Demand Guarantee

A demand guarantee is a written promise, usually issued by a bank, to pay a named beneficiary up to a stated amount when the beneficiary presents a demand that meets the terms of the guarantee. The guarantor does not investigate whether the party that asked for the guarantee, the applicant, has actually failed to perform its contract. If the demand and any required documents comply on their face, the guarantor pays. Demand guarantees are widely used in international construction and supply contracts.

A demand guarantee is a form of bank guarantee, and it is also called an independent or first-demand guarantee. It differs from a traditional suretyship or surety bond, where the guarantor is liable only if the principal debtor is proven to be in default and can raise the debtor's defences. In function it is close to a standby letter of credit.

Three parties are involved in a direct guarantee: the applicant, typically a contractor or seller; the beneficiary, typically the employer or buyer; and the guarantor, the applicant's bank. The applicant asks its bank to issue the guarantee and gives the bank a counter-indemnity, promising to reimburse any payment. The bank treats the guarantee as a credit exposure to the applicant and may take collateral.

Where the beneficiary insists on a guarantee from a bank in its own country, an indirect structure is used. The applicant's bank issues a counter-guarantee to a local bank, which then issues the guarantee to the beneficiary. Guarantees between banks are normally sent as authenticated SWIFT messages.

• Tender or bid guarantee. Secures the bidder's commitment to sign the contract if its bid is accepted.
• Performance guarantee. Secures proper performance of the contract, often for 5% to 10% of its value.
• Advance payment guarantee. Secures repayment of money paid up front if the contractor fails to perform; see advance payment guarantee.
• Retention guarantee. Allows release of sums the employer would otherwise hold back; see retention money guarantee.
• Warranty or maintenance guarantee. Covers defects during the period after completion.
• Payment guarantee. Secures the buyer's obligation to pay the seller.

Most international demand guarantees are made subject to the Uniform Rules for Demand Guarantees published by the International Chamber of Commerce. The current version, URDG 758, came into force on 1 July 2010 and replaced the 1992 rules known as URDG 458. The rules apply when the guarantee says so, and their main provisions include the following.

• Independence. The guarantee is separate from the underlying contract and from the applicant's arrangement with the guarantor, and the guarantor deals with documents only.
• Statement of breach. Unless the guarantee excludes it, a demand must be supported by a statement indicating in what respect the applicant is in breach.
• Examination. The guarantor has five business days following the day of presentation to examine a demand and decide whether it complies, a task similar to trade document examination under a letter of credit.
• Extend or pay. If the beneficiary demands payment unless the guarantee is extended, the guarantor may suspend payment for up to thirty calendar days while the parties consider an extension.
• Expiry. A guarantee that states neither an expiry date nor an expiry event ends three years after issue.
• Information. The guarantor must tell the instructing party without delay of any demand received.

Standby letters of credit more often use the International Standby Practices (ISP98) or the letter of credit rules, UCP 600. A United Nations convention of 1995 on independent guarantees and standby letters of credit sets similar principles in the countries that have adopted it.

Because payment is due on demand, the applicant bears the risk that the beneficiary calls the guarantee without justification. Courts in most jurisdictions will stop payment only in narrow cases, chiefly clear fraud by the beneficiary known to the bank; some legal systems add abuse of rights or unconscionable conduct. A dispute about the underlying contract is not enough. The applicant's normal remedy is to let the bank pay and then claim against the beneficiary under the contract. Exporters can insure against unfair calling through export credit insurance.

Careful drafting reduces disputes. The parties should state the amount and currency, the documents required, a clear expiry date, any reduction mechanism as work is completed, and the governing rules and law. Open-ended guarantees and those governed by laws that ignore expiry dates can remain a liability on the applicant's credit lines for years. Banks record issued guarantees as contingent liabilities and charge a periodic fee based on the amount and the applicant's credit standing, as part of their trade finance business.

• International Chamber of Commerce