Why choose bank guarantee over security cheque in commercial transactions?

Commercial transactions are built on trust but prudent businesses rarely rely on trust alone. Suppliers extend credit, contractors undertake projects, and financier advance funds with the expectation that contractual obligations will be honoured. To mitigate the risk of default, parties often insist on security.

In Nepal, the most common form of security is the post-dated or undated cheque, popularly known as a security cheque. While convenient, the increasing reliance on security cheques has generated considerable legal uncertainty and commercial disputes. A bank guarantee, by contrast, provides a more reliable and commercially sound mechanism for securing contractual performance.

What differentiates Cheque from Bank Guarantee?

As per Negotiable Instruments Act, 1977 , cheque is a bill of exchange drawn on a bank and payable on demand. Security refers to any property, or any document relating thereto, that has been or is to be provided as collateral in accordance with the prevailing law at the time of granting or obtaining a loan. The NRB Directive, 2026  has explicitly restricted the licensed financial institutions from extending a loan against any type of cheque as collateral security. Considering the restrictions, licensed financial institutions do not disburse loans against the cheque, however, security cheques are widely in use in commercial transactions between private parties.

A cheque functions primarily as a payment instrument. The drawer instructs a bank to pay a specified amount to the payee from the drawer’s account. It involves only the parties to a commercial transaction. The chances of recovery of payment depend on availability of funds and willingness of the drawer to honour the payment. However, bank guarantee functions as a proper security instrument. It involves financial institutions as guarantors.

The obligation to pay to the beneficiary under the contract between the parties is undertaken by the bank as a guarantor rather than the contracting party. Since the guarantor financial institution is independently liable to the beneficiary once the conditions in the bank guarantee are satisfied, the chances of recovery remain on the higher side.

Nature of Bank Guarantee

Bank guarantee is a commitment issued by a bank (Guarantor) on behalf of its client (Applicant), promising to pay a specified amount to a beneficiary (Beneficiary) if the Applicant fails to fulfil a contractual obligation arising from a separate contract between the client and the beneficiary. This arrangement relies on three distinct contracts. The first is the underlying business contract between the applicant and the beneficiary. The second is the contract between the applicant and the bank whereby the bank retains the property of the applicant as a collateral for issuing bank guarantee. The third is the bank guarantee itself, which creates a direct obligation between the bank and the beneficiary. The primary value of a bank guarantee lies in the autonomy of this third relationship.

Why Bank Guarantee?

A guarantee is irrevocable on issue even if it does not state this . The cornerstone of a bank guarantee is its independence from the underlying contract . Once a bank issues a guarantee at the request of an applicant, it creates a new legal obligation that exists regardless of any disputes, disagreements, or misunderstandings between the buyer, seller or contractor in the primary commercial deal . The banks are generally required to honour the claim upon the beneficiary’s first written demand, provided the demand complies with the terms of the guarantee. Meanwhile, if the cheque is dishonoured, the aggrieved party has to undergo the whole litigation process which shall be lengthy. Since the recovery depends on the financial capacity of the drawer, sometimes the chances of recovery will also remain low. There are thousands of cases of cheque bounce running across different courts in Nepal.

Nepali law perspective on Bank Guarantee

Nepali law integrates the bank guarantee into its standard legal and regulatory frameworks. The underlying commercial contract between the applicant and the beneficiary is governed under the National Civil Code, 2017 . At the regulatory level, NRB Directives, 2082, require financial institutions to pay claims within seven working days of a demand. The directive also recognises ICC Uniform Rules for Demand Guarantees (URDG 758) .

Reinforcement by the Nepali Courts

The Supreme Court of Nepal consistently upholds the independence of bank guarantees through two primary lines of jurisprudence. First, regarding jurisdiction, the court firmly restricts contractual disputes from entering extraordinary writ proceedings. In the case of Advocate Tej Rawal v. Kailali District , a full bench held that contract terms bind the parties as private law, creates no public duty, and cannot support a writ of mandamus when ordinary civil remedies exist. This aligned with the Supreme Court’s previous view in the case of Siddheshwor Kumar Singh et al. v. Government of Nepal , which ruled that contractual rights must be pursued through statutory or agreed remedies rather than constitutional writs. Similar view was taken by the court in Ram Bahadur Bhandari et al. v. Government of Nepal establishing that contractual breaches require private law remedies rather than extraordinary judicial intervention.

The second line of jurisprudence has been set on the substance of bank guarantees. The Supreme Court has time and again reinforced the independent nature of the bank guarantee. In Himalayan Bank Ltd. v. Nepal Rastra Bank , the Court ruled that while a guarantee originates from an underlying deal, it forms an independent contract; thus, underlying commercial disputes cannot impair the bank’s obligation to pay. The case of Himalayan Industries Pvt. Ltd. v. Ministry of Commerce and Supplies  affirmed that banks must honour guarantees immediately upon demand without applicant consent or interference from underlying party disputes. The court reinforced this in NIDC Bank Ltd. v. Lumbini Bank Ltd. et al.  by rejecting underlying disputes as valid grounds for refusal. Recently, in the case of Khampache/PSJV v. Jalap Nepal Pvt. Ltd. , the court ruled that banks must honour valid demands immediately, leaving underlying disputes to separate legal remedies.

Conclusion

The legal framework and judicial precedents in Nepal establish why a bank guarantee is a far superior security instrument for commercial transactions compared to a cheque. While a cheque remains tied to the drawer’s account status, operational disputes or potential payment stops, a bank guarantee provides an autonomous, irrevocable financial commitment backed directly by a regulated financial institution.

Furthermore, Nepal’s Supreme Court has consistently barred applicants from using court injunctions or extraordinary writ jurisdiction to block encashment. By severing the payment obligation from commercial disputes, the bank guarantee offers absolute certainty and legal protection that any post-dated or security cheques simply cannot match