Demand guarantee

In general, guaranteeing something is the same as promising that an action will be done or an item will be delivered. In a similar vein, a guarantor is an entity who assures one party that, in the event that the second party can no longer fulfill his obligations, the guarantor will cover for these.

A demand guarantee performs a similar function, as it is a form of protection which may be required by an entity from another, should the second party be unable to meet its obligations. In such a situation, the second party may go to the bank to purchase a guarantee which it then presents to the first party. If the second party is indeed unable to fulfill his obligations to the first party after some time, the first party can go to the bank and present the guarantee. He will then be compensated for the amount specified.

A demand guarantee functions somewhat similarly to a letter of credit. A letter of credit is a document issued by a bank which assures a seller that full payment will be received by the buyer, and that this will be delivered in a timely manner.

If the buyer becomes unable to fulfill his payment obligations, the bank, which acts as a guarantor, covers the necessary payments, which are then charged to the buyer. Letters of credit, however, are limited only to situations in which the buyer is unable to make the necessary payments. On the other hand, demand guarantees cover other factors, such as late performance.

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