Don’t Issue Blank Cheques!

By Patrick Verspecht, Treasury Professional

A few months ago, I got a call from a friend who is the Global Controller of a small Belgian multinational company. He was seeking an opinion on how to prevent one of their customers drawing on two bank guarantees for a quite significant amount, representing almost 40% of the group’s net annual income! Unfortunately, I couldn’t help him, as the wording of these advance payment and performance bonds matched the terms which should never be accepted by any issuer….

This incident, however, led me to think it would be a good idea to share some views and best practices, as experienced during my career, especially when I was confronted with a similar case a few weeks ago.

While there has always been a debate on whether or not trade finance should fall under the umbrella of treasury, I can’t see any better place. The role of treasury has evolved over the last decade and risk is now probably the most important element of the treasurer’s roles and responsibilities, and issuing a bank guarantee has become even more risky today than in the past.

Historically, the company representatives facing the customer during the pre-order negotiation phase are part of the commercial team. Their number one goal is to get the order signed by the customer at a reasonable margin, so they can reach their target and help the company to achieve its aims. So, whether through ignorance or opportunism, they will tend to neglect negotiation over any of the documents annexed to the request for proposal (RFP), such as the required wording of the various guarantees. In my view, however, this not so much the fault of the commercial team as it is of the finance and treasury departments, who are either not implementing the right processes or not making the necessary effort to implement educational programmes for the sales people. I have noted in recent years that more large corporates are rewriting their processes so that these annexes are reviewed by their legal team, and should be considered just as important as the other parts of the contract before the acceptance of the sales order.

There are several non-negotiable rules that an issuer should follow, and they all seem to be a matter of common sense, but the issuance processes (or sometimes the lack of them) too often lead to acceptance of risky terms. 

Seven vital rules

1. Firm expiry date

Without a firm expiry date clearly included in the wording, a bond could be open forever, and on top of the continuing risks of drawdown, the bank will continue to charge bank fees forever… or at least until you finally obtain from the counterparty a release from your liabilities. I have seen bank guarantees open for more than 10 years after the underlying contract was closed.

2. Automatic extension (Evergreen)

Basically, this is the same trap as the previous one. The issuer should explain to the beneficiary that he/shehas the possibility to send an ‘Extend or Pay’ request before the expiry date which is equivalent to an Evergreen format. 

3. Maximum amount

Always insert a maximum capped amount, never accept wording which would transform your originally accepted liability to a variable, unlimited amount (avoid wording such as …. Plus interest, direct and indirect damages costs, legal costs...).

4. Not assignable

Even if you accept this clause (meaning that you authorise the original beneficiary to transfer the bond to another counterparty), your bank will most likely decline to issue a bank guarantee containing an open transferability clause for various reasons, the main one being the danger of it being transferred to an entity which is part of a company or institution on an international blacklist such as that issued by the US Office of Foreign Assets Control (OFAC).

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5. Cure period

A cure period embedded in the bank guarantee explicitly requires its beneficiary to grant a defined period to the issuer in order for him to resolve the issues prompting the draw. Generally, 30 days is an acceptable period.

6. Notification period

Too often we see wording such as “…to pay the Beneficiary any sum not exceeding in aggregate the amount of XXXXX within 3 working days of receipt by the Bank of the Beneficiary’s first written claim demand”. Three days does not give the issuer enough time to contact the beneficiary and try to fix the underlying issues. There should be a clause requiring the issuer to be informed of any scheduled draw at least 15 days prior the draw date.

7. Identified beneficiary, part of underlying contract

The beneficiary must be clearly identified and fully part of the underlying contract parties.

It is also important to consider other elements such as what is defined as the jurisdiction’s location, the adoption of the Uniform Rules for Demand Guarantees (URDG) issued by the International Chamber of Commerce, and the choice of issuing banks, when issuing a guarantee to prevent it becoming a ‘blank cheque’. 

Often, even if the clauses of the bank guarantee are reasonable, and depending on the country of issuance, the issuing bank might not consider it as closed until the original is sent back to them. This means that the company issuing bank guarantees should have a good, accurate process and tool to monitor the life of the guarantees. Typically, in the absence of a TMS or vendor’s tool, a good Excel spreadsheet and regular communication between the process owner (treasury, commercial finance department and so on) and the sales team could save significant bank fees.

 

Patrick Verspecht Treasury Professional Patrick Verspecht is an experienced treasury professional who has held several senior roles in IT, finance and treasury. He held various positions in Dresser Inc (Finance Controller, European Treasurer, EMEA Treasurer) and most recently as Global Treasurer for GE Measurement & Control (part of General Electric Oil & Gas). He remained in that role from November 2012 until February 2016. He is currently working in the areas of financial risk management and corporate treasury, and teaching at the House of Training (Luxembourg Chamber of Commerce). He is an active Board member of the ATEB (Belgian Corporate Treasurers’ Association), and a member of ATEL (Luxembourg Corporate Treasurers’ Association) and the Finance Club of Brussels. Patrick graduated from the EPHEC (Brussels) in 1982 in Computer Sciences and obtained an Executive Master in Finance in 2011 from the Solvay Brussels School of Economics and Management.

 

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Patrick also offers his insight and expertise in FX treasury management and financial modelling in our TMI Academy Advanced Financial Modelling in Excel with Risk Management training sessions.

Join him and other experienced trainers from the Solvay Business School for an intensive 2-4 day session on how to develop stable, collaborative financial models for finance and treasury functions, plus methods on how you can maximise the effectiveness of your treasury workflows in Excel.

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