A demand guarantee is an obligation for a third party to perform the terms of a contract for one of the parties. It is often used to protect against non-performance or defective performance. Financial institutions may require a waiting period before fulfilling the obligations of an on-demand guarantee. It is different from a letter of credit as it provides broader protection.
A demand guarantee obliges an individual who is not a party to a contract to perform the terms of the contract for one of the parties to that contract. The guarantor is the natural or legal person who undertakes to pay for the party which is unable or unwilling to make a payment and which was required to obtain the guarantee. In some cases, the parties are only willing to enter into an agreement because there is a guarantee of demand. Otherwise the contractual relationship would seem too risky without it. Some banks provide a bank guarantee upon request; the party that insisted on the guarantee can get payment from the bank, and the second part of the agreement should repay the bank.
Many commercial and personal transactions require demand guarantees, such as buyers and sellers in real estate transactions and creditors and debtors when signing bills. The party who is protected by a demand guarantee can often invoke it at any time during the contractual relationship without proof of default, although it is often used to protect against non-performance or defective performance. For example, if a landlord is unsure of receiving payment for rent, he can file a payment claim with the guarantor. The tenant would then have to pay off the guarantor, but the landlord would benefit from the protection provided by an demand guarantee. The guarantee of the claim is often made in writing and signed by the guarantor.
A financial institution may require a waiting period before fulfilling the obligations of an on-demand guarantee. The waiting period is often used to contact the person they are paying for to get paid or to notify the person that a payment request has been made. Whether or not the guarantor can obtain payment first is not relevant to the guarantor’s obligation to make payment in accordance with the guarantee that has been given.
Letters of credit are not the same thing as collateral on demand. A bank may issue a letter of credit stating that the bank will pay the specified amount once the recipient of the letter meets the terms of the agreement. For example, in a real estate transaction, the buyer might get a letter of credit from the bank promising to pay the purchase price of a home once the seller delivers good title and the sale is completed. A demand guarantee protection is broader than a letter of credit can provide, because the seller would not have to wait for the sale to be completed or for the buyer to cancel the contract. Anyone with an application guarantee can write a letter asking for the application to be enforced and is often entitled to it.
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