Bank guarantee: types, rules and how it works

What is a bank guarantee?

A bank guarantee (BG) is an undertaking by a bank (the guarantor), issued at the request of its customer (the applicant, or principal), to pay a beneficiary up to a stated amount if the applicant does not fulfil an obligation. It is used where one party needs security for the other’s performance: a public buyer awarding a construction contract, an importer paying an advance, a landlord, a customs authority.

A guarantee is a safety net. If the contract is performed, it expires or is returned without being called. For the beneficiary, its value lies in the bank’s creditworthiness and in how easy it is to obtain payment. For the applicant, it uses part of its credit capacity with the bank for as long as it remains outstanding.

Demand guarantee or accessory guarantee: what is the difference?

Terms such as “on first demand”, “irrevocable and unconditional” or “without objection” signal an independent guarantee. Many legal systems recognise the distinction; French law, for example, sets out the independent guarantee (garantie autonome) separately from suretyship (cautionnement).

What are the main types of bank guarantee?

The amount is normally a percentage of the bid or contract value, fixed by the tender documents or the contract. Other guarantees cover customs duties, rent or court proceedings. Advance payment guarantees commonly state that they become effective only when the advance has actually been received, which protects the applicant.

How do direct and indirect (counter-) guarantees work?

In a direct guarantee, the applicant’s bank issues the guarantee straight to the foreign beneficiary. In an indirect guarantee, the applicant’s bank issues a counter-guarantee in favour of a bank in the beneficiary’s country, which then issues its own local guarantee to the beneficiary. Beneficiaries, particularly public bodies, often require a guarantee from a local bank, under local law.

The local bank pays the beneficiary under its guarantee and claims reimbursement under the counter-guarantee. The counter-guarantee is itself independent of the local guarantee and normally expires later, to allow time for the demand to be passed on. Under SWIFT standards, an MT760 used for a counter-undertaking carries a separate sequence for the local undertaking requested.

Example (illustrative): a Spanish contractor wins a water-treatment contract from a public utility in Senegal. The tender requires a performance guarantee from a bank licensed in Senegal. The contractor’s Spanish bank issues a counter-guarantee subject to URDG 758 to a Senegalese bank, which issues the local performance guarantee to the utility. If the utility makes a complying demand, the Senegalese bank pays and then claims from the Spanish bank, which debits the contractor.

How does URDG 758 work?

The ICC Uniform Rules for Demand Guarantees, 2010 revision (URDG 758), have applied since 1 July 2010 to guarantees and counter-guarantees that expressly incorporate them. Their 35 articles cover issuance, amendment, demand, examination and expiry. Key points include:

• Supporting statement. A demand must be accompanied by the beneficiary’s statement indicating in what respect the applicant is in breach, unless the guarantee excludes this requirement.
• Examination. The guarantor has five business days following the day of presentation to examine the demand, and must give a single notice of rejection listing each discrepancy.
• Extend or pay. If a demand asks, as an alternative, for the expiry to be extended, the guarantor may suspend payment for up to 30 calendar days.
• Expiry. A guarantee should state an expiry date or expiry event. If it states neither, URDG 758 provides that it terminates three years after issue.
• Governing law. Unless otherwise agreed, the law of the guarantor’s place of business governs the guarantee.

The ICC publishes model forms for demand guarantees and counter-guarantees under URDG 758, a useful starting point for wording.

What should you check in a guarantee’s wording?

• Trigger. Does a simple demand suffice, or is a statement of breach, a certificate or a court decision required?
• Amount and reduction. Does the amount reduce automatically as deliveries or milestones are completed, and on what evidence?
• Effectiveness. For an advance payment guarantee, does it come into force only on receipt of the advance?
• Expiry. Is there a fixed date? Open-ended guarantees tie up credit lines and can be called long after the work is done.
• Rules and law. Is the guarantee subject to URDG 758, and which law and courts apply?
• Language and form of presentation. Paper or electronic, at which address or SWIFT address?

A wording that is fair to both sides is easier for a bank to approve and less likely to be disputed. See our checklist of documents banks usually ask for.

What does a bank look at before issuing a guarantee?

A guarantee is a credit exposure for the bank: if it pays, it must recover the amount from the applicant. The bank therefore reviews the applicant’s financial statements, track record, the contract and the risk in the wording, and decides whether to issue under a credit line, against collateral or a cash margin. Commissions are usually quoted as a percentage per year or per quarter of the amount, plus fixed fees, and vary with risk, tenor and country. Approval time depends on the bank’s onboarding and credit process; our guide on realistic timelines describes the stages. Guarantees offered for “lease” by third parties are not a substitute; see leased SBLC and bank guarantee offers.

How Star Alliance helps with bank guarantees

Star Alliance Consulting reviews the contract or tender requirements, prepares the file and a proposed guarantee wording, and coordinates with the applicant, the beneficiary and the issuing and local banks. We do not issue, sell or lease guarantees, and the final decision belongs to the issuing institution. Details are on our contractual guarantees page.

Frequently asked questions