Entrepreneurship involves - in addition to opportunities - continuous risks. Consider, for example, the risk of bankruptcy of your customer or buyer, while you still have an outstanding claim against that party. These risks can be limited by means of guarantees. The bank guarantee is probably the best known, but the group guarantee is also a possibility. Reinier Pijls and Paula Röttjers discuss these two forms of security and explain the differences.
The bank guarantee
What is a bank guarantee?
With the bank guarantee, the bank undertakes to pay the guarantor's debt up to an agreed amount. The bank does this to the beneficiary when the beneficiary claims it. A bank guarantee thus involves three parties: the guarantor, the bank and the beneficiary. For the amount to be paid out, the conditions stated in the bank guarantee must be met. In return, the guarantor must pay costs and provide a deposit or counter-guarantee to the bank. Thus, a bank guarantee affects the guarantor's credit line.
Types of bank guarantees
1. Bank guarantee 'on demand'
The 'on demand' bank guarantee obliges the bank to pay an agreed sum to the guarantor when requested by the guarantor. The "on demand" bank guarantee is also called the "pay first then talk" guarantee. This guarantee often stipulates no more than that when the beneficiary reports to the bank, the bank must pay out the bank guarantee. It must then be the case that the guarantor defaults on the agreement. The beneficiary does not have to substantiate the damages suffered due to the breach of performance and the extent of those damages. The bank, in turn, does not have to check whether the guarantor actually defaulted and what the cost of repairing the damage suffered as a result would be.
2. Bank guarantee under conditions
The 'conditional' bank guarantee is less freely invoked than the 'on demand' variant. There are agreed conditions attached to this form that must take effect before the bank makes payment. These conditions include:
- expiration of a deadline;
- A joint request by the parties; or
- the court's adjudication of a claim.
The corporate guarantee
Sometimes it is not possible or desirable to provide a bank guarantee. This may be the case, for example, if there is financial room to provide a counter-guarantee. The corporate guarantee may then be a good option.
What is a corporate guarantee?
A group guarantee is agreement between the beneficiary and the parent company of the guarantor. The parent company undertakes to fulfill the obligations of its subsidiary (the guarantor) if the subsidiary fails to do so. Therefore, the condition for using this form of security is that the guarantor is part of a group or holding company.
Advantages and disadvantages
Credit space
The major advantage for the guarantor is that the corporate guarantee, unlike the bank guarantee, does not cost the guarantor any money. Thus, the guarantor's credit margin is not affected.
Taking sides
One danger lurking when invoking the group guarantee is that in the event of a dispute between the guarantor and beneficiary, the parent company party will usually opt for the guarantor's position and not pay (immediately). The group guarantee thus has less value than, for example, a bank guarantee 'on demand' because the beneficiary will have to go to court to enforce payment.
This risk can be mitigated somewhat by formulating the corporate guarantee in such a way that payment must be made on first demand. But even then it cannot be ruled out that the parent company will not pay voluntarily. With a bank, that chance is much smaller.
Bankruptcy
In case of bankruptcy of the guarantor, the bank guarantee provides much security for the beneficiary. Even in that case, the bank must pay out to the beneficiary when requested. Thus, bankruptcy does not affect the beneficiary's ability to extract the bank guarantee.
If there is a bankruptcy and a corporate guarantee has been issued, the parent company of the bankrupt subsidiary is obliged to still fulfill the contract . This can be positive for continuity of operations, for example, in a construction project. But the group guarantee may also turn out to be worth nothing. If not only the subsidiary, but the entire group or holding company fails, the beneficiary is left empty-handed. That risk is much lower with a bank guarantee.
Best of both worlds
The bank guarantee offers more security than the corporate guarantee in most cases. It can also be used as a means of putting pressure on the guarantor to perform. If this still does not happen, there is security for payment of a certain sum by the bank on the basis of the guarantee provided. The disadvantage with the bank guarantee is that it is often limited to a maximum amount or certain damages. Thus, it may not cover all damages suffered.
Certainty of continuity
The group guarantee generally provides assurance of continuity of operations. The parent company will still perform as agreed, thus covering all damages. However, if there is bankruptcy and the entire group or holding company fails, the group guarantee is worth nothing and the beneficiary still loses out.
Often the bank guarantee provides the best security, but sometimes the corporate guarantee or some other form of security may be better. It really depends on the specific situation and possibilities and circumstances of the case.
Establishing and issuing guarantees requires customization. If you would like advice on the possibilities of obtaining or giving additional security, please feel free to contact one of our attorneys. We specialize in the establishment and enforcement of various securities, including guarantees.
