Bank Guarantee Explained in Detail | Types, Process, Charges & Legal Risk

A Bank Guarantee (BG) is one of the most powerful non-fund-based banking instruments used in business and government contracts. It builds trust between parties by ensuring that financial obligations will be fulfilled.

In this detailed guide, we will cover:

What is a Bank Guarantee

Types of Bank Guarantees

Process of obtaining a BG

Charges involved

Legal risks

Eligibility criteria

Documents required

Merits & Demerits (in table form)

10 Frequently Asked Questions

What is a Bank Guarantee?

A Bank Guarantee is a written promise given by a bank to a beneficiary (usually a government department or business entity) that if the applicant (customer) fails to fulfill contractual obligations, the bank will compensate the beneficiary up to a specified amount.

It is governed under the provisions of the Indian Contract Act, 1872 (in India).

Simple Example:

If a contractor wins a government tender worth ?1 crore, the department may ask for a 10% performance bank guarantee (?10 lakh). If the contractor fails to complete the project, the department can invoke the BG and recover the money from the bank.

Parties Involved in a Bank Guarantee

Applicant – The person/company requesting the guarantee

Beneficiary – The party in whose favor the guarantee is issued

Bank – The guarantor

Types of Bank Guarantee

1. Financial Bank Guarantee

Ensures payment of financial obligation.

Example:

Loan repayment guarantee

Deferred payment guarantee

2. Performance Bank Guarantee

Ensures completion of contractual performance.

Common in:

Government tenders

EPC contracts

Infrastructure projects

3. Bid Bond Guarantee (Tender Guarantee)

Submitted while bidding in tenders to assure seriousness.

4. Advance Payment Guarantee

Issued when advance payment is taken from buyer.

5. Foreign Bank Guarantee

Used in international trade transactions.

6. Deferred Payment Guarantee

Used in machinery purchase or capital equipment financing.

Process to Obtain a Bank Guarantee

Step 1: Application Submission

Applicant submits BG request with contract copy.

Step 2: Credit Assessment

Bank evaluates:

Financial statements

Net worth

Cash flow

Credit history

Step 3: Margin Requirement

Bank may ask for:

10% to 100% cash margin

Collateral security

Property mortgage

Step 4: Sanction & Issuance

BG is issued after approval.

Step 5: Monitoring

Bank monitors performance until expiry.

Charges of Bank Guarantee

Bank Guarantee charges vary depending on:

Creditworthiness

Collateral security

Tenure

Type of BG

Common Charges Include:

Charges differ from bank to bank such as State Bank of India, HDFC Bank, ICICI Bank, etc.

Legal Risks in Bank Guarantee

A Bank Guarantee is an independent contract between the bank and beneficiary.

Key Legal Points:

Unconditional BG can be invoked without proof of default

Courts rarely interfere unless:

Fraud is proven

Irretrievable injustice is evident

In India, courts generally uphold the sanctity of bank guarantees.

Merits and Demerits of Bank Guarantee

Eligibility Criteria for Bank Guarantee

Banks generally require:

Registered business entity

Minimum 1–3 years business track record

Good CIBIL score

Positive net worth

Profitable financial statements

Adequate collateral or margin

Startups may also obtain BG against 100% cash margin.

Documents Required for Bank Guarantee

For Companies / Firms:

KYC documents (PAN, Aadhaar, GST)

Incorporation certificate

MOA & AOA

Partnership deed (if applicable)

Financial statements (2–3 years)

ITR copies

Bank statements (6–12 months)

Copy of contract / work order

Net worth certificate (CA certified)

Property papers (if collateral)

Bank Guarantee vs Letter of Credit (Short Comparison)

A BG is different from a Letter of Credit.

A BG ensures compensation on default.
An LC ensures payment upon compliance of terms.

When is Bank Guarantee Used?

Government contracts

Infrastructure projects

Import-export transactions

Construction contracts

Supply agreements

Advance payments

Important Legal Concepts

BG is an independent obligation

Invocation must be as per terms

Expiry date is critical

Claim period matters

10 Frequently Asked Questions (FAQs)

1. What is a Bank Guarantee in simple words?

A Bank Guarantee is a promise by a bank to pay the beneficiary if the applicant fails to fulfill contractual obligations.

2. Is Bank Guarantee a loan?

No. It is a non-fund-based facility unless invoked.

3. How much margin is required for BG?

It varies from 10% to 100% depending on credit profile and bank policy.

4. What is the validity period of BG?

It depends on contract terms. Usually 6 months to 5 years.

5. Can a Bank Guarantee be cancelled?

Yes, only with beneficiary consent.

6. What happens if BG is invoked?

Bank pays the beneficiary and recovers the amount from the applicant.

7. Is collateral mandatory for BG?

Not always. It depends on the financial strength of the applicant.

8. Can startups get Bank Guarantee?

Yes, generally against 100% cash margin or collateral.

9. What is the difference between Financial and Performance BG?

Financial BG covers payment default; Performance BG covers performance failure.

10. Is Bank Guarantee legally enforceable?

Yes. It is legally enforceable under applicable contract laws.