Bank guarantees are contractual agreements between the principal -- the person applying for the guarantee -- and the bank that can be used to strengthen the terms of a business agreement with a third party. A beneficiary receives the benefits of the guarantee from the bank if the principal cannot meet the terms of their contract. Many factors go into choosing the correct type of guarantee: whether you are working with an out-of-country partner and need an indirect guarantee, whenther your goal is to provide security for the principal or the beneficiary, and whether or not you want the guarantee to be linked to your business contract.
An accessory guarantee is inherently linked to the underlying contract between the principal and the beneficiary. Under this type of guarantee, neither the principal nor the bank are required to make payment to a beneficiary’s claim unless the beneficiary has proven the validity of their claim and presents a court decision, arbitration agreement or written consent from the principal allowing payment.
Non-accessory guarantees do not have ties to the underlying business agreement between the principal and beneficiary and instead of requiring the beneficiary to prove the validity of their claim, payment is made first and questioned later; this is a more secure form of guarantee for the beneficiary. Standby letter of credit and demand guarantees fall under the non-accessory category. The demand or simple demand guarantees, in most cases, do not require documentation to back up a claim for payment.
Direct and Indirect
Direct guarantees are set up and executed through one bank, the bank at which the principal applies for the guarantee, known as the issuing bank. Indirect guarantees are set up through one bank and then executed through another bank that is local to the benefactor. The local bank then gets a guarantee from the issuing bank to cover any claims. Direct guarantees are typically less expensive and more secure for the principal, whereas indirect guarantees are more secure for an out-of-country beneficiary.
Supporting the Prinicipal
There are several types of guarantees designed to support a principal’s contractual obligations to the beneficiary of the guarantee. These principal supporting guarantees include tender and bid, advanced payment, and performance and retention guarantees are designed to assist the principal in either meeting their contractual obligations or in making remands for an inability to meet them.
Supporting the Beneficiary
Some guarantees are designed to assist the beneficiary in meeting their contractual obligations or recovering losses for the inability of the principal to live up to their end of the deal. Warranty, loan and payment guarantees are all structured to support the beneficiary in making payments or recovering funds from an unsatisfied contract. These types of guarantees usually guarantee a certain percentage of the value of the contract, for instance 5 percent, but may cover the full value.