What it means
In international trade, a buyer often wants reassurance that a seller will deliver, and a seller often wants reassurance that a buyer will pay. A demand guarantee gives that comfort by putting a bank's promise behind the contract.
The bank agrees to pay if the beneficiary presents a complying demand, usually a signed statement saying the other party has defaulted. The key feature is independence.
The guarantee is separate from the underlying sale or construction contract, so the bank looks only at whether the demand and any other documents comply with the guarantee's wording. It does not investigate whether a dispute is justified, which is why the beneficiary can obtain cash quickly.
The best-known version is URDG 758, published by the ICC in 2010, which replaced an earlier set known as URDG 458 from 1992. A guarantee only follows these rules if it says so, typically with a short sentence stating that it is subject to URDG 758.
Without that sentence, a mix of local laws and bank practice would decide any argument instead. The rules cover practical points such as when a guarantee expires, what a compliant demand looks like, how amendments work and how long a bank has to examine a demand.
Banks usually have a limited number of business days to examine a demand and decide whether to pay or reject it. This makes timing very clear for both sides, which is valuable when a project is under pressure.
For a manager, the practical message is to read the wording and the expiry date carefully, because the guarantee does exactly what it says and nothing more. Common types include bid guarantees, advance payment guarantees, performance guarantees and warranty guarantees.
The applicant, the party who asks the bank to issue the guarantee, usually pays a fee and may have to put up cash or credit lines as security.
In practice
Real-world examples.
Example
A machinery exporter agrees to supply equipment worth $4,000,000 and receives a 20% advance payment. The buyer insists on an advance payment guarantee under URDG 758, so if the exporter fails to deliver, the buyer can claim back its $800,000 from the issuing bank.
Example
A civil engineering company bids for a government road contract. The tender requires a bid guarantee of $150,000 that stays valid for 90 days, and the contractor's bank issues it subject to URDG 758.
Example
A software supplier sells a hospital system and gives a warranty guarantee for 12 months after go-live. The hospital's finance team diarises the expiry date, because any claim made after that date will be rejected.
Formula
Calculation
Guarantee fee = guarantee amount x annual fee rate x (months open / 12)
Suppose a construction firm needs a performance guarantee of $2,000,000 for a contract that runs for 18 months, and the bank charges 1.5% a year. The fee is 2,000,000 x 0.015 x (18 / 12) = 30,000 x 1.5 = $45,000. The firm treats this $45,000 as a cost of winning the contract, and if the bank pays out under the guarantee, the firm must reimburse the bank in full.Case study
Seen in the real world.
Marlow and Finch Engineering is an illustrative, fictional firm that wins a $6,000,000 water treatment contract abroad. The client asks for a performance guarantee of 10%, payable on first written demand, issued subject to URDG 758.
The finance director negotiates the wording carefully so that the guarantee expires on a fixed date, instead of at an open-ended event such as final acceptance. She knows that an open-ended expiry could leave the firm's credit line tied up for years.
In this illustrative story the project finishes two months late, and the guarantee is extended once by agreement. Because the date was fixed in the wording, the bank released the $600,000 exposure promptly at the extended expiry, and the firm's credit line was freed for the next bid.
Watch out
Common mistakes.
- Treating a demand guarantee as if it depended on the underlying contract, when the bank pays on a compliant demand even if the applicant disputes the claim.
- Forgetting to state that the guarantee is subject to URDG 758, which leaves the issue open to local law and practice.
- Ignoring the expiry date, so that the guarantee lapses before the beneficiary has made a claim or the applicant remains exposed longer than planned.
Questions
People also ask.
What is the difference between a demand guarantee and a standby letter of credit?
Both are payment promises from a bank, but a demand guarantee is usually governed by URDG while a standby letter of credit is usually governed by other rules such as ISP98 or UCP 600.
Who is the applicant, the beneficiary and the guarantor?
The applicant is the party who asks for the guarantee, the beneficiary is the party who may claim under it, and the guarantor is the bank that issues it.
Can the applicant stop the bank from paying?
In most cases no, because the bank's promise is independent of the contract, so any dispute usually has to be settled separately between the parties afterwards.
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