Delta Asia Capital: Effects and Leasing of Bank Guarantees

The guarantor bank is not obliged to supply goods or perform work on the principal’s behalf. It will not, for instance, build an airport itself if its client fails to do so, neither will it manufacture or supply looms or chemicals if its client falls behind with deliveries. The bank’s commitment is solely a financial one, as its obligation as a guarantor is limited to the payment of a sum of money as a substitute for performance that has not been rendered.

How, then, does a bank guarantee provide protection against non-performance? In three ways:

Legitimization:

A bank guarantee testifies to the principal’s ability to carry out the contract. Since the issuance of a guarantee constitutes an irrevocable payment undertaking, a bank will not enter into such a commitment without first thoroughly examining the principal’s financial status and technical capability.

Motivation:

The principal stands to lose the guarantee amount if it fails to fulfill the contract terms. This is a strong incentive to complete the contract, even if the transaction has lost its appeal in the meantime.

Compensation:

If the principal fails to fulfill its obligations, the buyer is entitled to demand payment of the guarantee sum, which will compensate fully or partly for the financial consequences of the breach of contract.