CAN A BANK BRANCH ISSUE A GUARANTEE BACKED BY ITS OWN HEAD OFFICE’S COUNTER-GUARANTEE?

An unusual guarantee structure raises an important question: Can a bank obtain legal protection from a counter-guarantee issued by another part of the same bank? Mr. Old Man shares his views on the legal and credit risks involved.

Question

Dear Mr. Old Man,

Our bank is considering a transaction in which our head office would issue a counter-guarantee, while our local branch would issue a local guarantee. The proposed structure is as follows:

• Counter-guarantees: One issued by our head office and another by a foreign bank.
• Local guarantee: Issued by our local branch and backed by the two separate counter-guarantees mentioned above.

No fronting bank is involved, at the client’s request.

What are the potential risks for our head office and local branch in issuing a guarantee backed by two separate counter-guarantees?

Thank you for your time and consideration.

Best regards,
H.

____

Answer

Dear H.,

Thank you for your question.

Based on your description, I understand that your local branch intends to issue a local guarantee backed by two separate counter-guarantees: one issued by your head office and the other by a foreign bank.

In my view, this is an unusual and impractical arrangement that raises a fundamental legal question.

Can a branch obtain a legally independent counter-guarantee from its own head office?

From a legal standpoint, a branch cannot obtain an independent counter-guarantee from its own head office because both are parts of the same legal entity. A counter-guarantee creates an undertaking by one party to reimburse another, but the head office and its branch are not separate legal persons.

Consider this simple question: If the head office fails to reimburse the branch, can the branch sue its own head office to enforce the counter-guarantee? The branch cannot bring a claim against its head office as though they were two separate legal entities. Consequently, such an arrangement would not provide the branch with independent legal protection.

An internal commitment may allocate responsibilities between the head office and the branch, but it cannot create an independent counter-guarantee between two separate legal persons where only one exists.

My recommendation is to simplify the structure. Ideally, either the head office or the local branch should issue the local guarantee based solely on the counter-guarantee provided by the foreign bank.

Prior to issuance, the issuing bank must assess the creditworthiness of the foreign bank providing the counter-guarantee and carefully examine its terms and conditions to ensure that, should a payment obligation arise under the local guarantee, the issuing bank can successfully claim reimbursement from the counter-guarantee issuing bank.

In short, do not overcomplicate the transaction by introducing an internal counter-guarantee that provides no independent legal recourse. Focus instead on obtaining effective protection from the foreign bank and ensuring that the counter-guarantee is legally enforceable.

Best regards,
Mr. Old Man