A bank guarantee is insurance provided to a party in case a transaction doesn’t go as planned. It reduces the cost and delay associated with a failure and is used in various business transactions.
A bank guarantee is a form of insurance provided to a party to a transaction in case the transaction does not go as planned. The bank agrees to pay the designated party a sum of money if the buyer or seller is unable to meet the contractual obligations. Large performance-based contracts frequently require this special severance letter as part of the award or negotiation.
Prudent business transactions consider what might happen if the parties to a transaction are unable to complete their required obligations under the contract. Many contracts are traded to cover a long period of time, with multiple transactions under the same contract. In this type of contract, each party can require the other party to execute a bank guarantee. The bank guarantee is intended to protect each party in case of default.
Non-compliance may be a factor beyond the control of the contracting party. Despite the party’s intentions to perform its obligations under the contract, the party may not be able to perform as designated in the contract. In this circumstance, the bank will pay the party receiving the goods or services an amount of money designated in the contract and the bank guarantee document. The parties agree in advance what the damages would be in the event of a breach. The purpose of the bank guarantee is to reduce the loss in case of default.
By determining in advance what the damages would be when a party fails to perform, the parties to the contract can reduce the cost and delay associated with such a failure. The designated party receives its funds in accordance with the contract and can find a third party to provide the goods or services that the contracting party was unable to provide in a timely manner. Without the bank guarantee as part of the original contract, the designated party would have to go through some type of dispute resolution process with the original provider before receiving damages.
Bank guarantees are used under different names in a variety of business transactions. In the construction industry, offer bonuses or performance bonuses are required as part of the hiring process. These bond documents are a form of bank guarantee. When a company ships products with another company, the shipping company may require a letter of indemnity from the shipper in case the documents are lost or other requirements cannot be met.
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