Types of Bank Guarantees

Types of Bank Guarantees

This article provides an overview of the main types of bank guarantees. Under Iranian banking practice, requests to extend the validity period of a bank guarantee are generally accepted.

Bank Guarantees in Iran

The most important types of bank guarantees commonly issued by banks are as follows:

• Bid Bond Guarantee: Companies, organizations, and public institutions typically award projects, services, the procurement of required assets, the use of facilities, or the sale of surplus assets through tenders or auctions. In such cases, bid bond guarantees are issued to secure the bidder’s commitment to enter into a contract if selected as the winning bidder. Since winning bidders may refuse to accept contractual obligations or decline to sign the contract after the tender or auction, thereby causing financial loss to the organizer, bank guarantees are required to prevent withdrawal. If the bidder refuses to proceed, the guarantee amount may be forfeited to the beneficiary.
• Performance Bond Guarantee: When a contract or agreement is executed for a project or transaction, the employer requires a performance bond to ensure the contractor fulfills contractual obligations in a timely and proper manner. This guarantee ensures the obligor’s performance of the contract terms in favor of the employer.
• Warranty Guarantee for Proper Performance: This type of guarantee is issued to assure the beneficiary, usually the employer, of the contractor’s proper performance and the expected operational efficiency of the work for a specified period after the project’s completion and commissioning. The guarantee remains valid for a defined period following project completion.
• Advance Payment Guarantee: After execution of the main contract between the employer or buyer and the contractor or seller, the contractor often conditions performance upon receipt of a portion of the contract price as an advance payment. This payment is intended to facilitate preparation for the performance of contractual obligations. To ensure the advance payment is used solely for the contract, the employer or buyer requires an advance payment guarantee. In the event of a breach, the beneficiary may recover the guaranteed amount from the bank.
• Retention Money Release Guarantee: Despite ongoing supervision and testing during contract execution, employers often withhold a portion of payments as security for proper performance after final delivery. This retention amount is typically 10% of the contractor’s gross value as reflected in the contractor’s interim payment statements and is held by the employer for a specified period. At the contractor’s request and against issuance of a bank guarantee, the employer may release the retained amount and return it to the contractor.
• Customs Guarantee: Importers who are unable to pay customs duties in cash at the time of clearance must submit a bank guarantee in favor of the customs authority for the amount due. This guarantee may be issued with a fixed maturity, such as six months, or structured in installments. By issuing a customs guarantee, the bank undertakes to pay the guaranteed amount to the customs authority on the specified due date or on each installment date, without delay.
• Payment Obligation Guarantee: A guarantee issued by a bank to secure payment of specific debts on a predetermined maturity date. Examples include guarantees issued to pay taxes or other statutory obligations.
• Miscellaneous Guarantees: In addition to the guarantees described above, banks issue other types of guarantees for various purposes. The wording of these guarantees is usually determined by the beneficiary. Examples include guarantees required for individuals subject to compulsory military service who intend to leave the country.
• Extension of a Bank Guarantee: A bank guarantee is generally issued for a specific period, such as several months, several years, or until the end of business hours on a specified future date. Upon expiration of this period, both the validity of the guarantee and the bank’s obligation cease to exist. Once a guarantee has expired, any payment request is ineffective. If a bank mistakenly pays the guaranteed amount after expiration, it has no right of recourse against the applicant. Therefore, where the validity period of a guarantee is approaching its end, the underlying transaction has not yet been concluded, and the beneficiary wishes to grant additional time to the contracting party or obligor, the issue of extending the guarantee arises. Since a bank guarantee constitutes an independent legal relationship between the issuing bank and the beneficiary, the beneficiary may request an extension directly from the bank. Alternatively, the contracting party may obtain the bank’s consent to extend the guarantee in order to prevent a demand for payment. In certain cases, the beneficiary may use a clause granting the bank discretion and notify the bank to either extend the validity of the guarantee or make payment.

Frequently Asked Questions About Bank Guarantees