Counter Guarantee

A counter guarantee is an undertaking by one bank (the counter-guarantor) to pay another bank (the guarantor) on demand, given so that the second bank will issue its own guarantee to a beneficiary. It is the standard way of providing a beneficiary with a guarantee from a bank in its own country when the applicant, typically an exporter or contractor, banks somewhere else.

The arrangement is known as an indirect guarantee, as opposed to a direct guarantee issued straight to the beneficiary by the applicant's bank. Counter guarantees sit behind every type of contract guarantee, including the bid bond, advance payment guarantee, performance bond and retention money guarantee. The ICC Uniform Rules for Demand Guarantees (URDG 758) define and govern them, and the term back-to-back guarantee is often used for the same structure.

Suppose a landlord in another city will only accept a guarantor who lives locally, but your only willing guarantor is your aunt back home. A friend in that city agrees to sign the landlord's form, as long as your aunt promises to pay the friend back if the landlord ever calls on them. The landlord deals only with someone nearby; your friend relies on your aunt; your aunt relies on you.

A counter guarantee is your aunt's promise to the friend. In banking, the landlord is a foreign buyer, the friend is a bank in the buyer's country and the aunt is the exporter's own bank. Each promise points to the next one up the chain, and money flows back the same way if a claim is made.

A typical indirect guarantee involves four parties:

1. The applicant (for example an exporter that has won a tender) asks its bank, acting as the instructing party's bank, to arrange a guarantee in favour of the foreign buyer.
2. That bank issues a counter guarantee in favour of a bank in the beneficiary's country, usually by authenticated SWIFT message, asking it to issue a local guarantee in agreed wording.
3. The local bank issues the guarantee to the beneficiary, which now holds a claim on a bank it knows, under its own law and in its own language.
4. If the beneficiary makes a complying demand, the local bank pays it and then demands reimbursement under the counter guarantee, and the counter-guarantor in turn debits the applicant.

Chains can be longer, with several counter guarantees between the applicant's bank and the final guarantor, for instance when a correspondent bank is used as an intermediary. Each link is an independent obligation, which means a bank can be bound to pay under its counter guarantee even if a later dispute arises over the underlying contract.

URDG 758, in force since 1 July 2010, treats the counter guarantee as an instrument in its own right and includes a model form for it. Several points distinguish it from the guarantee it supports:

• Demand requirements. A demand under a counter guarantee is normally supported by a statement that the guarantor has received a complying demand under its own guarantee, rather than a statement about the applicant's performance.
• Expiry. The counter guarantee usually expires some days or weeks after the local guarantee, so that the guarantor has time to pay the beneficiary and then claim reimbursement.
• Governing law. Unless the parties choose otherwise, the rules point to the law of the place of the counter-guarantor's branch for the counter guarantee and the guarantor's place for the guarantee, so a single chain can be governed by two legal systems.
• Extend-or-pay. When a beneficiary demands payment unless the guarantee is extended, the request passes down the chain, and each bank has a short period to obtain the applicant's decision.

A guarantee issued under URDG does not automatically make the counter guarantee subject to the same rules, so careful banks state the applicable rules in both instruments. Standbys follow the same logic under ISP98, where a standby letter of credit may be issued against another bank's counter standby.

Government agencies and state companies in many countries are required by procurement law to accept guarantees only from locally licensed banks, and some will accept only certain named institutions. Local issuance also means the beneficiary can enforce in its own courts and avoids the delay of claiming on a foreign bank. For the applicant, the cost is higher: it pays fees to both banks, and the local bank prices the counterparty risk of the counter-guarantor into its charge.

The local guarantor relies entirely on the counter-guarantor, so it sets exposure limits on foreign banks and may refuse counter guarantees from banks in countries with weak ratings or capital controls that could block reimbursement. The counter-guarantor, for its part, faces the risk that a local court in the beneficiary's country restrains payment or that the local bank pays a demand it should have rejected and then claims reimbursement anyway. Sanctions screening applies at each link, and a sanctions change during a long chain can freeze payment at any point. Banks that issue many counter guarantees, such as those in export-oriented economies, manage these lines through their correspondent banking relationships.

• International Chamber of Commerce
• SWIFT