Bank Guarantees: Beware of Fraudsters

Harini Subramani

Small companies are often caught unaware and inadvertently find themselves entangled in fraudulent financial and legal transactions. This can take many forms but what we are discussing here is the issue of bank guarantees.

Small and medium enterprises (SMEs), especially in the export and import segment, use bank guarantees a great deal. The guarantee is very handy because it is an assurance given by a bank on behalf of one party to another party that has entered into a contract with the other. A bank guarantee can be executed by a bank on behalf of the seller for the buyer or vice-versa.

How Does A Bank Guarantee Work?

A bank guarantee uses basic legal language. Depending on the type of guarantee and the line of service (import, export, construction, etc), a simple format can be obtained online.

Next, ensure that this document is on a stamp paper. The value of the stamp depends on where you intend to execute the guarantee. For example, if it is a document executed in the state of Tamil Nadu, the stamp value would be Rs 100 regardless of the sum involved in the bank guarantee.

The content should specifically detail the names of the two/three parties entering into the contract, including the name of the bank and its branch; the amount mentioned in the guarantee along with the date and mode of payment; the period of validity of the bank guarantee; the purpose for providing the guarantee (this has to be specific, do not allow any room for ambiguity); grace period to enforce rights and provide allowances; and events of default under which the guarantee stands terminated.

Once all the details are typed, both parties must proof-read the document and suggest changes, if any. The leeway to suggest changes is acceptable commercially. Once the document content is approved and accepted by all parties involved, a bank representative signs and seals the guarantee.

At the time of maturity, the money is remitted by the bank by way of a demand draft.

At The Receiving End

Companies engaged in foreign trade have to be very cautious as information asymmetry is still a cause to worry about. Yes, even in the 21st century. Vanadhi Devi, an entrepreneur associated with Vista Expedition, a Chennai-based company that provides logistics support and services including customs clearance, reveals a bitter experience. "Our company had a close call with fraudsters who issued fake bank guarantees. While the guarantee looked totally genuine, the facts of the content had to be examined thoroughly."

Vista Expedition had had to export some bulk goods to a buyer in Europe. "We demanded a bank guarantee from the potential buyer and this was provided to us on demand." However, Vista Expedition was not completely convinced about the authenticity of the document it had received. "Our apprehensions were confirmed when we took it to a representative of the Export Credit Guarantee Corporation (ECGC), who told us we were holding a fraudulent bank guarantee," says Devi. Vista then realised that the name of the foreign bank was one that did not exist.

The ECGC, among others, provides information on the credit-worthiness of overseas buyers. Interestingly, the Reserve Bank of India (RBI) has issued notices warning users of bank guarantees obtained through fraudulent means. In 2011, for instance, the RBI had made public a specific forgery case relating to bank guarantees and even listed the names of the parties involved.

How To Minimise Fraud

B Jaiganesh, a Chennai-based independent services consultant in the infrastructure industry, is a frequent user of bank guarantees. He advises, "The type of bank guarantee is very important in order to avoid frauds."Broadly, there are cash bank guarantees and non-cash bank guarantees. In his line of work, he ideally insists on the former. "When the transaction involves cash, the guarantee should be such that it can be easily encashed. This cannot be substituted by a corporate guarantee. However where performance guarantees are involved, those that are not for cash, they may not be a viable option as they do not hold water when there is an issue," reveals Jaiganesh.

Since this involves corporate companies, the matter typically goes to litigation, which involves a lot of time.

According to a Deloitte India Banking Fraud study conducted in 2012 among private, public, multinational and cooperative banks, 20 per cent of respondents admitted to falling prey to a high level of fraudulent documentation. Interestingly, 64 per cent said that bank frauds in general involved at least one employee while the rest acknowledged a collusion involving more than one bank employee.

These fraudulent transactions take place despite a certain level of precaution among financial institutions in the domestic market. There is a definite need for more checks and balances when it involves international transactions.

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