Bank guarantee: what it is, what types exist and how to get one

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What a bank guarantee is

A bank guarantee is an undertaking of the bank (not yours) to pay the third party (the beneficiary) a stated amount when the conditions written in the letter of guarantee are met. The structure consists of three separate contractual relationships: you and the beneficiary in the underlying transaction; you and the bank in the agreement under which the guarantee will be issued (the security you will provide and the commission you will pay); and the bank and the beneficiary, a relationship defined in the letter of guarantee itself, and only in it.

The practical meaning of this separation is sharp: the bank has no interest in the underlying transaction. It did not examine it before issuing the guarantee, and according to case law, as a rule, it is not its role to decide a dispute arising from it when a payment demand arrives.

The document that the bank gives the beneficiary is called a letter of guarantee (in searches the term “bank guarantee note” sometimes appears too, but the name of the document is a letter of guarantee), and its terms decide when the bank will pay.

An autonomous bank guarantee: what it is, and how it differs from an ordinary guarantee

An autonomous bank guarantee is a guarantee that the bank pays at the beneficiary’s demand and according to the terms of the letter of guarantee only, without checking whether the underlying contract was breached. In this it differs from an ordinary guarantee, in which every defense that the debtor has against the creditor is also available to the guarantor (section 7(a) of the Guarantee Law).

To understand what is given up, you need to see what the Guarantee Law, 5727-1967 (חוק הערבות, התשכ״ז-1967) gives an ordinary guarantor by default:

• Section 2: “A guarantee exists only for a valid obligation.” If the guaranteed obligation is void, there is nothing for the guarantee to apply to.
• Section 4(a): “The guarantor is not liable for more than the debtor’s obligation, nor more severely.”
• Section 5(c): a change in the guaranteed obligation gives the guarantor a choice, and in a fundamental change that harms their rights, the right to cancel their guarantee.
• Section 7: “Any defense that the debtor has against the creditor in connection with their obligation is also available to the guarantor”; and under section 7(b), if the claim against the debtor has become time-barred, it is also time-barred against the guarantor.
• Section 8: the guarantor and the debtor are jointly and severally liable, but the creditor may not make a demand on the guarantor without first making a demand on the debtor, except in the circumstances listed in the section.

An autonomous bank guarantee is worded so that none of these mechanisms will apply. It is not a “type of guarantee” that the law defines: the Guarantee Law has no section with the heading “autonomous guarantee”. The courts have classified the autonomous bank guarantee as an undertaking to indemnify under section 16 of the Law, so only sections 3, 9, 11 and 12 apply to it, “with the necessary changes”, and not sections 2, 7 and 8.

The distinction is not binary. The letter of guarantee decides how far the guarantee is detached from the underlying transaction, and in practice intermediate arrangements form between an ordinary guarantee and an undertaking to indemnify. So the three wordings “on first written demand”, “on a reasoned demand” and “against presentation of documents” are not a linguistic nuance: they are three different balances of power.

Types of bank guarantee: tender, performance, advance payment, Sale Law and rental

In the Israeli market, types of bank guarantee are distinguished by what they secure. Three of them have a basis in legislation, and so it is precisely in them that forfeiture is limited:

Two points worth knowing in this table. A Sale Law guarantee is not a standard autonomous bank guarantee but a hybrid arrangement: it is governed both by the mandatory rules of the Law and by the wording set by the bank. Under section 2 of the Law, a seller may not receive from a buyer more than seven percent of the price of the apartment unless it has provided the buyer with one of the securities listed in the section, and a bank guarantee (or a guarantee from another guarantee provider) is the first of them. A residential rental guarantee is limited by law: under section 25J(b), the total of the securities that involve a monetary expense for the tenant (including a bank guarantee) may not exceed the lower of the rent for one third of the rental period or three months’ rent.

Obtaining a bank guarantee: how it works and what it costs

Issuing a guarantee is credit in every sense. The bank puts its signature on the line, so it first checks whether it will be able to recover the money from you if it pays, and it requires security. According to Kol Zchut (All Rights), the common practical condition is that the amount of the guarantee is available and frozen in the account when the guarantee is issued; in large businesses it is common instead to reserve the amount within the credit line or to provide a dedicated deposit.

The Banking Supervision Department regulates the operational side in Proper Conduct of Banking Business Directive No. 353, “Control over the Issuance of Guarantees by a Banking Corporation”. The directive requires every banking corporation to set a standard wording for each type of guarantee and a procedure for deviations from it, to regulate the approval of the letter of guarantee by authorized signatories, to monitor the fulfillment of the obligation for which the guarantee was given and to cancel guarantees that have expired, and to carry out a periodic reconciliation between the guarantees register and the accounting records. This leads to a practical point: the wording that the bank offers you is a standard wording, and a deviation from it is possible but requires approval.

The cost. The commission for a bank guarantee is not set by law. It is set in the bank’s schedule of charges and in your agreement with it, and it varies according to the type of guarantee, its duration, the security you provided and the risk the bank attributes to you, so any sweeping “commission range” you find online does not bind any bank. What does bind: section 5A of the Banking (Service to Customer) Law, 5741-1981 (חוק הבנקאות (שירות ללקוח), התשמ״א-1981) requires a banking corporation to give its customers written information on the amounts or rates of the commissions and interest for each service, and to display the information prominently in all its branches. Ask for the relevant item in the schedule of charges before signing, not after.

And a point that many people miss at the end of the road: under section 9A of the Banking Law, when a customer has repaid all the obligations for which charges were created, the banking corporation must cancel the charges and put the assets at the customer’s disposal within two weeks, and for a registered mortgage or pledge it must file a deletion notice within 30 days, at its own expense. Releasing the security is not a favor.

Realizing a bank guarantee (forfeiture): what happens when the beneficiary demands the money

Forfeiture (realization) starts with a written demand that the beneficiary submits to the bank. With an autonomous guarantee, the bank carries out a formal check: whether the demand matches the terms of the letter of guarantee, whether it was submitted while the guarantee was valid, and whether the amount is within the guarantee. If so, it pays. It does not examine whether the contract between you and the beneficiary was actually breached.

Case law has recognized two exceptions to the principle of independence: the fraud exception and the special circumstances exception. According to case law, they are applied sparingly and in extreme cases, and the fraud exception applies only to a serious act of fraud. In practical terms, this means that an argument that “the beneficiary is not right”, “the work was done” or “I have a set-off” does not stop payment. It remains to be decided with the beneficiary, after the money has gone out.

After the bank has paid, it turns to you. The source of its right is not only the contract you signed with it: because the guarantee is classified as an undertaking to indemnify under section 16 of the Guarantee Law, section 9 (the right to recover from the debtor what it gave, plus reasonable expenses and interest) and section 12 (transfer of a charge on the debtor’s asset to the guarantor) also apply, “with the necessary changes”. In practice, the bank relies first of all on the independent securities it required from you in advance.

A guarantee was forfeited against you unlawfully: what to do

The only tool that stops the money before it goes out is a temporary injunction, and you must apply for it before the bank pays. After payment, what remains is a claim against the beneficiary, which is a longer proceeding with a heavier burden of proof. So the three things that decide the outcome are done early: ongoing documentation of the performance of the obligation, a careful reading of the demand terms in the letter of guarantee (a forfeiture that does not meet them can be challenged even without an exception), and an immediate response the moment a notice arrives.

In two contexts, the law itself protects you better than the two general exceptions:

• A tender guarantee in state tenders. Under regulation 16B(b) of the Mandatory Tenders Regulations, the tenders committee may order the forfeiture of a tender guarantee, in whole or in part, only after it has given the bidder an opportunity to present their arguments, and only on one of four grounds: conduct that is cunning, deceitful or lacking in clean hands; giving misleading information or materially inaccurate information; withdrawing the bid after the final date for submission; or failing, after winning, to meet the preconditions for entering into the contract. A forfeiture without a hearing, or for a reason that is not on the list, is a flawed forfeiture.
• A residential rental guarantee. Section 25J(c) of the Rental and Loan Law sets out a closed list of cases in which the landlord may realize the security, and the maximum amount in each of them. Section 25J(d) requires the landlord to notify the tenant a reasonable time in advance and to allow them to remedy the matter. And section 25J(e) requires the landlord to return the security or its balance, including its proceeds, within 60 days of the return of the apartment or by the date on which the tenant’s debts under section 25J(c) were paid, whichever is later.

In these two cases, the argument is not “the beneficiary was not entitled to it” but “a condition that the law sets for forfeiture was not met”, and that is a much stronger argument.

Frequently asked questions

What is a bank guarantee?

An undertaking of the bank to pay the beneficiary a stated amount when the conditions written in the letter of guarantee are met, without the beneficiary having to prove that the contract between the beneficiary and you was breached. The bank is not a party to the underlying transaction and does not examine it; it checks the demand against the wording of the guarantee only.

What is the difference between an autonomous bank guarantee and an ordinary guarantee?

In an ordinary guarantee, the law stands on the guarantor’s side: section 2 of the Guarantee Law requires a valid obligation, section 7 makes the debtor’s defenses available to the guarantor, and section 8 requires the creditor to turn to the debtor first. The courts have classified the autonomous bank guarantee as an undertaking to indemnify under section 16, so these sections do not apply to it. How far it is detached from the underlying transaction is decided by the wording of the letter of guarantee.

How much does a bank guarantee cost, and what does the bank require in return?

The commission is set not by law but in the bank’s schedule of charges and in the agreement with it, and it varies by the type of guarantee, its duration and the security. The bank requires security, usually reserving the amount in the account or within the credit line, and sometimes a personal guarantee. Section 5A of the Banking (Service to Customer) Law requires the bank to give written information about its commissions and to display it in its branches, so you can ask for the schedule of charges before signing.

Can a bank guarantee be canceled?

Not unilaterally. Proper Conduct of Banking Business Directive No. 353 defines a guarantee as an “irrevocable written undertaking” of the banking corporation to pay a third party, and according to Kol Zchut, the amount the bank took from your account as security is returned only when the guarantee has expired or when the guarantee document has been returned to the bank. So what decides in practice is the expiry date in the letter of guarantee, or the beneficiary’s agreement to return the document earlier.

A bank guarantee was forfeited against me. Can the payment be stopped?

Only by a temporary injunction applied for before the bank has paid, and only within two narrow exceptions, fraud and special circumstances, which the courts apply sparingly. A demand that does not meet the terms of the letter of guarantee, as to timing, manner or amount, can be challenged even without the exceptions. For a tender guarantee in state tenders and for a residential rental guarantee, the law sets conditions for forfeiture (a hearing, a ground from a closed list, advance notice), and failure to meet them is an independent argument.

A bank guarantee for a rental: how much may the landlord demand, and when is it returned?

In a residential rental, the total of all the securities the landlord asks for, including a bank guarantee, may not exceed the lower of the rent for one third of the rental period and three months’ rent (section 25J(b) of the Rental and Loan Law). The landlord may realize the security only in the cases in section 25J(c), after advance notice (section 25J(d)), and must return it or its balance within 60 days of the return of the apartment, or by the time the tenant’s debts have been paid, whichever is later (section 25J(e)).

A Sale Law guarantee: when must the contractor provide it?

A seller of a new apartment may not receive from the buyer, on account of the price, more than seven percent of the price unless it has given the buyer one of the securities in the law. A bank guarantee is the first on the list; the others are insurance, a first mortgage in favor of the buyer, a cautionary note or transfer of ownership (section 2 of the Sale (Apartments) (Assurance of Investments of Persons Acquiring Apartments) Law).