First Demand Bank Guarantees: The Bank’s Obligations

This post is also available in:

What is a (first demand) guarantee?

A bank guarantee is a tripartite mechanism by which a bank undertakes towards a beneficiary to pay a set sum, in the cases and on the terms set out in a guarantee letter. Where the guarantee is a first demand guarantee, the beneficiary need only apply to the bank in accordance with the guarantee letter to obtain payment, without the bank having, in principle, to examine the underlying merits of the call. The bank may thus undertake to pay a landlord a rental deposit on simple demand, leaving the tenant to contest the call afterwards. In business law and international banking law, first demand guarantees are common: they reassure a creditor as to a debtor’s performance, whether payment or acts (works, delivery of goods, and so on).

How is a first demand guarantee analysed in banking law?

A first demand bank guarantee is a literal, autonomous and independent undertaking of the bank towards the parties, the principal and the beneficiary. It is imperative that the beneficiary seeking release of the guarantee comply with its text to the letter, starting with the stipulated conditions of call; failing that, the bank will not release the funds. Conversely, if the conditions in the guarantee letter are strictly met, the bank must release the funds, independently of the main contract between principal and beneficiary, save a manifestly abusive call (a subjective notion left to the court). Once the bank pays, it passes the operation on to the principal by debiting its account or enforcing its own security. Strict application of these principles is essential to legal certainty: the bank commits almost blindly and is a stranger to the underlying contract, while the principal does not want its banker engaging in a subjective interpretation of the order.

A Brussels case

Most disputes over first demand guarantee calls begin in summary proceedings, given the urgency and the bank’s usually imminent obligation to perform. Proceedings brought before the bank releases the guarantee can sometimes suspend the payment resulting from a regular call.

A case decided by the Brussels Court of Appeal concerned a rental deposit set up as a first demand bank guarantee (not to be confused with the classic rental deposit of a main-residence lease). The guarantee letter provided for its automatic lapse on early termination of the underlying lease; the guarantee then had to be called at the latest one month from the judgment terminating the lease, or from the agreement by which tenant and landlord agree to terminate. Here, such an early-termination agreement had been concluded, the parties specifying that the landlord would refrain from calling the guarantee as long as the former tenant respected an agreed payment plan for rent arrears. The bank was a stranger to that agreement. The plan was not respected, and the beneficiary called the guarantee. For the bank, the call was late, coming more than a month after the agreed termination. The bank considered itself bound only by the strict text of the guarantee letter, disregarding the agreements between principal and beneficiary. The Court of Appeal upheld the bank’s position.

This article is a translation. Only the French version is authoritative. It is provided for information purposes and does not constitute legal advice.