Nowadays, business operations are very dynamic and bear various risks. These risks can be classified into as risks from a business partner and external (third party) risks. In other words, it is clear that "My business partner is reliable", "We have known each other for a long time, I trust him" or "We have always worked together, there has been no problem" type of attitudes are very fragile and risky. How one might ensure the payments or on-time delivery of goods under a sale agreement? What if the other party disregards the contractual obligation, intentionally, recklessly or unintentionally? Or what if he/she does not violate his/her obligation, but he/she is not able to ship the goods without his/her fault due to external stakeholders? What if he/she intentionally ommits delivery of goods or delivers defective goods? What if any prohibition of production or shipment of goods is imposed on him/her?
There are a number of assurance methods in commercial negotiations and contracts which may defend the parties in such circumstances. These include various types of assurance include insurance, guarantees, letters of credit, warranty, pledges and other collateral methods in business practices.
Article 460 of Civil Code specifies "other means envisaged by Civil Code or a contract" along with a pledge, forfeit, withholding (keeping) debtor’s assets, surety, guarantee, deposit as means of ensuring the obligations are performed . The Constitutional Court ruled with its decision of July 14, 2015, "On interpretation of some provisions of Article 460.1 of the Civil Code of the Republic of Azerbaijan" that, based on the principle of the free will of the debtors and creditors, the parties may determine any other method for ensuring the performance of obligations in any contract between them,- i.e. in a separate subsequent agreement or within the main agreement.
Each of the assurance methods has different functions and legal nature. In this short note, we define "Guarantees" as assurances provided by third parties. As a legal concept, according to Article 478 of the Civil Code, Guarantee has the following meaning:
"For the purpose of guarantee, the Guarantor (bank, other credit institution or insurance company), upon a request of a third party (principal), undertakes in the written form, to pay the principal’s creditor (beneficiary), the amount of funds upon receiving a written demand from the beneficiary, in accordance with the terms of the obligation undertaken by the Guarantor."
That is, the guarantee is only a written demand by the abovementioned organizations (credit or insurance companies) to pay funds to a third party beneficiary during any event. For example, the seller obtains a guarantee from the bank as to guarantee the seller's obligation to deliver goods, and the bank submits this guarantee to the buyer as beneficiary (beneficiary) with the seller's instruction. If the goods are not delivered or the delivered goods are incompatible with the terms of the contract, the buyer may apply to the bank and receive the guaranteed amount from the bank. The bank, in its turn, will try to get back this amount from the seller, which is not anymore the matter of concern for the buyer.
There are the following types of guarantees in business practice:
· Payment Guarantee: If the payments are not made within the determined period and/or conditions, the Guarantor undertakes to pay the funds. This is usually issued by banks in the form of bank guarantee.
· Performance Guarantee: In the case of non-performance of obligations, it implies the realization of such execution by a third party or the payment of a certain amount of funds. This obligation is reflected in Azerbaijan purchase legislation as performance assurance. Advance Payment Bank Guarantee is an obligation to carry out execution by the bank in the amount of advance payment.
· Collection Guarantee: This is usually the case when resolving disputes. If the court or arbitral award has not been enforced, a third party undertakes to do so.
· Parent Company Guarantee: The founder enterprise provides assurance for the contractual obligations of the subsidiaries. Because of the fact that there are usually a group of companies and more assets, such a guarantee of the parent is useful.
· Subsidiary Company Guarantee: a subsidiary provides assurance for the founder entity's obligations. Generally, such a guarantee is required for the parent obligations from a subsidiary which has real assets, if core assets of the founder enterprise is the shares in subsidiaries subsidiary.
· Crossed Guarantee: entities with the same ownership guarantee each other's obligations.
Depending on the nature of the commercial transaction, one of these type of guarantees can be selected. Here are some points to be noted and should be considered:
· If the law to be applied to the contract or Guarantee is English (Anglo-Saxon) law, the guarantor should demand something in exchange for such guarantee, or the guarantee and the contract be should considered as a single transaction, as an integral part of each other, and this guarantee should be approved with seal before witness(es), all due to the requirement of consideration under English law.
· Financial position and liquidity of the Guarantor should be additionally investigated and asked for documentational evidences. (example: statements from bank accounts, external audit opinion etc ) When the Guarantor is a bank, a ranking requirement should be set.
· The terms and conditions of effectiveness and the termination of the Guarantee should be clearly stated. In some cases, it can be required to provide a Guarantee as a condition precedent for entry into force of the commercial agreement.
· The type of Guarantee, the amount, currency of the guaranteed funds, the required documents for payment and the order of submission of this document (via which address, directly or in case of a bank guarantee through an authorized bank etc.)
· Whether the Guarantee may be revoked or terminated unilaterally under certain conditions by the Guarantor.
· It should be specified that the Guarantee will only be paid on the first demand of the beneficiary or additional documents (and evidence) will be required. If there is an obligation to submit additional evidence, it must be clearly defined what these evidences will be comprised of.
· In addition to referring to the main agreement, if there will be any addendum or amendment to that agreement, the impact of such amendment on the terms and validity of the guarantee should be noted.
It is reasonable to use guarantees, especially in large-scale and international contracts. Please contact us for detailed information and consultancy.