BONDS, STAND-BY LETTERS OF CREDIT AND COUNTERTRADE
The Role of Bonds in international trade
- A bond is issued by a guarantor, usually a bank or an insurance company, on behalf of an
exporter. It is a guarantee to the buyer that the exporter will fulfill his contractual
obligations.
- If these obligations are not fulfilled, the guarantor undertakes to pay a sum of money to the
buyer in compensation. This sum of money can be anything from 1% to 100% of the contract
value.
- If the bond is issued by a bank, the exporter is asked to sign a counter-indemnity which
authorizes the bank to debit his account with any money paid out under the bond.
- Bonds are usually required in connection with overseas contracts, or with the supply of
capital goods and services. When there is a buyer’s market, the provision of a bond can be
made an essential condition for the granting of the contract.
- Bonds are commonly required by Middle Eastern countries, but nowadays many other
countries also require them. International aid agencies, such as the World Bank or the
European Development Fund and most government purchasing organizations in the
developing world, plus major purchase of goods and services in the North Sea oil sector now
require bonds from sellers.
Types of Bonds
The various types of bond are set out below:
a) Tender or Bid Bonds
A tender or bid bond is usually for between 2% and 5% of the contract value, and will
guarantee that the exporter will take up the contract if it is awarded. Failure to take up the
contract results in a penalty for the amount of the bond. In addition, the tender bond
usually commits the exporter and his bank to joining in a performance bond if the contract is
awarded. Tender bonds serve to prevent the submission of frivolous tenders.
b) Performance Bonds
Performance bonds guarantee that the goods or services will be of the required standard
and a stated penalty is payable if they are not. The amount payable will be a stated
percentage of the contract price; often it is 10%, but sometimes more.
c) Advance Payment Bonds
Advance payment bonds undertake to refund any advance payments if the gods or services
are unsatisfactory.
d) Warranty or Maintenance Bonds
Warranty or maintenance bonds undertake that the exporter will maintain the equipment
for a period of time.
e) Retention Bonds
Retention bonds enable retention monies, which would otherwise be held by the buyer
beyond the completion of the contract, to be released early. These bonds guarantee the
return to the buyer of these retention monies in the event of non-performance of post-
completion obligations by the exporter.
f) Recourse Bonds
, Recourse bonds are sometimes demanded by the ECGD to cover the potential recourse by
the ECGD under buyer credits.
‘On Demand’ Bonds and Conditional Bonds
a) ‘On Demand’ Bonds
These bonds, sometimes known as ‘unconditional bonds’ can be called at the sole discretion
of the buyer. The bank must pay if called upon to do so, even in circumstances where it may
be clear to the exporter that the claim is wholly unjustified. UK courts have often ruled that
the bank must honour claims under on demand bonds.
If the bank has to pay under the bond, it will debit the customer’s account under the
authority of the counter-indemnity. The exporter will then be left with the unenviable task
of claiming reimbursement in the courts of the buyer’s country.
It must be stressed that banks never become involved in contractual disputes. If payment is
called for which conforms to the terms of the bond, the bank must pay.
b) Conditional Bonds
Conditional bonds can be divided into two types:
i) Conditional bonds requiring documentary evidence
ii) Conditional bonds that do not require documentary evidence
Conditional bonds requiring documentary evidence give maximum protection to the
exporter. Payment can be called for by the buyer only against production of a specified
document, such as a certificate of award by an independent arbitrator. Unfortunately, this
type of conditional bond is often unacceptable, particularly in the case of Middle East
buyers.
On the other hand, conditional bonds which do not require documentary evidence are little
better than on demand bonds from the exporter’s point of view. Such bonds often specify
that payment must be made in the event of default or failure on the part of the contractor
to perform his obligations under the above-mentioned contract. This terminology is so
vague that banks are often obliged to pay a simple on demand claim if one is received.
The Procedure for Issuing Bonds
1. Approach to the operation
First, the company talks to the bank and explains its need for financing. The bank analyzes the
company’s financial situation, determines whether a bond issue is appropriate and if the
company meets the essential requirements for the market.
2. Rating analysis and documentation preparation
In order to issue a bond on the market, it is recommended that the company have a rating from
a rating agency. If it does not yet have one, the bank examines the company’s credit and, based
on its sector, tells the company which rating agencies would be the most appropriate.
Throughout this process, the company is under the auspices of the bank that is advising and
assisting it, starting from the preliminary meetings with the agencies - which they attend - to the
actual preparation of the presentation to be given to the agencies.
The Role of Bonds in international trade
- A bond is issued by a guarantor, usually a bank or an insurance company, on behalf of an
exporter. It is a guarantee to the buyer that the exporter will fulfill his contractual
obligations.
- If these obligations are not fulfilled, the guarantor undertakes to pay a sum of money to the
buyer in compensation. This sum of money can be anything from 1% to 100% of the contract
value.
- If the bond is issued by a bank, the exporter is asked to sign a counter-indemnity which
authorizes the bank to debit his account with any money paid out under the bond.
- Bonds are usually required in connection with overseas contracts, or with the supply of
capital goods and services. When there is a buyer’s market, the provision of a bond can be
made an essential condition for the granting of the contract.
- Bonds are commonly required by Middle Eastern countries, but nowadays many other
countries also require them. International aid agencies, such as the World Bank or the
European Development Fund and most government purchasing organizations in the
developing world, plus major purchase of goods and services in the North Sea oil sector now
require bonds from sellers.
Types of Bonds
The various types of bond are set out below:
a) Tender or Bid Bonds
A tender or bid bond is usually for between 2% and 5% of the contract value, and will
guarantee that the exporter will take up the contract if it is awarded. Failure to take up the
contract results in a penalty for the amount of the bond. In addition, the tender bond
usually commits the exporter and his bank to joining in a performance bond if the contract is
awarded. Tender bonds serve to prevent the submission of frivolous tenders.
b) Performance Bonds
Performance bonds guarantee that the goods or services will be of the required standard
and a stated penalty is payable if they are not. The amount payable will be a stated
percentage of the contract price; often it is 10%, but sometimes more.
c) Advance Payment Bonds
Advance payment bonds undertake to refund any advance payments if the gods or services
are unsatisfactory.
d) Warranty or Maintenance Bonds
Warranty or maintenance bonds undertake that the exporter will maintain the equipment
for a period of time.
e) Retention Bonds
Retention bonds enable retention monies, which would otherwise be held by the buyer
beyond the completion of the contract, to be released early. These bonds guarantee the
return to the buyer of these retention monies in the event of non-performance of post-
completion obligations by the exporter.
f) Recourse Bonds
, Recourse bonds are sometimes demanded by the ECGD to cover the potential recourse by
the ECGD under buyer credits.
‘On Demand’ Bonds and Conditional Bonds
a) ‘On Demand’ Bonds
These bonds, sometimes known as ‘unconditional bonds’ can be called at the sole discretion
of the buyer. The bank must pay if called upon to do so, even in circumstances where it may
be clear to the exporter that the claim is wholly unjustified. UK courts have often ruled that
the bank must honour claims under on demand bonds.
If the bank has to pay under the bond, it will debit the customer’s account under the
authority of the counter-indemnity. The exporter will then be left with the unenviable task
of claiming reimbursement in the courts of the buyer’s country.
It must be stressed that banks never become involved in contractual disputes. If payment is
called for which conforms to the terms of the bond, the bank must pay.
b) Conditional Bonds
Conditional bonds can be divided into two types:
i) Conditional bonds requiring documentary evidence
ii) Conditional bonds that do not require documentary evidence
Conditional bonds requiring documentary evidence give maximum protection to the
exporter. Payment can be called for by the buyer only against production of a specified
document, such as a certificate of award by an independent arbitrator. Unfortunately, this
type of conditional bond is often unacceptable, particularly in the case of Middle East
buyers.
On the other hand, conditional bonds which do not require documentary evidence are little
better than on demand bonds from the exporter’s point of view. Such bonds often specify
that payment must be made in the event of default or failure on the part of the contractor
to perform his obligations under the above-mentioned contract. This terminology is so
vague that banks are often obliged to pay a simple on demand claim if one is received.
The Procedure for Issuing Bonds
1. Approach to the operation
First, the company talks to the bank and explains its need for financing. The bank analyzes the
company’s financial situation, determines whether a bond issue is appropriate and if the
company meets the essential requirements for the market.
2. Rating analysis and documentation preparation
In order to issue a bond on the market, it is recommended that the company have a rating from
a rating agency. If it does not yet have one, the bank examines the company’s credit and, based
on its sector, tells the company which rating agencies would be the most appropriate.
Throughout this process, the company is under the auspices of the bank that is advising and
assisting it, starting from the preliminary meetings with the agencies - which they attend - to the
actual preparation of the presentation to be given to the agencies.
