You want security and are considering a surety bond or a bank guarantee? Which do you choose?

As business owner , you regularly enter into agreements. You want the debtor to fulfill his payment obligations to you and therefore require security. In many cases, you will opt for a surety bond or a bank guarantee. But what exactly is the difference between the two? Which of these two means offers you the most security?

A surety bond is an agreement whereby the surety undertakes to the creditor to perform the performance which the principal debtor, has or will obtain against the creditor. A surety can only be entered into for future obligations of the principal debtor if they are sufficiently determinable. In most cases, the surety agreement will be entered into as security for the fulfillment of the obligation to pay a sum of money. However, it is also possible that the surety agreement relates to an obligation that is for another performance that can also be performed by the surety. A characteristic feature of surety is that the defenses that the principal debtor has against the creditor can also be invoked by the surety. The surety can be sued only after it has been established that the principal debtor will not make payment. The prerequisite is that the principal debtor has been given notice of default (if necessary) and that the term mentioned therein has expired without the principal debtor fulfilling his obligations.

A bank guarantee, on the other hand, is characterized precisely by the fact that the bank must pay out at the creditor's first request, without the bank first having to investigate (in substance) the reason for the claim invoked by the creditor. The bank thus has a purely financial obligation of its own. The bank will, during the term of the bank guarantee, pay the creditor a certain amount if the conditions, as included in the agreement, are met.

It sometimes happens that it is unclear whether there is a surety or a bank guarantee. This confusion occurs especially when the guarantee stipulates that the bank will pay on demand all that the creditor claims from the debtor, but it also stipulates that the defenses granted to the guarantor are explicitly excluded. If such a provision is included, it is true that the exclusion of defenses accruing to the guarantor only makes sense if there is a guarantee. To avoid any misunderstanding about the interpretation of the contract, one can either state that the bank acts as guarantor by way of an independent obligation and assumes a debt of its own in this regard or explicitly state in the contract that the guarantee is not a surety.

There are differences between the surety bond and a bank guarantee. But what exactly are these differences? First, the surety takes the place of the original creditor at the time of payment under the surety. This is also known as subrogation. The surety then gains a so-called right of recourse against the debtor. In the case of an (abstract) bank guarantee, subrogation cases do not apply. Another difference with bail is that bail can only be entered into for future obligations if they are sufficiently determinable. However, this rule does not apply to abstract bank guarantees. The main difference between a bail bond and a guarantee, however, is that the guarantor does not have to readily accept the invocation of the bond. The guarantor can oppose the invocation of the surety by invoking the defenses that the principal debtor has against the creditor. A guarantee lacks the main legal protections that protect a guarantor.

In short, for a creditor, a bank guarantee is a stronger tool for insuring against his contracting party's performance of its obligations.

If, as business owner , you desire security and are unsure about which form of security is most appropriate, seek expert advice. There are many forms of security for which some are more appropriate than others. Be aware of this.