Demand guarantee explained

The basis of any contractual agreement between two parties is the performance of duties or services for a pre-decided consideration. In the case that one of the parties fails to keep their share of the contract, leading to a loss for the other party, demand guarantees can be extremely useful.

The definition of a demand guarantee refers to a financial protection offered by a guarantor to the beneficiary party in case the principal party doesn’t perform their contractual obligations.

To understand what a demand guarantee is, it’s important to know about the three parties involved in situations where a demand guarantee is warranted. These are the guarantor, beneficiary and principal.

A demand guarantee means an agreement whereby a beneficiary’s performance must be met by the guarantor, in the event of the principal party’s non-performance. The guarantor can seek repayment from the principal party. The essence of a demand guarantee lies in the fact that the beneficiary will be compensated, if not through the principal party, then through a guarantor.

Demand guarantee example 

Typically demand guarantees can be found in international trade transactions, where risks can be high.

Say that a company in the UK is looking to import machinery from Singapore. Fearing the consequences if the Singapore-based company doesn’t honour its commitment, the UK company can ask them to provide a demand guarantee from their banking institution stating that the bank would pose as a guarantor for this transaction. After compensating the UK company for any non-performance by the exporter, the bank can seek repayment from the Singaporean company directly.

Utility of demand guarantee

A demand guarantee helps reduce counterparty risk and boost business transactions that may not have been possible due to high risk. To maintain consistency, the standard rules that govern demand guarantees are issued by the International Chamber of Commerce. 

These rules act as a guideline for the different parties involved. However the enforcement of a demand guarantee can vary from one country to another. Considering the tremendous security a demand guarantee involves, the beneficiary may be paying the cost through the pricing of the initial contract.