Managing Performance Guarantees

A Performance Guarantee (sometimes known as a Performance Bond) is often required when the customer has either paid funds upfront or guaranteed funds through a Letter of Credit, but wants or needs a guarantee from the supplier that the goods/services supplied will be as per the contract terms.

In some countries, such as Ethiopia, Bid Bonds/Guarantees (issued when bidding for a tender) and Performance Bonds/Guarantees are almost always required for the supply of goods, and it is quite important, when working out pricing for a contact, that costs of guarantees are taken into consideration right from the beginning. Otherwise, this cost will come straight out of the profit margins and this can be costly, not only because of the actual costs, but also from the viewpoint of cash flow.

The issuance procedure and the costs of issuing Bank Guarantees vary between the different banks, but the principles are the same in that funds often need to be secured by the bank issuing the Guarantee prior to issuance and these funds, depending on the relationship between the supplier and their bank, are usually placed in a separate account. The bank will charge for issuing the Guarantee, but also will charge a commission based on the value and length of time that the Guarantee is in place. This charge is usually taken in advance for a 3 month period. Please note that commission will continue to be charged until the Guarantee is formally cancelled by the bank and this means when the physical Guarantee is returned back to the bank. There are also additional charges if the Guarantee has to be extended. (The value of the Guarantee will be determined by the supplier and can vary from 5% to 20% of the contract value.)

Once the contract has been awarded, the customer often asks for the Performance Guarantee to be issued prior to them sending the funds or issuing the Letter of Credit. If the goods being supplied are ex-stock, then this is not too problematic, but if the lead time on supplying the goods into the country of import is more than three months, then the costs can start adding up, because not only has a chunk of money been taken away from the company to cover the Guarantee, but the longer the Guarantee is in place, the more the costs will mount up.

Therefore, it would be helpful to try and negotiate at the contract stage for the Guarantee to be issued as close to the shipment of goods date as possible. With pre-payments this can be sometimes difficult to arrange. Some suppliers require a deposit with the order and payment prior to shipment and would probably be required to issue the Performance Guarantee from the time the deposit is paid. However, if a deposit is not required, then it could be possible to negotiate that the Guarantee is issued just prior to payment and shipment.

The same negotiation can be tried with Letter of Credit shipments, where a copy of the Performance Guarantee is one of the documents supporting the Letter of Credit presentation. However, in these circumstances it must be remembered that it can take up to 3 weeks (and sometimes longer) to obtain a Guarantee and that the wording on the Letter of Credit must state that the Performance Guarantee or Bond is exempt from any clauses or statements that the customer would require on other documents, mainly because the wording on Guarantees is very strictly controlled by the legal departments of banks and they may not be able to include additional information such as Letter of Credit numbers or other clauses. It would also be useful to find out from the bank that issues the Guarantee how they name their documents, because this needs to match the document name stated on the Letter of Credit.

The main obstacle to arranging this, however, is if the supplier’s bank cannot issue the Guarantee themselves, and the Guarantee is issued by another bank, usually in the country of import. In which case, the Letter of Credit must make it clear that the document supplied is not a copy of the Bank Guarantee itself, but a copy of the instruction from the UK bank to the Overseas bank. Therefore, it is strongly recommended that if a Bank Guarantee is required for a contract, and the supplier wants to try and negotiate for this Guarantee to be issued for the shortest possible period, then they must talk to their bank before even issuing the quotation, to ensure that they understand all the conditions that will take place in the issuance process of the Guarantee and plan accordingly.

Maria Narancic from Point to Point Export Services is an independent international trade adviser who assists organisations world wide with their international trade projects, documentation, Documentary Credits and import/export training.  She is based in the United Kingdom.  If you require any further assistance with the matters mentioned above, please do contact us by e-mail on info@point-point.com or check out other articles on International Trade on the Point to Point Export Services website at www.point-point.com.
 

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