What is Bank guarantee
First let's get into the meaning of guarantee -Guarantee is basically a contract to perform the promise and to discharge the liability of a third person in case of default -and this is what we have in section 126 of Indian Contract Act 1872.
Guarantee is basically a contract -where you are going to perform the promise - becasue you have made the promise that if third party is not going to perform then you would perform -so it's a contract to perform and discharge the liabilities of a third person in the event of default.
Who are the parties involved in bank guarantee?
Basically there are three parties
Applicant would be banks customer - Beneficiary is the person in whose favour bank guarantee has been created or say guarantee is given and Guarantor is generally banker.
Now let us understand what is the nature of this contract - i.e., whether this contract for guarantee is a primary contract? answer is NO - the nature of guarantees are Collateral - it means they are consequential to the main contract between the applicant and beneficiary - -it means there is a contract between applicant and beneficiary -say for exchange of goods or for rendering of services or for some fulfillment of promise and if the contract is not executed -then this contract comes into picture -so we say guarantee is Collateral In nature -now lets say, bank is going to give guarantee say in favour of a beneficiary on request by applicant - what is the risk bank has with regard to guarantee?
Risk arises in the event of default by applicant -that is applicant is supposed to perform some promise or make some action and he is not doing that then if the default is brought to the notice by beneficiary then the guarantor should perform that promise but if the guarantee is given by the bank then the bank will not perform the promise rather bank would compensate the loss that was suffered by the beneficiary on account of non performance / non fulfillment of promises - and this compensation will be restricted to originally guaranteed amount.
We have to understand one thing - in the event of default by applicant the default has to be brought to the notice by beneficiary to the Guarantor and guarantor would compensate the loss - it's not that guarantor is going to perform the promise here when bank is the guarantor - OK - Also understand when beneficiary makes claim to the guarantor we call it is invocation of guarantee..