee is studied carefully to make sure that there is no room for any condition or phrase that would suggest or give rise to any dispute between the parties involved.
2. The discounting bank should obtain an assignment of benefits under the payment obligation. This can be done under an irrevocable letter from the beneficiary in favour of the discounting bank. The assignment of benefits will block any rights and duties to the beneficiary under the guarantee in favour of the discounting bank. It will also keep the issuing bank within the circle of the discounting process. The assignment of proceeds will keep the beneficiary’s right to perform under the guarantee, however only proceeds will be the right of the discounting bank.
3. The bank should obtain the negotiable instruments, if any, from the beneficiary endorsed on collection to the order of the discounting bank to collect them from the principal. Alternatively, the instrument itself could be considered as a dead collateral.
4. That the beneficiary is not entitled to cancel amend or otherwise the guarantee in question and that the guarantee will remain in force until the discounting parties releases the issuer of its obligation.
5. It is very important that the discounting bank obtains the express consent of the issuing bank to the assignments of benefits and I would suggest that the discounting bank intentionally refers to the discounting action when seeking the approval of the issuing bank to the assignment. Why? Well my interpretation of such direct payment guarantee is that it is “partially conditional” in the sense that payment under it is implied to be only on due dates and not before, therefore if the beneficiary’s is allowed to get out of the circle of this guarantee and later there is a fraud or a litigation on default on the part of the beneficiary regarding the equipments, the discounting bank may find itself in an unfavorable situation.
6. Proper loan/discounting documentation, as the case may be, should be put in place. It is advisable that the loan or discounting agreement state and refer to the guarantee as a collateral for the loan and not as a financial instrument.
Precautions / Risks to be considered
1. The duty of care on the part of the discounting bank is highly at test in this type of transaction. The bank has to look at the underlying contract, the parties involved, the activities and performance of the beneficiary even if the later is his customer, because in effect the discounting party is in a way releasing the beneficiary from the mandate of the guarantee as discounting will likely to be without recourse to the beneficiary. Although the recourse issue is a contractual one, however the payment with recourse in view of an issuing bank is a different bank from the discounting bank will imply that the issuing bank may not pay.
2. If the discounting bank is the same as the issuing bank then it should know that by issuing the direct pay instrument the beneficiary obtains payment of the paper from the bank that issued it rather than from the corporation. Therefore this makes it clear that payment is being paid from the bank’s assets rather than from the debtor’s. The bank is then faced with the problem of getting reimbursement from the insolvent debtor.
3. It would be prudent not to accept the payment of the direct pay guarantee to be forthcoming into the beneficiary account to avoid any risks in right to set-off or in the event of injunctions.
4. The consent of the guarantor should be obtained in case assignment of benefits is sought before imposing a new contracting party on him “the discounting bank”, since the consequences of this assignment is sever.
5. It might be advisable that the discounting bank in case he is the issuer of the guarantee to seek the principles consent on the assignment of benefits. Otherwise the bank, unilaterally amending the guarantee by accepting another beneficiary different from the one specified in the principal’s instruction form would put the bank’s recourse against the principal in peril. This does not apply to assignment of proceeds.
6. There are different mechanisms that may be applied to prevent payment. In common law jurisdictions, courts are requested to impose an interim injunction. In civil law countries, the procedure is often referred to as interlocutory relief. As an alternative in these countries an application of arrest or attachment may be ordered, although the applicability of this procedure is disputed. An attachment order applies where a debtor is himself owed money by a third party. The money owed to the debtor by the third party is seized by the creditor at the end of the chain. In Saudi Arabia, as far as I know formal injunction procedure does not exist.
Of course this type of facility can be done in two ways: whether to transfer the non-funded commitment into funded commitment on the part of the issuing bank who is now also a discounting bank, or to grant a capital equipment line of finance with repayment installments within two weeks prior to the due date of the installment of the direct pay guarantee or maturing on the same due dates thereof. In the second option, the bank will have no interest exposure, while in the first option the bank will have to build upon this interest of exposure if it decides to discount the payments before they mature. The first option might be more practical and time saving for both parties as the granting of line financing may take additional time than that of required in the second option. The capital equipment line of finance, will mean that the bank will advance the payment of the guarantee well before due dates, therefore the bank has to look for the working investment, the financing needs, the course of activities of the beneficiary. I would anticipate that the line should not exceed 60% of the guarantee value, while the discounted amount under it could go up to 90% of the total value as it could be done by one. Of course all these factors are dependent on the internal policies and procedures of the bank, the risk factors and other things that might come into the picture.
I hope that these brainstormed idea will be of help to Abdulkader.
Discounting Payments under Direct Payment Guarantees
We would like to add the following points to caution AbdulBaker,
(1) The banker’s guarantee and the DC have similarities but also a lot of differences. So it is risky to treat them as the same instruments in discounting and assignment of proceeds.
(2) This “discounting banker’s guarantee and related assignment of proceeds” appears to be more a legal issue than a banking issue. So legal counsel must be sort. For this highly specific topic, we should not go to the generalized law services but only to experts in this particular area, if we can identify one ourselves.
(3) There is no clear provision in the most popular rules on banker’s guarantee, the URDG, on discounting and assignment of proceeds to give us a clearer picture of what we are trying to venture into. So the parties are to be protected by the agreements made amongst them. In this case, this is a matter for the lawyers to resolve.
(4) The Santander case may also apply to discounting a banker’s guarantee where frauds are found before the payment maturity date. This is of particular importance to those areas that are subject to the UK jurisdiction.
(5) If the customer is not an important one and there is no frequent such business, we would suggest not to touch this risky business. To be or not to be is a matter to be determined by sound commercial sense, including cost/risk and benefit analysis. This is also the reason why we do not wish to deal with this issue in a fuller extent.
http://www.tolee.com
[edited 12/3/01 5:00:01 PM]
(1) The banker’s guarantee and the DC have similarities but also a lot of differences. So it is risky to treat them as the same instruments in discounting and assignment of proceeds.
(2) This “discounting banker’s guarantee and related assignment of proceeds” appears to be more a legal issue than a banking issue. So legal counsel must be sort. For this highly specific topic, we should not go to the generalized law services but only to experts in this particular area, if we can identify one ourselves.
(3) There is no clear provision in the most popular rules on banker’s guarantee, the URDG, on discounting and assignment of proceeds to give us a clearer picture of what we are trying to venture into. So the parties are to be protected by the agreements made amongst them. In this case, this is a matter for the lawyers to resolve.
(4) The Santander case may also apply to discounting a banker’s guarantee where frauds are found before the payment maturity date. This is of particular importance to those areas that are subject to the UK jurisdiction.
(5) If the customer is not an important one and there is no frequent such business, we would suggest not to touch this risky business. To be or not to be is a matter to be determined by sound commercial sense, including cost/risk and benefit analysis. This is also the reason why we do not wish to deal with this issue in a fuller extent.
http://www.tolee.com
[edited 12/3/01 5:00:01 PM]
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hatemshehab
- Posts: 220
- Joined: Fri Apr 05, 2019 5:19 pm
Discounting Payments under Direct Payment Guarantees
I believe that the assignment of proceeds or the assignments of benefits is merely a contractual matter that can be applied to guarantees as well. Although I recognize that there are differences between the letters of credit and the letters of guarantee but let us remember that the first paragraph of article 4 in the URDG regulates assigning of benefits of a guarantee or counter guarantee.
“The beneficiary’s right to make a demand under a guarantee is not assignable unless expressly stated in the guarantee or in an amendment thereto.
This article shall not, however. Effect the beneficiary’s right to assign any proceeds to which he may be, or may become, entitled under the guarantee.”
Therefore in certain cases there might be multiple assignments or partial assignments of proceeds under this instrument.
In addition to that the credit department should assess the credit worthiness of the beneficiary to come up with a decision on the viability of such request, as this matter is more of credit that of a trade department issue.
I think a prudent credit department in close coordination with the legal department should be able to finalize this issue to the satisfaction of both parties.
“The beneficiary’s right to make a demand under a guarantee is not assignable unless expressly stated in the guarantee or in an amendment thereto.
This article shall not, however. Effect the beneficiary’s right to assign any proceeds to which he may be, or may become, entitled under the guarantee.”
Therefore in certain cases there might be multiple assignments or partial assignments of proceeds under this instrument.
In addition to that the credit department should assess the credit worthiness of the beneficiary to come up with a decision on the viability of such request, as this matter is more of credit that of a trade department issue.
I think a prudent credit department in close coordination with the legal department should be able to finalize this issue to the satisfaction of both parties.
Discounting Payments under Direct Payment Guarantees
Hatem,
CLARIFICATION OF OUR STATEMENT
By the statement
“There is no CLEAR provision in the most popular rules on banker’s guarantee, the URDG, on DISCOUNTING and ASSIGNMENT OF PROCEEDS to give us a clearer picture of what we are trying to venture into”,
we intent to say that there is no CLEAR (or DETAILED if you will) stipulation in the URDG in such details as in the UCP 500 on NEGOTIATION on Article 9 and on ASSIGNMENT OF PROCEEDSD in Article 49. Article 4 of the URDG only says that a banker’s guarantee is not assignable unless otherwise stated in the banker’s guarantee and/or amendments and the Articles in URDG do not affect a beneficiary's right to assign (because URDG, merely reflecting trade practice, cannot override or have conflicts with the local laws)
However, we appreciate your time and efforts contributed to the issues in your previous posting
http://www.tolee.com
[edited 12/4/01 7:50:04 PM]
CLARIFICATION OF OUR STATEMENT
By the statement
“There is no CLEAR provision in the most popular rules on banker’s guarantee, the URDG, on DISCOUNTING and ASSIGNMENT OF PROCEEDS to give us a clearer picture of what we are trying to venture into”,
we intent to say that there is no CLEAR (or DETAILED if you will) stipulation in the URDG in such details as in the UCP 500 on NEGOTIATION on Article 9 and on ASSIGNMENT OF PROCEEDSD in Article 49. Article 4 of the URDG only says that a banker’s guarantee is not assignable unless otherwise stated in the banker’s guarantee and/or amendments and the Articles in URDG do not affect a beneficiary's right to assign (because URDG, merely reflecting trade practice, cannot override or have conflicts with the local laws)
However, we appreciate your time and efforts contributed to the issues in your previous posting
http://www.tolee.com
[edited 12/4/01 7:50:04 PM]
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hatemshehab
- Posts: 220
- Joined: Fri Apr 05, 2019 5:19 pm
Discounting Payments under Direct Payment Guarantees
Clarification noted.