A demand guarantee is sometimes confused with surety because they are similar undertakings to pay a sum of money. However, the demand guarantee must be distinguished from surety because there is an important difference between them. A demand guarantee is an independent transaction from the underlying commercial contract in connection to which it has been issued. Surety, on the other hand, is an accessory to the underlying contract and is not independent from it in the same way as the demand guarantee.
As explained in the eLearning course Demand Guarantees, an unconditional demand guarantee gives the beneficiary the right to demand payment from the issuing bank when it is justified in the beneficiary’s sole opinion. For example, when a demand guarantee is a payment guarantee, the bank cannot refuse payment to the beneficiary because the bank’s client, also called the principal, has disputed the beneficiary’s right to payment under the commercial contract. An example of such a dispute between the beneficiary and the principal is the principal’s objection that the goods delivered by the beneficiary under the commercial contract do not function properly. In such a situation, where the beneficiary is the seller and the principal is the buyer, the principal would have the right to withhold or refuse payment of the contractual price. However, since the demand guarantee is an independent transaction, the issuing bank is prevented from making the same objection against the beneficiary, and the bank must pay under the guarantee when the beneficiary demands that.
The issuer of surety, on the other side, has the same rights against the beneficiary as the principal has under the commercial contract. This means that the issuer of surety is entitled to refuse payment under the surety if the principal has disputed the beneficiary’s right under the commercial contract. Therefore, the surety is seen as an accessory transaction to the underlying commercial contract. Banks are usually unwilling to issue surety since they do not want to be involved in possible disputes between the principal and the beneficiary. For this reason, the surety is not frequently used in international trade, and for the same reason, our eLearning programme does not contain a course about surety.
It is important to explain that in some countries, the surety is referred to as a guarantee, in everyday language. This should be observed, and the contractual parties, especially the beneficiary in whose favour such document is issued, should analyse whether such a guarantee is independent from the commercial contract or an accessory to it. If the analysis shows that a document called ‘guarantee’ is actually the surety, this should be addressed with the other party, and issuing a demand guarantee should be requested.
See our eLearning course Demand Guarantees