A Letter of Guarantee is a letter issued by a bank addressed to the beneficiary, guaranteeing the fulfillment of an obligation that the addressee has undertaken towards the beneficiary. In this article, the fields where the letter of guarantee is used, the legal nature of the letter of guarantee, its elements and types will be explained.
In business life, when traders do not have sufficient information about each other's ability to pay, the party who concerns about collecting their receivables from the other party may request guarantee. In these circumstances, letter of guarantee provides assurance to the creditor for the collection of receivables. Due to this need in business life, the scope of using the letters of guarantee is now beyond just commercial transactions. In fact, letters of guarantee can be used to stop execution proceedings, to participate in public tenders, to submit to custom authorities, and to obtain injunctions or attachment orders.
Legal Nature: Is it Surety, Guarantee or Atypical?
Despite such an extensive presence in business and the law, there is no definition or written regulation on letter of guarantee. Furthermore, there is no consensus in the doctrine on the legal nature of letter of guarantee. In the doctrine, there are opinions about legal characteristic of letter of guarantee, such as surety, guarantee or atypical contracts. Contracts of surety and guarantee are types of security contract with similar legal qualities and are often confused with each other in practice. We have elaborated on the characteristics and differences between contracts of surety and guarantee in detail in our article at https://www.mondaq.com/Article/1269270 . Finally, in terms of its legal nature, the Court of Cassation has concluded that letter of guarantee is an example of guarantee contract:
Court of Cassation Assembly of Civil Chambers., Case No. 1969/4, Decision No. 1969/6, dated 11.06.1969
Here, by agreeing to pay the amount to the customs authority upon its request, without raising any objections or allowing for the issuance of a judgment, the guarantor has undertaken a separate obligation under Article 497 of the Turkish Code of Obligations, by waiving the right to assert that the principal debt is legally existing, valid, and actionable. Although the principal debtor has the right to raise such defenses and the guarantor is legally obligated to do so, the bank, by waiving these defenses, is under a heavier burden than the principal debtor.
Today, this opinion is more predominant. The parties to bank letters of guarantee in the form of a contract of guarantee are as follows: (i) the bank (ii) the beneficiary, who is a person or legal entity whose favor the bank provides a guarantee (iii) the addressee, who is a person or legal entity in whose favor the bank undertakes to fulfill the obligation or otherwise to pay compensation.
For a bank guarantee letter to have a security function, it must meet the conditions of guarantee contract. A bank letter of guarantee will not be completely invalid, even if it does not contain the necessary elements of a guarantee contract. It will simply not be considered a contract of guarantee. 1
The guarantor bank undertakes to cover the risk arising from this action or the underlying debt relationship in order to induce the beneficiary to take a specific action and, to secure its rights as a creditor in the debt relationship..2 Sometimes the risk may increase naturally. In cases where the risk increases in this way, if the letter of guarantee does not specify an amount limit and the risk has increased due to the nature and purpose of the contract of guarantee, the guarantor remains liable for the increased part.3
The bank undertakes the performance of the beneficiary with the letter of guarantee independently of the contract between the beneficiary and the addressee. Here, "independence" refers to the fact that the guarantor's obligation is not dependent on the existence, validity, or enforceability of the underlying contract. 4 Undertaking an independent commitment confirms that bank letters of guarantee have the characteristics of guarantee contract rather than surety. This is because in a contract of surety, the surety is liable as a secondary obligor, whereas in a contract of guarantee, the guarantor is liable as a primary obligor independent of the main obligation.
Letters of guarantee are divided into different types according to the form, subject and validity period of the payment request.
- There are 2 types of bank letters of guarantee according to the form of the payment request: Letters of guarantee collectable upon first request and conditional letters of guarantee. Usually, letters of guarantee collectable upon first request are used in practice. In the case of letters of guarantee collectable upon first request, the bank is obliged to make payment to the addressee up to the amount guaranteed without any investigation at the time of the addressee's request.5 In the case of conditional letters of guarantee, if it is not proven that the conditions attached to the letter of guarantee have been fulfilled, the bank will not pay the addressee.6 A letter of guarantee can be conditioned upon the occurrence of a specific event or the presentation of a document agreed upon by the parties.
- There are 3 types of bank letters of guarantee according to their subject matter: Bid bonds, performance bonds and advance letters of guarantee. Bid bonds are issued to facilitate participation in a tender and guarantee that, if the tender is won, the beneficiary will provide a performance bond and sign the contract.7 Performance bonds are a type of guarantee letter where the bank guarantees that the beneficiary will fulfill the obligations specified in the letter. If the obligations are not fulfilled, either partially or completely, the bank is liable for compensation.8 Advance letters of guarantee, which are usually encountered in tenders, are a guarantee by a bank of the amount of the advance payment received by the contractor for the start of the work. As the contractor fulfills its commitments in accordance with the terms of the contract, the advance is recovered by deducting it from progress payments.
- There are 2 types of letters of guarantee according to their validity period: Dated and undated letters of guarantee. Dated letters of guarantee are letters of guarantee in which the bank's liability arising from the letter of guarantee is limited to a certain period. In order for the bank to be liable for dated letters of guarantee, the risk secured by the letter of guarantee must be realized within the specified period of time. The bank will not be liable if the risk does not occur in the anticipated period.9 In undated letters of guarantee, no specific time limit is set for the undertaking of the risk.
Footnotes
1. Doğan, Vahit, Banka Teminat Mektupları, 3.b., Ankara 2005, s. 39
2. TANDOĞAN, Özel Borç İlişkileri, s.811.
3. REİSOĞLU, Garanti Mukavelesi, s.11.; YAVUZ, Özel Hükümler, s.879.
4. Tandoğan, A.G.E, s. 812;
5. YENER COŞKUN, Hilal: Banka Teminat Mektuplarında İlgililerin Hak ve Borçları, Vedat Yayıncılık, İstanbul, 2012, s. 64.
6. YENER COŞKUN, a.g.e, s. 117
7. Türkiye'de Teminat Mektupları: Uygulamalar ve Hukuki Sorunlar, Abdurrahman ÇETİN, Yusuf DİNÇ, s. 73
8. YENER COŞKUN. A.g.e 118.
9. YENER COŞKUN. A.g.e 121.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.