Difference Between Bill of Lading Consigned to Order - PDF by fdh16177

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     International Trade Finance

                                  7 OCTOBER 2002

1.   Time allowed                                 : Three (3) hours

2.   Total number of questions                    : Seven (7) questions

3.   Number of questions to be answered           : Five (5) questions of which at least two (2)
                                                    must be from Part A [20 marks each]

4.   Candidates must obtain a minimum of 16 marks in Part A as well as pass the paper as a

5.   Begin each answer to a new question on a fresh page.

6.   Answer all questions in English.

7.   A blank page is provided at the end of the question paper for rough work.

1.        Best Trading Sdn Bhd (“Best Trading”) requested its banker, General Bank Bhd, to issue an irrevocable
          letter of credit which, among other terms and conditions, has the following requirements:

          •     Signed commercial invoices in three copies;
          •     Packing list in duplicate;
          •     Inspection certificate to be issued by SGS Surveyor Pte Ltd; and
          •     A full set of clean on-board bills of lading consigned to the order of the issuing bank covering
                shipment of goods from an Italian port to Port Klang.

          Upon shipment, the beneficiary, Compressor Spa Italiano, presented the documents to Banca
          Commerciale for payment. Banca Commerciale examined the documents and determined that the
          documents were not in order for the following reasons:

          •     Inspection certificate issuance date is later than the shipment date and the date of inspection of the
                goods was not indicated.
          •     Packing list was not issued on the beneficiary’s letterhead and was not signed by the beneficiary.
          •     Forwarder’s certificate of receipt was presented instead of bill of lading.

          Banca Commerciale informed the beneficiary of the discrepancies and requested for instructions as to
          the disposal of the documents. Compressor Spa Italiano requested the negotiating bank to send a telex
          to General Bank Bhd to request for permission to pay despite the noted discrepancies.

          General Bank Bhd discussed with the applicant to determine if they wished to waive the discrepancies.
          Best Trading refused to waive the discrepancies, as they were not sure if the goods were properly
          inspected and shipped. General Bank Bhd informed the negotiating bank of the rejection and requested
          for instructions as to the disposal of the documents.


          (a)       Was Banca Commerciale correct in rejecting the negotiations due to the discrepancies? Briefly
                    explain your answer.                                                                      [4]

          (b)       Must the inspection certificate indicate an issuance or inspection date that is the same or
                    earlier than the shipment date? Give reasons for your answer.                           [4]

          (c)       Does a packing list have to be issued on the beneficiary’s letterhead? Briefly explain your
                    answer.                                                                                 [4]

          (d)       Does the packing list have to be signed? Briefly explain your answer.                              [4]

          (e)       If the letter of credit calls for a bill of lading, is a forwarder’s certificate of receipt acceptable?
                    Briefly explain your answer.                                                                        [4]
                                                                                                           (Total:20 marks)

2.        (a)       Endorsement on a bill of exchange is provided for in sections 32 to 35 of the Bills of Exchange
                    Act 1949. For an endorsement to be valid, it must be written on the bill itself and signed by the
                    endorser or the endorser’s agent.

                    Name four types of endorsement and briefly explain its implication.                                [8]

          (b)       State and briefly explain three parties to a “bill of exchange”.                                   [6]

          (c)       Explain why would a bank also request the importer to accept a usance bill of exchange drawn
                    by the bank on the importer after having signed the trust receipt with the importer.      [4]

          (d)       Why is “noting” cheaper than “protesting”?                                                       [2]
                                                                                                        (Total:20 marks)

2 of 10                                    DBFS October 2002 – DP06                        Institut Bank-Bank Malaysia
3.      Sally Trading Sdn Bhd (“Sally Trading”) imported some goods from its regular supplier in Germany and
        the invoices were accompanied by a collection order, and a bill of exchange, drawn and payable at 60
        days after the date on the invoice. No other documents of title were attached to the collection order. The
        German bank’s instructions were to release the documents against acceptance, but no protest
        instructions were given.

        Your bank presented the documents to Sally Trading but Sally Trading has not always been prompt in
        returning the accepted bills to your bank and also frequently delayed in making payments on the bills of
        exchange. Due to the long-standing relationship your bank has with Sally Trading, your bank does not
        wish to apply any pressure with regard to the collection.

        Today, your bank received a claim from the German bank for Sally Trading’s account for one month’s


        (a)       Briefly explain your bank’s position under the International Chamber of Commerce Uniform
                  Rules for Collection (URC) in connection with the presentation of documents.          [6]

        (b)       Briefly explain your bank’s position under the Malaysian banking practices in relation to the
                  presentation of the bill of exchange for acceptance in the circumstance described above.  [4]

        (c)       Briefly describe your bank’s position in relation to the interest claim made by the German bank.

        (d)       What would be your bank’s advice to the remitting bank as to the specific instructions to be
                  incorporated in the collection order which are acceptable under the URC to encourage Sally
                  Trading to pay the bills promptly at the maturity date?                                   [6]
                                                                                             (Total:20 marks)

4.      Your bank issued an irrevocable letter of credit and advised it to the beneficiary through PT Bank Agong
        in Jakarta. Among other terms and conditions, the letter of credit asked for the following:

        •     Signed draft drawn on the issuing bank;
        •     Bill of lading issued and consigned to the order of the issuing bank notifying the applicant;
        •     Special condition: Payment of drafts drawn hereunder will be made only after the realisation of
              proceeds from the “re-export programme”.

        In view of the special conditions related to the payment and because the credit expired at the counter of
        the issuing bank, PT Bank Agong informed the beneficiary that PT Bank Agong would only forward all
        the documents to the issuing bank for payment upon receipt of the documents. The beneficiary agreed
        to this arrangement.

        The issuing bank advised PT Bank Agong that, while the documents were in compliance with the terms
        of the letter of credit, PT Bank Agong was not able to honour the drawing as PT Bank Agong has not
        received the proceeds from the re-export programme. The beneficiary will only be paid for the drawing
        under the letter of credit when the payments are received under the re-export programme.

        The beneficiary never received the proceeds. Your bank advised the beneficiary to obtain the proceeds
        direct from the applicant.


        (a)       Would your bank have issued such a letter of credit in the first place? Give reasons for your
                  answer.                                                                                   [5]

        (b)       If your bank were to advise such a credit to the beneficiary, would you have warned the
                  beneficiary about the special conditions?                                           [5]

        (c)       (i)      Is it correct for your bank to have issued this credit and subject it to the Uniform
                           Customs and Practice for Documentary Credits (UCP 500)? Explain your answer. [6]

                  (ii)     List four lessons that you have learnt from this case.                              [4]
                                                                                                  (Total:20 marks)

Institut Bank-Bank Malaysia             DBFS October 2002 – DP06                                           3 of 10
5.        Iqbal Metals Sdn Bhd (“Iqbal Metals”) has been importing scrap metals from China into Malaysia on a
          collection basis. The commercial documents and the documents of title are accompanied by drafts
          drawn at 60 days’ sight.

          There have been problems with Iqbal Metals in the past due to the following:

          •     Goods were being consigned to your bank without your authority;
          •     Collection orders does not indicate whether the documents were to be released against payment
                (D/P) or against acceptance (D/A);
          •     Iqbal Metals has the habit of accepting the usance bills of exchange, examining the goods and
                offering partial payments of the accepted bills of exchange on maturity date;
          •     Iqbal Metals refuses to pay bank charges claimed by your bank and the remitting bank in their
                collection order.

          You called En Ishak of Iqbal Metals to your office to discuss these problems and to explain your bank’s
          position under the Uniform Rules for Collections (URC).


          (a)       Briefly indicate the responsibilities of your bank under the current URC with regard to the

                    (i)      Goods being consigned to your bank without authority.                              [4]

                    (ii)     The failure of the collection order to indicate the basis upon which the documents are
                             to be released.                                                                    [4]

                    (iii)    The offer of partial payment to your bank after Iqbal Metals has obtained the
                             underlying documents by accepting the usance bills of exchange.           [3]

                    (iv)     Iqbal Metals’ refusal to pay bank charges to your bank and the remitting bank.     [3]

          (b)       Under the normal Malaysian banking practices, how would you deal with Iqbal Metals’ offer to
                    pay partially on maturity date and the balance on an undeterminable future date?           [6]
                                                                                                  (Total:20 marks)

6.        Your bank has recently been nominated by Bank Negara Malaysia to be the designated bank under the
          Bilateral Payment Agreement (BPA) Scheme.

          (a)       What is the BPA Scheme?                                                                     [3]

          (b)       List four key features of a BPA Scheme.                                                     [8]

          (c)       Briefly explain three types of BPA.                                                         [9]
                                                                                                   (Total:20 marks)

7.        (a)       Define the following types of bank guarantees and briefly explain its usage:

                    (i)      Bid or tender bond                                                                 [3]

                    (ii)     Progress payment bond                                                              [3]

                    (iii)    Retention bond                                                                     [3]

                    (iv)     Performance bond                                                                   [3]

          (b)       Briefly describe the difference between a guarantee and an indemnity.                       [4]

          (c)       From the viewpoint of an exporter’s bank, why is a “standby letter of credit” less burdensome
                    than a “bank guarantee”?                                                                    [4]
                                                                                                   (Total:20 marks)

4 of 10                                   DBFS October 2002 – DP06                    Institut Bank-Bank Malaysia
                                      OUTLINE ANSWERS


                                                   Question 1
As usual, questions on letter of credit are popular choice among the candidates, who are usually well prepared
for this topic. Candidates also managed to quote the correct UCP Article in their answers.

1.      (a)      Banca Commerciale was correct in rejecting the negotiations with the exception of their
                 rejection of the packing list.

        (b)      Yes. An inspection certificate MUST bear an issuance date showing or otherwise indicating
                 that the goods were inspected prior to the goods being loaded on board for shipment.

        (c)      No. Unless the letter of credit requires the issuance of the packing list by a specific entity,
                 UCP 500 Article 21 clearly states that when the documents other than transport documents,
                 insurance documents and commercial invoices are called for under the letter of credit, the
                 letter of credit should stipulate by whom the documents are to be issued. If the letter of credit
                 fails to so stipulate, a packing list will be accepted as presented provided the data content is
                 not inconsistent with other stipulated documents presented.

        (d)      No. Unless the letter of credit requires it to be signed or if the packing list requires a certain

        (e)      No. A freight forwarder type documents such as Forwarder’s Certificate of Receipt (FCR) is
                 NOT a transport documents, and is therefore not covered by UCP 500 Article 23. This type of
                 documents is not specifically addressed in the UCP 500 and falls into the category of
                 documents that are covered under Article 21.

                                                  Question 2
This was a fairly easy question on the definition of the bills of exchange. Some candidates did not manage to
score more marks, because they did not elaborate or illustrate on their answers clearly.

2.      (a)      The four types of endorsement are:

                 •        A blank endorsement
                          This type of endorsement specifies no endorsee and so the bill of exchange becomes
                          payable to bearer. With this type of endorsement, the payee (or endorser) merely sign
                          on the bill (the payee may add the date, indicate their capacity in signing and place
                          their signature in a space left by a chop).

                 •        A special endorsement
                          This type of endorsement specifies the type of person to whom the bill becomes
                          payable. Thus, a transferee (or endorsee) is indicated. Such a bill will retain its order
                          status after endorsement.

                 •        A restrictive endorsement
                          This type of endorsement specifies the person to whom the bill is to become payable
                          and prevents further transfer. The prevention of further transfer is achieved by adding
                          the word ‘only’ after the designated transferee’s name.

                 •        A conditional endorsement
                          Such an endorsement will take one of the above three forms. However, when
                          endorsing the bill of exchange, not only the endorser would put his signature on the
                          BE, he would impose a condition as regards the bills payment. The payer, i.e. the
                          drawee, may disregard any such condition, as there is no obligation on his part to
                          establish whether or not the condition has been met.

Institut Bank-Bank Malaysia            DBFS October 2002 – DP06                                            5 of 10
          (b)    The parties to a bill of exchange are:

                 •        The drawer
                          This is the person who makes out the bill of exchange as an order and signs it,
                          thereby making himself liable for it.

                 •        The drawee
                          This is the person who is being endorsed by the drawer to pay. If the drawee does not
                          pay, a holder of a bill of exchange is able to enforce payment against the defaulting
                          drawee but he can also seek recourse against the drawer. Where a bill of exchange is
                          to be accepted, it is the drawee who accepts. With bills that require acceptance, the
                          drawee, after acceptance, becomes known as the acceptor.

                 •        The payee
                          This is the person in whose favour a bill of exchange has been drawn and, as such, he
                          can be considered as the beneficiary. Sometimes, the drawer and the payee are the
                          same person. If the payee decides that he wants to pass the title of the bill of
                          exchange to someone else, he may transfer the title. This may be achieved by merely
                          delivering the bill of exchange to the other person, provided that the bill of exchange
                          is payable to bearer, or by endorsing the bill of exchange it is payable to order and
                          the delivering the bill of exchange. Where the bill of exchange is endorsed as part of
                          the transfer process, the payee will become known as the endorser (indorser or
                          transferor). The party in whose favour the bill of exchange is transferred becomes
                          known as the endorsee (indorsee or transferee).

          (c)    Besides asking the customer to sign a trust receipt, some banks may additionally get the
                 importer to accept a usance bill of exchange, on which the financing bank is both the drawer
                 and payee and the importer is the drawee. The reasons for doing so are:
                 •   the bank may not want to solely rely on the goods as security
                 •   the bank may not always be in control of the goods, e.g. if the customer holds the
                     documents of title, or the customer place the goods in his warehouse of choice, or if the
                     customer attends the delivery of the goods to the onward buyer, etc.

                 By taking the accepted bill of exchange, in any event of default, the bank can present the bill
                 of exchange to the importer on the maturity date for payment. If the importer does not pay for
                 the bill, it can be enforced under the Bill of Exchange Act (BEA). To obtain payment from the
                 BEA is much simpler than having to sue someone for repayment of debt.

          (d)    With noting, the notary public does not personally visit the drawee but with protesting, he

                                               Question 3
Although this question was previously examined, there are some candidates who are still confused/unfamiliar
with the terms and rules in the URC.

3.        (a)    In accordance with Article 1 of the URC, the bank should act in good faith and exercise
                 reasonable care at all times. This means that the bank should have acted in accordance with
                 the instructions contained in the collection order. We should check that the documents
                 received under the collection order are disposed of in accordance with the instructions.

                 In accordance with Article 9 of URC, the bank should have ensured that where an acceptance
                 was called for, the bill of exchange was accepted. Presentation should have been made and
                 payment claimed not later than the appropriate maturity date.

                 In accordance with Article 17 of URC, the collection order should have given specific
                 instructions concerning protest but as protest were not given, your bank was under no
                 obligation to have the bill of exchange protested for non-payment or non-acceptance. This is
                 the general rule accepted in many parts of the world and embodied in the above article.

6 of 10                                DBFS October 2002 – DP06                      Institut Bank-Bank Malaysia
        (b)      Your bank’s position under the Malaysian law maybe somewhat different from that described
                 above. However, your bank in the circumstances described in the question would not have
                 exercised reasonable care and could be claimed as not acting in good faith and has been
                 negligent. It has ignored, in some measure, part of the terms laid down by the URC and has
                 not acted in accordance with the normal Malaysian banking practice. Having said that, the
                 collection order is incomplete and your bank is under no obligation to have the bills protested.

                 In accordance with the standard Malaysian banking practice, your bank has not exercised due
                 care and should have protested the bill of exchange to obtain the protection offered under the
                 Bill of Exchange Act for the benefit of the German bank and its customer. It may be difficult
                 to give an appropriate satisfactory answer to the German bank concerning the delay in
                 remitting the payment other than to claim that the full protest instruction were not given.
                 However, as the documents of title were not attached, this method of selling and obtaining
                 payment is similar to an open account sale.

        (c)      As far as the claim for interest is concerned, a collection order must clearly state if interest is
                 to be collected and indicate if this is mandatory instruction (Article 21).

                 The claim for interest is principally for overdue interest from the date of maturity of the bill of
                 exchange until the date of claim, and this is outside the terms of reference covered by the
                 URC. Morally, the customer may be liable to pay the interest claim but legally any such claim
                 would have to be under the commercial contract. The customer can ignore the claim unless a
                 mandatory instruction was included in the invoice, which in the circumstances described,
                 would be difficult to include in the collection order. In commercial practices, many invoices
                 do state that overdue interest may be claimed in the event of delay in settling the amount
                 covered by the invoice. In the event of such an instruction being included in the collection
                 order, your bank should have told the customer of the potential interest claim at the time the
                 bills of exchange were presented for acceptance, but in any event this should have been clearly
                 covered by the collection order.

                 In this case, the matter is to be settled between the banks as correspondent banks and it is for
                 them to settle the claim amicably or otherwise.

                 Most banks would refuse to pay the interest but such refusal may jeopadise the relationship
                 between the two banks. Because your bank has been negligent, it will only be prudent for your
                 bank to pay the interest claim to the German Bank.

        (d)      The change in instruction which might assist the supplier in Germany and be clearly in
                 accordance with the “instructions” covered by the URC and be in accordance with the
                 Malaysian banking practices, would be for the German bank to give specific protest and/or
                 noting instructions in the event of dishonour either upon presentation for acceptance or

                 In the event of change of instruction, your bank would clearly have to act in accordance with
                 the Malaysian banking practice to protest the bills of exchange within 24 hours of dishonour
                 in order to obtain the full protection of the Bill of Exchange Act. Further, your bank will act in
                 accordance with Article 17 of URC.

                If there is an intention to claim interest, this must be stated on the invoice and probably on the
                bill of exchange as well as the collection order.


                                                  Question 4
Candidates did not know how to apply their understanding of the UCP in a practical situation to answer this
question, which is very much based on their day-to-day department operation and approach to customers.

4.      (a)      A prudent banker would not have issued such an irrevocable letter of credit under which
                 certain contingencies had to be met outside their control before honoring their obligations.
                 This type of letter of credit provides no security to the beneficiary and in reality is NOT an
                 irrevocable letter of credit.

Institut Bank-Bank Malaysia            DBFS October 2002 – DP06                                             7 of 10
          (b)          It is suggested that the advising bank inform the beneficiary of the special payment condition
                       and the risk associated with them, though it is NOT an obligation for them to do so.

          (c)          (i)      The beneficiary unfortunately relied on the letter of credit that did not provide
                                security for him, thereby losing the goods and not obtaining payment. Unfortunately,
                                the letter of credit makes it perfectly clear that it was subject to the realisation of
                                proceeds from the “re-export program”.

                                Despite the statement that the letter of credit is subject to UCP, it is obviously not a
                                letter of credit that should have been accepted, because it is linking payment with
                                release of the goods and with receipt of proceeds for end product to be produced
                                from the goods on resale to some unknown third party.

                                The implication of accepting such a credit is that the issuing bank is allowed to
                                release the goods to the applicant for the letter of credit, despite the goods being
                                consigned to the issuing bank. This is the case in which the wording in the letter of
                                credit is not carefully studied and the implications has not been realised.

                (ii)            Lesson learned:
                                •   That this was a case of the wording of the letter of credit had not been fully
                                    studied and its implications realised.
                                •   That such a letter of credit does not provide any security and should never have
                                    been issued.
                                •   That by using such a letter of credit the beneficiary was fully responsible for the
                                    loss of goods and the money.
                                •   That advising this type of letter of credit was not a service to the banking

                                              Question 5
This question was also previously examined and candidates’ performance was average although there were
some who managed to do well.

5.        (a)          (i)      URC states that the bank has no responsibility at all to deal with goods that have been
                                consigned to the bank without authority. It could tell En. Iqbal to refer to the shipper
                                (exporter) if he wished.

                       (ii)     Documents can only be released on payment if the collection order does not quote
                                “DP” or “DA”.

                       (iii)    Part payment can be accepted in the case of CLEAN collections only, but cannot be
                                accepted with documentary collections (unless the collection order specifies so).

                       (iv)     Our bank will treat the collections honored if the charges are merely stated on the
                                collection order without any clause “do not waive”. Thus, our bank will deduct our
                                bank’s charges from the proceed to be remitted. The remitting should be doing the
                                same before effecting the final payment to the exporter.

          (b)          As our bank is the presenting bank acting as an agent to the remitting bank under the URC,
                       our duty shall be to the remitting bank. We would accept the part payment. And either remit it
                       to the remitting bank, or hold it their order under advice. Once the part payment has been
                       accepted, the collection is now considered as ‘clean’, as the commercial and transport
                       documents has been released. Receipts of the bill of exchange for the amount paid and protest
                       for the FULL amount if the collection order says to protest. Tactfully explain to our customer,
                       En. Iqbal, we have no alternative but protest the bill of exchange under the Bills of Exchange

8 of 10                                     DBFS October 2002 – DP06                      Institut Bank-Bank Malaysia
                                                 Question 6
Not many candidates attempted this question, most likely because this product is only available in selected local
banks nominated by Bank Negara Malaysia (although BPA is explained in the study manual). However, this
was an easy question as it asked on some brief explanation of the BPA. Surprisingly, there are candidates who
thought that BPA is an Islamic-banking product.

6.       (a)      Bilateral Payment Agreement is one method to promote trade between Malaysia and other
                  developing countries. To do so, Bank Negara Malaysia and the central bank or monetary
                  authorities of the counterparty’s country have entered into various methods of BPA. Under the
                  scheme, the central bank located in the buyer’s country will either:
                  •   Claim payment from the respective importer and will later pay the amount to the central
                      bank in the exporter’s country; or
                  •   The central bank in the exporter’s country will guarantee that if the exporter does not pay,
                      it will (i.e. the central bank in the importer’s country acts as a guarantor).

         (b)      The main features of the agreement are as follows:
                  •   Only designated banks (i.e. those which have been duly authorised by the respective
                      central bank) can participate in the scheme.
                  •   Settlement takes place as follows: The exporters central bank pays the exporter, while the
                      importer’s central bank claims the some due from the importer. The inter-country debt is
                      not settled on a transaction-by-transaction basis. Instead, upon arrival of a pre-agreed
                      date, the respective central banks settle their inter-country indebtedness on the net sum
                      that is due.
                  •   All trading transactions have to be expressed in US Dollars.
                  •   The respective central banks allocate credit limit to each other.
                  •   Financial and other documents, which are subject to the BPA scheme, must be marked
                      accordingly. Thus, a phrase along the following lines should be made in the documents:
                      Reimbursement through the Malaysia/counterparty country (the name of the respective
                      country should be stated). Payment under the number XXX (this number is allocated by
                      one of the designated banks).

         (c)      The three types of Bilateral Payment Agreements are:

                  •        the ALADI scheme
                           The scheme possesses all the key features of the BPA. Under this scheme, the
                           respective central banks agree on the credit lines (expressed in US Dollar) between
                           themselves. The respective central banks authorise certain banks (i.e. the designated
                           bank) to either issue or negotiate letters of credit, with the letters of credit being
                           subject to the BPA. If the exporter is located in Malaysia, he will be paid by Bank
                           Negara Malaysia, while the central bank or the monetary authority in the importer’s
                           country will claim payment from the importer. Hence, settlements are effected
                           between the traders and their own central banks in the first instance. The central
                           banks later settle their indebtedness at a designated point in time on a net basis.

                  •        the IRANIAN scheme
                           Under this scheme, a central bank will act as a guarantor, rather than the medium
                           through which settlement takes place. Thus, the respective traders will deal with each
                           other in the ‘normal’ way; i.e. in relations to the goods, documents, settlement, etc.
                           However, in the event that he importer does not pay on the due date, the guaranteeing
                           bank will do so on the importer’s behalf and then counter-claim against the party who
                           has defaulted.

                  •        the POCPA (Palm Oil Credit and Payment Agreement) Scheme
                           This scheme has been set up by the Malaysian Government to promote the export of
                           palm oil or its derivatives on a revolving credit basis. In this respect, it is similar to
                           the ALADI scheme, but it is restricted to the export of palm oil and its derivatives
                           only. Another difference is that with the POCPA scheme, settlement periods of up to
                           two years are available. In contrast, with the ALADI scheme, the maximum
                           settlement period is four months.

Institut Bank-Bank Malaysia             DBFS October 2002 – DP06                                             9 of 10
                                                  Question 7
All candidates attempted this question on the definition and explanation relating to bank guarantees. However,
some candidates could not explain and elaborate their answers correctly.

7.         (a)   (i)      Bid or tender guarantee
                          It is to support a customer’s tender and sometimes used as a substitute for the
                          remittance of cash deposit that has been called for by an exporter in support of a bid.
                          It is used to confirm the genuineness of the tender, as best as possible, that if the
                          person is successful with the tender bid, he will proceed and enter into a formal
                          contract. Should the successful bidder fail to enter into the formal contract, the
                          beneficiary of the tender guarantee is entitled to make a claim on the guarantee. The
                          amount will enable him to re-advertise the tender.

                 (ii)     Progress payment guarantee
                          It is similar to a performance guarantee. With this guarantee, the exposure under this
                          guarantee will be at its maximum when the underlying contract is at its early stages.
                          Once the buyer has confirmed that such stages have been satisfactory, so the level of
                          the contractor diminishes. If the underlying guarantee makes provision for the
                          diminution of the financial exposure after certain stages of the contract have been
                          satisfactorily completed, the guarantee will be a progress payment guarantee.

                 (iii)    Retention guarantee
                          After a major contract has been completed, the buyer wishes to retain a balance of the
                          cash that is due to the contractor for a certain period of time. This some of money
                          retained for what could be called a ‘warranty period’. The objective of retaining the
                          money is that, if anything negative should happen and this causes problem to the
                          buyer, the buyer can remedy the problem by using the money he has retained.

                 (iv)     Performance guarantee
                          A performance guarantee is given to support a contractor’s obligation in relation to a
                          contract that he has entered into. As a separate agreement, it will be entered into after
                          a previously executed tender guarantee has been successful. Such guarantee may
                          retain the full exposure of the issuing bank until the project is completed.
                          Performance guarantee has a high exposure to the issuing bank.

           (b)   Lets take an example where X (lender) is to lend his money to Y (borrower) but X is
                 concerned with the credit risk once the money is disbursed. So X request for a security and Y
                 offers a security in form of a promise from a third party, Z. Depending on the words used in
                 the agreement signed by Z, the agreement may take the form of either a guarantee or an

                 Where a guarantee has been executed and Y does not pay, X must first make a demand from Y
                 and, if it remains in default, X can then claim from Z.

                 Whereas, when an indemnity is executed and Y does not pay, X may not need to make
                 demand on Y in the first instance. X is able to make an immediate first claim on Z.

           (c)   A standby letter of credit is governed by a clear set of rules, UCP. In addition, there is a stated
                 expiry date, which cannot be amended without the exporter’s consent and that of his bank.

10 of 10                               DBFS October 2002 – DP06                      Institut Bank-Bank Malaysia

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