The definition of a Bank Guarantee, is where a bank promises to cover a loss in the event a borrower defaults on a loan. The Bank Guarantee or Letter of Guarantee is issued by one Bank (The Issuer), on behalf of their client (The Applicant or Provider) to another Bank (The Receiving Bank), in favour of their client (The Beneficiary or Borrower). There are differing kinds of Bank Guarantees including direct and indirect Bank Guarantees (See Below). Issuing Banks invariably issue Direct Bank Guarantees which are issued direct to the beneficiary’s banker (The receiving Bank). In the case of Collateral Transfers, Demand Bank Guarantees are the prevailing instrument.

A commonly asked question is “What is the difference between a Bank Guarantee (BG), a Documentary Letter of Credit (DLC) and a Standby Letter of Credit (SBLC)”. The main difference is that both Documentary and Standby Letters of Credit are a Means of payment, whilst a Bank Guarantee acts as SECURITY for payment.

Legally a Bank Guarantee is governed almost exclusively by the laws of the country in which the issuing bank is domiciled NOT the laws of the country where the beneficiary is domiciled. It is therefore imperative that laws pertaining to each Bank Guarantee must be studied separately to ascertain all the legal implications.

As mentioned above Bank Guarantees take several different forms. An Indirect Bank Guarantee is issued by the correspondent bank under instruction from the Issuing Bank, and upon receipt of a Counter Guarantee. A Direct Bank Guarantee is self-explanatory, where the Issuing Bank transfers a guarantee direct to another bank. A Surety Bond (or Performance Guarantee), is another form of Bank Guarantee and it is essential to understand what distinguishes a Bank Guarantee from a Surety bond. A Surety Bond is a type of insurance and will only pay if a certain set of conditions are met, whereas a Bank Guarantee will pay immediately upon demand if default has occurred.

Collateral Transfer facilities are underwritten by Demand Bank Guarantees and are payable on FIRST DEMAND. The Demand Guarantee is underpinned by specific formats or verbiage (wordings) as evidenced and governed by ICC Uniform Rules for Demand Guarantees (URDG 760). The Demand Guarantee is issued to secure loans, capital injections and lines of credit, which are commonly referred to as Credit Facility Guarantees and are worded appropriately.