Bank Guarantees in Spain: All That You Ever Wanted to Know but Were Afraid to Ask

Raymundo Larraín Nesbitt - Lawbird Legal Services
12th of November 2008

Bank Guarantees are a legal tool devised to secure the deposits of prospective off-plan purchasers should their properties not be delivered on time or their developers file for bankruptcy. Post credit-crunch, bank guarantees are acting as safety nets for many purchasers in dire cases. Regrettably we have witnessed over the last months how some financial institutions are in fact refusing to honour bank guarantees. It is in such cases in which the need of a specialized litigation lawyer comes into play to help enforce them before a Law Court.

Bank guarantees may be a daunting minefield for many albeit with the assistance of an independent lawyer acting on your side you will be able to waive the pitfalls both safely and successfully.

Off-plan Property

Buying off-plan has many advantages but also its associated risks. Not long ago it was normal to obtain a significant discount (premium) on buying off-plan as you assumed a risk (mainly the uncertainty of the property ever being delivered and the time elapsed until completion) until the unit was ready to be delivered legally (with a Licence of First Occupation). Many took advantage in the boom selling on these properties for a sizeable profit prior to completion (also known as “flipping”) as it was basically a leveraged investment which only required a fraction of the funds paid up front. That same off-plan dwelling was significantly more expensive (i.e. 30%) if you purchased it key-ready as now there was no risk because it was finished. This, however, changed over time leading us onto today’s depressed market. Off plan hazards nowadays frequently outweigh the rewards, making the resale and let market look very appealing; that is until the dust settles and we start the boom cycle anew.

What is a Spanish Bank Guarantee?

A Spanish Bank Guarantee may be either an Insurance Policy or Guarantee issued respectively by an Insurance Company or Bank. In this article, for the sake of simplicity, we will group both types under the generic term bank guarantee. A bank guarantee purpose is to secure the full amount of deposits paid by off-plan purchasers. It secures the initial reservation deposit, which strikes the property off the market, the interim or stage payments as well as the applicable VAT (currently set at 7%) paid on said amounts. On top of this you are also entitled to the legal interests on the amounts secured.

A bank guarantee has a cost to be issued. Law states this expense must be borne by the off-plan developer. A bank guarantee is of critical importance acting as a safety net securing our full deposits should something go wrong.

How long does the Protection of a Bank Guarantee Last?

In strict accordance with Law 57/68 bank guarantees have no expiration date. They should only expire upon the granting of the Licence of First Occupation by the Town Hall (art 4) where the property is located. In practice this seldom happens and almost all bank guarantees are issued with an expiration date spanning typically 2 years. It is critical that your appointed conveyance lawyer renews them on time so your deposits are secured at all times.

What details should a Bank Guarantee include?

A bank guarantee should be individualised for each particular purchaser. It should include the following:

Name & surname of purchaser/s.
Their nationality & passport number/s.
Their homeland address.
The exact amount in Euros which is being guaranteed.
Developer’s name.
The name and address of the development where they are purchasing.
The details of the residential unit they are purchasing i.e. Block 1, third floor, flat F.
Name & seal of the Bank or Insurance Company guaranteeing said stage payments.

The number of the Registro Especial de Avales (if it’s a bank guarantee) as well as the bank account details where the secured amounts will be lodged.

Figure 1: Anatomy of a Spanish bank guarantee

What the Law Says

Law 57/1968 rules the protection of stage payments in off-plan properties. This very short law of only seven articles was enacted to secure the stage payments of purchasers should for example a developer file for creditor protection or the build be cancelled for planning reasons and thus not delivered in the stipulated deadline. bank guarantees are only applicable to off-plan properties, not to resales.

Brief Overview of Law 57/1968

Article 1 rules that developers will have to provide free of charge to the purchaser/s a bank guarantee or Insurance Policy (henceforth bank guarantee for either) to guarantee the refund of their stage payments plus 6% interest in the event of the developer becoming insolvent. The Building Act (Law 38/99) actually amends this percentage in its first additional disposition and it will be the legal interest set in the Budget Law published annually by Spain’s Law Gazette (Boletín Oficial del Estado). These legal interests are simple annual interests, not compounded. For 2008 the legal interest has been set at 5,50%. However if a developer expressly accepts the 6% interest set in Law 57/68 then said interest will overrule the legal interest (which currently is lower).
Article 2 makes it imperative to include a clause in the Private Purchase Contract (PPC) by which it is stipulated that all interim payments are guaranteed by means of bank guarantees. Section a) allows the purchaser to execute a bank guarantee on the development not having even been started to be built after the delivery deadline is overdue, not being finished in time (*) or the developer failing to obtain the Licence of First Occupancy.(*) Almost all developments in Spain are delivered late so this remark by the law is advised to be taken with a pinch –or two- of salt in practice. Another fact worthy of highlight is that only because your PPC has a specific clause whereby it is mentioned you have a bank guarantee issued securing your funds this doesn’t mean you have one. You have to be thorough and crosscheck with your lawyer you do in fact have bank guarantees issued under your name securing all your deposits including the initial reservation fee.
Article 3 stipulates that if the deadline is surpassed without the development being finished or even started the purchaser may execute their bank guarantee or else grant expressly the developer with an extension of the delivery date with an addendum to the PPC.
In compliance with article 4, these guarantees will be cancelled upon the granting by the Town Hall of the First Occupation Licence. At completion the lawyer appointed by the purchaser will hand over these guarantees to the developer’s legal representative.
Article 7 stipulates the Consumer’s Rights set forth in this law cannot be waived by the purchasing party even if they agree to it. These purchaser’s rights cannot be renounced under any circumstance.

Types of Bank Guarantees in Spain

As the Law 57/68 doesn’t specifically rule which type of bank guarantee should be issued by the developer there is freedom. Basically this allows for two types:

Ordinary Bank Guarantee - Bank guarantees ideally can be claimed upon immediately by the purchaser in case the developer defaults or the property not being delivered. However post credit crunch this is no longer the case as some banks are refusing to honour them. Prior to executing it, it actually requires a judge’s ruling stating that the bank ought to refund –or not- the off-plan purchaser. This means that the purchaser will actually have to engage the services of a specialized litigation lawyer who will claim upon said bank guarantee in a special executive procedure. The litigation expenses are borne initially by the purchaser up front albeit may be claimed back from the bank together with the full refund of the stage payments and legal interests. This Executive procedure is much swifter than an ordinary court procedure spanning normally between 3-8 months. This is the most common type of bank guarantee which is set-up and one cannot argue that it is illegal or unlawful, it is only less practical if Banks happen to refuse honouring them.
Aval a primer requerimiento -This is just an ordinary bank guarantee which includes a special clause by which it can be claimed upon immediately by the conveyance lawyer without the need of a judge’s ruling. The bank cannot refuse to honour it. This is really the ideal bank guarantee to have because it saves the hassle, stress and additional expenses of having to go through a Court Procedure, even if it’s an Executive one.

Obtaining a Bank Guarantee

Who requests a Bank Guarantee?

Ideally a developer should hand you over the bank guarantees without even having to request them, this seldom occurs of course. In practice it is the duty of the conveyance lawyer you appoint to request the bank guarantee from the developer. If you have appointed no lawyer then it will be up to yourself to request it from the developer. The developer in turn will arrange with the bank underwriting the whole development or with an insurance company the set-up of these bank guarantees.

Normally in off-plan property after having paid the initial security deposit which strikes the property off the market, you are typically required to make interim payments on 30/40% of the value of the property. These payments are normally made in regular instalments (i.e. 3 or 4). Your lawyer will then request from the developer one bank guarantee at a time to cover each and every instalment besides the initial security deposit. So normally your lawyer will have one bank guarantee for each of your stage payments securing the full amount.

As per this Law a developer cannot charge to issue a mandatory bank guarantee. Issuing a bank guarantee has high set-up fees for the developer as they must allocate an amount of money in a special bank account besides being a cost of opportunity for them as they could allocate these funds elsewhere. Perhaps this may help to explain why some developers may seem not be particular eager to hand them out willingly unless the purchaser’s lawyer has requested it from them.

When are Bank Guarantees Issued?

Bank guarantees are issued normally 30 or 40 days after you have made the down payment they are securing. Naturally a bank cannot issue a bank guarantee if you have yet not paid the stage payment. In other words, a bank guarantee cannot be issued prior to handing over the stage payment to a developer as some people are advocating publicly. This just shows a lack of understanding, however wishful, on how the system works.

Bank Guarantees on Self-Built Properties

I am building my own dream-villa, should the constructor hand me a bank guarantee? The answer is no. In this particular case in which a person has bought a plot of land and they are building their own detached villa the Building Act regards them as self-developers. The constructor is hired by them and is acting on their behalf. In this particular case bank guarantees are not applicable as the purchaser is the developer. However, Law requires the self-developer to arrange the mandatory Ten-Year Insurance (Seguro Decenal). A lack of compliance attaining this mandatory insurance will result in this self-developer being forbidden to sell their house within the next ten years whilst alive unless expressly waived by the purchaser.

Common Bank Guarantee Pitfalls

There are far too many pitfalls to be included in this brief bank guarantee overview. Please take professional advice from your appointed lawyer on this matter.

However, we will name the most common:

The bank guarantee has a wording that makes it subject to the granting of the Certificate of End of Construction instead of the mandatory Licence of First Occupation. Law 57/68 sets forth in article 4 that the bank guarantee should be valid until the granting of the Licence of First Occupation. The problem is that a Certificate of End of Construction, which is the prerequisite prior to the granting of the Licence of First Occupation, doesn’t mean the development is regarded as legal. In fact the Certificate of End of Construction is issued by the architect in charge of the development who is actually on the developer’s payroll. Besides contradicting the specific wording of the said law this clause should not be accepted as a development in despite of having a Certificate of End of Construction issued may not be legal. Moreover, for the Certificate of End of Construction to be rendered valid it has to be signed by the architect, technical architect (aparejador) and must be approved and countersigned with the official seals of both the Architect’s regional College and Technical Architect’s regional College. So a Certificate of End of Construction only signed by one of them would not be deemed valid and bears no significance on the legality of the development. Only the Licence of First Occupation does.
The Licence of First Occupation is conditioned to an Expiry Date. This is fairly common and contradicts blatantly both the spirit and wording of the law. The problem with expiry dates is that almost all developments are handed late for one reason or another. The danger in including expiry dates is that if the development isn’t finished on time as per the clauses in the Private Purchase Contract and the deadline is overrun the bank guarantee will cease to be valid. However this is a subject of hot controversy between lawyers and judges as there are many who believe that the inclusion of expiry dates is null and void as it goes against the Law. This will remain contentious until there is a string of likeminded rulings from the Higher Courts. In the meantime being practical, I would advise to renew your bank guarantees to ensure your financial interests are secured at all times should the worst occur.
Cowboy Insurance Companies. On the wake of the long-lasting property boom many such cases have been reported in the media. Invariably these insurance companies are companies incorporated abroad specifically to be outside the reach of the Spanish Jurisdiction. On doing this they waive Spain’s requirements and should the developer default, they are purposely unable to back up the bank guarantees or insurance policies they have undersigned. The process to make them accountable for is long, winding, expensive and often fruitless. That is why it is most advisable that whichever Bank or Insurance Company that issues these bank guarantees is located within Spanish territory as a precaution. The Spanish Government has a list of unauthorised insurance companies in its website which it regularly updates which are not registered or authorised to trade in Spain.
Group or collective bank guarantee whose beneficiary is not the purchaser.- This happens typically when an entrepreneur buys from the developer at a discounted price the whole development or a large number of units to resell it abroad in the UK or Ireland at a higher price. The bank guarantee will be under the name of this company and not under the name of the final individualised purchaser as it ideally should. These bank guarantees are normally for a very high amount of money (millions of Euros) as they group various residential units.
My bank does not honour my bank guarantee. - Post credit crunch it is renowned that some banks are refusing to honour them as has been highlighted by the Bank of Spain itself. In this case a specific executive procedure may be followed by your lawyer as a bank guarantee is regarded as an Executive Title. However, not in all cases is it recommendable to follow this executive procedure and your litigation lawyer will advise accordingly. Consider it as a tactic devised to wear you out as litigation is daunting for many and requires to be paid up front. The expenses can normally be recouped from the other party later on.

Conclusion

A bank guarantee is a document of paramount importance for the off-plan purchaser as it secures their stage payments. We just cannot stress enough the importance of attaining a bank guarantee. So even if you are requested to pay a bank guarantee, which is unlawful, we would advise you to do so because it will act as a safety net securing your financial interests should the developer go into receivership or the development is stalled and overdue.

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The article Bank Guarantees in Spain: All That You Ever Wanted to Know but Were Afraid to Ask was originally published on belegal.com.