Demand guarantees explained in our eLearning course contain an obligation of the issuing bank to pay a sum of money to the beneficiary when the beneficiary demands payment. Since demand guarantees are often issued in connection to payment of a contractual price under a commercial contract, it is important to explain that a demand guarantee is not a method of payment. The purpose of issuing demand guarantees is securing payment, not making it. In other words, a demand guarantee is security, not a method of payment.

A payment under a demand guarantee issued by a bank should be demanded if the bank’s client, also called the principal, breaches the underlying commercial contract with the beneficiary. Demanding payment under a demand guarantee is not frequent, and there are numerous guarantees under which demand for payment has never been made.  In such transactions, the principal and the beneficiary have properly performed their contractual obligations under their commercial contract, and there was no need to demand payment under the demand guarantee.

In the context of demand guarantees, the term ‘security’ can be explained as protection of one contractual party in case the other contractual party breaches the commercial contract. However, demand guarantees have another important purpose: the beneficiary putting pressure on the principal to properly perform its obligations under the commercial contract. The beneficiary can do that by threatening to call the guarantee, in other words, to demand payment under the guarantee. It could therefore be argued that the primary purpose of the demand guarantee is to secure the proper performance of the commercial contract, rather than making payment to the beneficiary.

See our eLearning course Demand Guarantees