IntaCapital: What is a Bank Guarantee, and the difference between Standby Letters of Credit (SLBCs) and documentary credits (L/Cs)

Posted on by IntaCapital Swiss

In international trade dealings, buyers and sellers often experience problems of trust within each other to honour their payment obligations. A seller may find it difficult to ascertain the buyer’s willingness and ability to make payment, whilst the buyer may not be convinced that the seller genuinely intends to perform his side of the agreement or has the necessary financial and technical resources to do so. Just as the buyer needs protection against non-performance, so the seller will want to minimize or insure against the risk of non-payment. Documentary credits are generally used in such cases, yet various other forms of bank guarantees are available.

The term “bank guarantee” has no precise definition, particularly in international law. Some use the term exclusively to describe a transaction in which one party makes an independent guarantee commitment in respect of another party’s liabilities, regardless of the latter’s form and enforceability. Others describe guarantees as all transactions in which security is offered; from letters of comfort (which often are morally binding at most) to surety bonds and abstract payment undertakings. The custom and protocol in international trade is to have undertakings that are payable on first demand and that are legally separate from the underlying transaction, (Uniform Rules for Demand Guarantees).

The common element in all these arrangements is that the guarantor undertakes to be answerable for the payment of a debt or the fulfilment of a payment obligation in the event of default by the party that is responsible for it.

Thus the basic function of a bank guarantee is to provide security.

The main difference between a bank guarantee and a documentary credit is that the latter also functions as a means of payment. A bank guarantee acts as security for a payment, not as a means of payment.

Bank guarantees are governed almost exclusively by the law of the country of domicile of the bank that issues the guarantee to the beneficiary. This means that the legal position must be studied in each case.

Every declaration that is designated a “bank guarantee” must be examined carefully to ascertain its legal significance and implications. A particularly clear distinction must be made between a surety bond and an abstract payment undertaking.