Five Advantages and Disadvantages of Independent Guarantee

Just over a year ago a new method of security of obligations was introduced: an independent guarantee. Have the economic agents managed to find use for the specific features of this method?

Just over a year ago a new method of security of obligations was introduced: an independent guarantee. Experts started to analyze it from the point of view of the theory of law immediately after the publication of the corresponding amendments to the Civil Code. How is the guarantee used in practice? Have the economic agents managed to find use for the specific features of this method?

1 Advantage: A guarantee can be issued by any commercial organization.

This is an advantage of the independent guarantee compared to a bank guarantee, which can be issued only by a bank. This increased the range of potential issuers, which resulted in the growth of the number of guarantees in the market. The bank guarantee still exists as an independent guarantee issued by a bank.

A practical example: our client, the majority shareholder, held a mandatory buy-out of shares, which was preceded by a mandatory offer of the shares to minority shareholders. The bank that issued the mandatory bank guarantee (according to the requirements of the Federal Law "On Joint-Stock Companies") suggested that the majority shareholder issues surety in the form of an independent guarantee (counter-guarantee). It was issued by a company from the group of the majority shareholder which conducts intensive economic activity and has sufficient assets.

2. An advantage for the beneficiary: the guarantee is independent from the underlying obligation.

This is its advantage compared to other types of security, such as, for instance, a surety. The beneficiary (the recipient of money under the guarantee) provides a package of documents to receive money without having to prove the occurrence of the guarantee event.

An independent guarantee remains in force even if the underlying obligation is invalid.

A practical example: the bank that issued the bank guarantee preferred to have a counter-guarantee rather than a surety, due to the fact that a counter-guarantee is independent from the underlying obligation to compensate for the payment of the bank guarantee.

3. A disadvantage for the guarantor: the independence of the guarantee could be its weak point.

The guarantor has to pay upon the receipt of the documents, even if it is well aware that the trigger event has not occurred. To avoid that, guarantors require to submit the most complete and comprehensive set of documents for the payment.

A practical example: as the amount under the counter-guarantee has to be paid upon the submission of a certain package of documents, we recommended our client to include the documents which can be obtained only after a certain procedure, such as preliminary request to the principal.

4. Advantage: it is possible to change the amount of the guarantee.

It is possible to establish the amount as a constant value or specify the procedure to determine the amount.

This is a significant feature for bank guarantees issued for the procedure of voluntary/mandatory offer of shares of a public joint-stock company. The effective term of such guarantee cannot be reduced, but its amount can be cut down. This affects the provisions of the bank and, ultimately, determines the amount to be paid to the bank for the issuance of such guarantee.

A practical example: the cost of the issue of a bank guarantee depends on its amount and effective term. If the amount is several billion, the payment for its issuance is several million. The legislation does not allow to lower the term of the bank guarantee in case of a mandatory offer.

During the negotiations, our experts reviewed the situation and submitted their request to the Bank of Russia, which then explained that during the procedure of mandatory offer it is possible to reduce the amount of the guarantee by the amount of the expenses related to the redemption of the shares of minority shareholders, who received payment from the own funds of the majority shareholder. This was reflected in the bank guarantee, which led to a significant reduction of our client's expenses related to the purchase of shares.

5. Disadvantage: an independent guarantee can be issued only by a commercial organization.

In all other cases (if the guarantee is issued by an individual, an individual entrepreneur, or a non-profit organization) the document issued is considered to be a surety and not a guarantee. In other words, most final beneficiaries cannot issue a guarantee as they are individuals rather than legal persons.