“Leasing” Guarantees & SBLCs
Collateral Transfer (or otherwise mistakenly called ‘Leasing’ or ‘Lease’ of Bank Guarantees and Standby Letters of Credit), is a modern way to collateralise a business for loan or credit security. It can also serve as credit enhancement for a myriad of other purposes.
As the methodology mirrors that of conventional leasing (i.e. the business takes on a third party’s collateral with an underlying contract to return the collateral at the end of a given term), many refer to it as leasing. As the collaterals are often delivered by means of a Letter of Guarantee issued by a Bank (called Bank Guarantee or B/G), the act is often referred to as ‘leasing bank guarantees’.
It is actually a misnomer. It is not possible to lease, buy or sell bank guarantees. A bank guarantee is a Letter of Guarantee (L/G) issued by a bank on behalf of the applicant to a given beneficiary. The L/G is worded specifically for the purpose it is being used for. This may be for securing a credit line with another bank or lender, or may be used to guarantee performance of a contract or used as a surety.
A bank guarantee is not a means of payment. It’s use is to secure a payment. It is never issued with the clear intention of being called or claimed, but moreover acts as a last resort in the event of default. Bank will stake claim or ‘liberate’ the Guarantee in the event of default of the underlying contract, whether it be failure to repay a credit line or loan, or failure to make payment against a buy/sell contract for a commodity purchase for example.
L/Gs or B/Gs are governed by specific rules. These are the Uniform Rules for Demand Guarantees (or URDG).
The most recent publication to these rules is published by the International Chamber of Commerce (or ICC) and its publication number is 758. You may have heard of the expression, URDG ICC758 when referring to these instruments of guarantee.
Of course, from an outsider’s point of view, a Bank Guarantee is a guarantee being issued by a bank. From a banker’s perspective, it is his banks’ letter of guarantee. Therefore, you will often find professional bankers referring to these instruments as Letters of Guarantee.
It takes the form of an actual letter, worded specifically to give a guarantee to the recipient of payment in the event of a claim. The guarantee will be conditional, i.e. there has been a failure on behalf of the beneficiary to adhere terms to a contract.
WHERE THE ENTREPRENEUR may require additional investment, capital or credit (loans) or where project finance is needed but he has no sufficient security or assets to pledge to his bank for a conventional loan, he may choose to enter into a Collateral Transfer facility. He will obtain a Bank Guarantee that will act as solid security and allow his own bankers to advance him credit against it.
The entrepreneur will approach a provider of these facilities (typically a private equity company, hedge fund or investment company) and make the necessary application.
As stated above Bank Guarantees are issued dependant on an underlying contract. In this case (Collateral Transfer), the contract is one where the provider agrees to pledge his own assets with his bank and instructs his bank to issue a Guarantee in favour of the recipient. The recipient agrees to remove any encumbrance (i.e. to repay any loans secured on it) before the expiry of the agreed term. If the recipient defaults in his repayment of the loan secured over the Guarantee, the lending bank will of course demand against it, i.e will liberate the Guarantee. For this reason, the recipient also agrees within the Contract to secure the provider in this event by offering him an indemnity. This is often done by a pledge or lien over his share capital or other means as may be agreed between the parties.