A bank guarantee is an irrevocable promise of payment by a bank in favor of a beneficiary, at the request of a principal. It is one of the most widely used security instruments in international trade. In our practice, we see bank guarantees in construction projects, supply contracts, and tenders. There is a wide variety of types, rules, and pitfalls. For both the beneficiary and the principal, the legal details are crucial for effective operation. What is the legal issue? Bank guarantees are often on demand: the bank pays upon first request, without proof of default. This provides the beneficiary with strong security but the principal with little defense. Abuse (dishonest invocation, fraudulent call) is difficult to prevent. Internationally, rules regarding the request, maturity, languages, and formal requirements vary. Incorrect wording can lead to refusal by the bank or, conversely, to unexpected payment.
What does the law say?
The ICC Uniform Rules for Demand Guarantees (URDG 758, valid since 2010) provide the globally used framework. Some systems apply ISP98 for stand-by letters of credit. Under Dutch law, bank guarantees are autonomous contracts, separate from the underlying relationship. Under English law, the fraud exception applies only in cases of clear fraud (Edward Owen v Barclays Bank, 1978).
Local laws determine requirements regarding wording, language, and burden of proof upon invocation. Regarding on-demand payments, the Supreme Court confirmed in NJ 2009/127 (GTI) that intervention is only permitted in cases of clear abuse.
What risks do companies face?
For the beneficiary: formal errors can lead to refusal by the bank. Short maturities pose a risk of the request lapse. For the client: a dishonest request forces immediate payment, with a blocked defense. Fraudulent calls are difficult to stop below the strict Edward Owen threshold. Tax and cash flow impact can be significant because the bank charges the client directly.
Practical example from our practice
We represented a Dutch supplier who received a performance bond from an Italian bank for the benefit of his Italian client. The guarantee required a written request to exactly the same address as stated in the guarantee. The client sent it to a changed address and the bank refused. For contract renewal, we incorporated: URDG 758, flexible wording regarding address, six months validity with automatic renewal, and a clear list of documents for invocation. Subsequent guarantees were settled without dispute.
What can you do?
Work with standard URDG 758 wording. Clearly agree on term, currency, and amount. Make renewal or replacement simple. For principals: negotiate proof requirements. For beneficiaries: ensure flexible wording. Combine with a counter-indemnity and arrange security internally. Have bank guarantees reviewed by an international commercial law attorney and your banking partner. See also our article on International construction contracts.