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Are demand guarantees issued by third parties good enough?

Other parties, different from banks, may issue unconditional guarantees payable on demand, with terms identical to the terms included in the demand guarantees issued by banks. Such non-bank guarantors are usually the parent company of the principal or another company in the principal’s company group. It is usually said that such a guarantor controls the principal, which is the reason for issuing the guarantee.

What are the risks for non-payment under a demand guarantee issued by a non-bank guarantor?

There are three risks connected with guarantees issued by the non-bank guarantors.

The first risk is the guarantor’s inability to pay when the beneficiary demands payment under the demand guarantee. Since the guarantor is a company within a larger group of companies, it is likely that the financial difficulties that have negatively affected the principal and the entire group will negatively affect the guarantor. In such a situation, the beneficiary will not receive payment when demanding it under the guarantee.

The second risk connected with a non-bank guarantor is its unwillingness to pay under the demand guarantee. When the principal claims that no breach of contract has occurred and that the beneficiary’s demand for payment is not justified, the non-bank guarantor may take the principal’s side and refuse payment under the demand guarantee by using the same argument. Such risk exists even when the non-bank guarantor has issued an unconditional demand guarantee and is obligated to pay without interfering in the dispute between the principal and the beneficiary.

The third group of risks are the political risks explained in the eLearning course Risks in International Trade. These risks may negatively affect the non-bank guarantor and prevent transferring the payment under the guarantee. However, such political risks may also negatively affect a bank that issued a demand guarantee and prevent payment even though the bank is willing to pay.

The above considerations are made for the purpose of risk assessment, which is the main purpose of the eLearning programme provided, not for the purpose of legal analysis of the guarantees issued by the non-bank guarantors.

Should a small- or medium-sized company accept a demand guarantee issued by the counterparty’s parent company or another non-bank guarantor?

Since small- and medium-sized companies usually do not have the expertise to analyse the above risks, they can hardly assume the risks connected with a demand guarantee issued by a non-bank guarantor. Therefore, it is much better, from the risk point of view, not to accept such a guarantee, no matter how well-drafted the terms are included in it. A small- or medium-sized company should insist on obtaining a demand guarantee issued by a bank, which is always seen as a better risk than a demand guarantee issued by a non-bank guarantor.

For the reasons explained above, demand guarantees issued by non-bank guarantors are not included in the eLearning course about demand guarantees.


See our eLearning courses Demand Guarantees and Risks in International Trade

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