A bank guarantee is a form of security for payment of a claim. Bank guarantees are often required when buying a home, but also widely used in business transactions, such as when selling a business or lifting a seizure.
There is no legal regulation regarding bank guarantees. There are therefore no legal requirements for bank guarantees. However, the banks that issue the guarantees have their own conditions and standards, and rules from case law apply.
Parties to a bank guarantee
The parties to a bank guarantee are the principal, the bank and the beneficiary. Through the bank guarantee, the bank undertakes to pay the debt of the principal to the beneficiary if the conditions stated in the bank guarantee are met. Such conditions may include, for example, the expiry of a strict deadline or the awarding of a claim by the court. Of course, a bank does not issue a guarantee for free: the principal must pay costs and issue a deposit or counter-guarantee to the bank.
How a bank guarantee works
The principal pays the amount of the guarantee itself, but a bank guarantee has major conditions for the beneficiary. The most important is the (almost) absolute certainty that they will get paid, because a banking institution – not the counterparty – guarantees the payment. It is a debt of the bank itself, not a debt of the counterparty. Even if the principal goes bankrupt, or other creditors seize his assets, the beneficiary will not suffer any disadvantage.
A bank guarantee is often “abstract” or “independent”. This means that the bank must pay out the guaranteed amount at the first request of the beneficiary. This applies irrespective of the circumstances of the underlying dispute between the beneficiary and the principal. In such a situation, the bank is not permitted to delve into that issue.
Key considerations for a bank guarantee
Regardless of whether or not the conditions for payment of the bank guarantee are met, the bank (and the beneficiary and principal) must rely only on the text of the guarantee and the grammatical explanation thereof. This is in contrast to the interpretation of contracts, where the intention of the parties is decisive.
It is understood that the beneficiary may not abuse the abstract nature of the bank guarantee. If the underlying legal relationship with the principal does not allow payment of the bank guarantee, the principal can prohibit them – through the court – from invoking the guarantee or claiming compensation.
It is critically important to be very precise in the text of a bank guarantee in order to prevent problems and misunderstandings in the future. Whom should the bank pay? At what time should the bank pay out? Which conditions must be met?
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