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A word about credit risk mitigation

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A form of credit support where one chap agrees to make good the obligations of another chap to a third party, if the second chap can’t or won’t. Rather similar — very similar — strikingly similar — to a surety.

Types of guarantee

There’s a saying in legal circles: anus matronae parvae malas leges faciunt: little old ladies make bad law. In the history of the common law, more little old ladies than you’d expect seem to have given guarantees.The common law is therefore littered with well-meaning judgments applying (and, frankly, making up) idiosyncratic, counter-intuitive and at times plainly stupid rules just to let little old lady-guarantors off the hook. This means it is a minefield for lawyers. You know what you find in mines: GOLD. So a guarantee is a place, like no other, where you need magic words.

Continuing guarantee

A continuing guarantee is one where the guarantor assumes liability for all the debtor’s past, present and future obligations to a creditor. Even where the amount owing has been paid in full, the guarantor can still be liable under the same facility if there is a subsequent indebtedness. This is useful for revolving credit facilities and other forms of indebtedness with a “now you see it, now you don’t” sort of a flavour to them.

This is to overcome a principle articulated in Devaynes v Noble that payments are presumed reduce debts in the order in which the debts are incurred.

Demand guarantee

A demand guarantee is a guarantee that the guarantor must honour upon the beneficiary’s demand. The beneficiary is not required to first make a claim or take any action against the obligor of the obligation that the guarantee supports. A demand guarantee is enforceable notwithstanding any deficiencies in the enforceability of the underlying obligation.

Guarantee vs Indemnity

Not, strictly speaking, a guarantee at all, but a contractual obligation having a similar economic effect is the indemnity. Note the statute of frauds doesn’t apply to an indemnity - which is why it’s traditionally seen as a useful thing to attach to a guarantee.

Negotiation points

Assignment of a Guarantor’s rights

A Guarantor has certain rights it acquires at law, even where it executes as a deed (such as the right of subrogation), and there is a risk that a guarantor who assigns these rights might somehow mysteriously compromise a beneficiary’s rights under the guarantee. So, to be sure, limit that right of assignment.

Guarantees and the ISDA Master Agreement: why Transaction-specific guarantees don’t work

Should a client request a transaction-specific parental guarantee (or letter of credit) for a Transaction under an ISDA Master Agreement instead of the usual “all obligations” guarantee of all the counterparty’s obligations under the ISDA Master Agreement, hit the alarm button.

You should never agree to the guarantee of individual Transactions (nor accept a letter of credit with respect to individual Transactions) under an ISDA Master Agreement. If you do, because of the way ISDA Master Agreements are closed out under Section 6(e) — or rather, aren’t closed out, you might find that just when you want your guarantee to pay, the Transaction it is guaranteeing isn’t there anymore:

On a close-out, each Transaction is terminated, the individual close-out amounts are determined, they’re aggregated up to a single net sum (i.e. negative exposures are netted off against positive ones) and a single Close Out Amount is payable with respect to all terminated Transactions under 6(e) (Payments on Early Termination) of the ISDA Master Agreement.[1]

That is to say, payments following termination of a Transaction are not payable under the Transaction at all - they are payable under the ISDA Master Agreement itself. Therefore, if the guarantee relates to the single Transaction, at the point you wish to rely on it (i.e., upon the party’s default), it will have gone, with no payment required. Vanished, like tears in the rain.

The perils of unilateral termination rights

A related point: be careful about allowing the guarantor a termination right, even if amounts owing before termination are meant to remain guaranteed. For a mark-to-market exposure under a master agreement, whither the guaranteed obligation? The mark-to-market exposure isn’t, of itself, an obligation, at least not until until the contract has been closed out. Until then it is an emergent property of all the live transactions under the master agreement. Nor are those transactions “existing obligations” in whole: each will comprise future obligations, which may be contingent, and in any case are not yet due.

Consider providing for a lengthy notice period in such a termination period, which allows the beneficiary to adjust initial margin and precipitate a failure to pay (or rebase its credit support into tangible collateral). Alternatively make the termination of the master agreement a condition precedent to terminating the guarantee.

A brief anatomy

Here “guarantor” is the person providing the guarantee; “obligor” is the party whose obligations the guarantor guarantees and the “beneficiary” is the counterparty to the obligor who benefits from the guarantee.

The Guarantee

  • interim (re)payments,
  • the obligor’s insolvency (you’d like to think this would go without saying but guarantees are places you don’t want to assume anything)
  • amendment, discharge or vitiation of the obligor’s obligations
  • any waiver or forbearance by the beneficiary (against either the obligor or the guarantor)
  • any other customary grounds for discharge of guarantees.
  • The “punctual performance” of the guaranteed obligations: makes time of the essence.
  • Is given without prejudice to beneficiary’s rights against obligor.
  • Is independent of any other security or credit support arrangement between beneficiary and obligor.


In addition to the guarantee, an indemnity against:

  • Expenses: Beneficiary’s expenses incurred as a result of obligor’s non-performance of the guaranteed obligation,
  • Losses due to unenforceability: the value of obligations which have become void or unenforceable against the obligor for any reason. Especially where you are lending to sovereigns or undertakings in unsophisticated jurisdictions, whose governments are apt to change local laws to protect struggling local undertakings besieged by vultures and locust capitalists, the risk that a perfectly sensible loan suddenly becomes beyond the jurisdictional pale is not beyond the realms of possibility. By its nature, a guarantee depends on the existence and validity of the underlying obligation. An indemnity, being simply an unconditional obligation to pay a sum of money in a certain circumstance, does not.

Currency and payment

  • Currency: Payment must be in the currency of the underlying obligations
  • Freely available funds: in immediately available funds
  • No set-off or counterclaim: without set-off or counterclaim,
  • Interest: with interest at such rate as beneficiary reasonably determines, from the date of demand until payment in full.
  • Suspense account: beneficiary may place amounts beneficiary pays into a suspense account pending satisfaction in full.

Demand process

  • Beneficiary may make a demand under the guarantee without having first taken any steps to recover the debt against the obligor (this is another benefit of the indemnity).


  • No discharge of prejudice: Beneficiary does not have discharge the guarantee if that might prejudice its claim under insolvency laws. Though presuming you only discharge the guarantee once the debt is fully paid, it is hard to know what your residual claim against the obligor would be, before or after its insolvency.
  • Reinstatement: if beneficiary discharges guarantee following a payment that is then set aside, voided or found unenforceable, the guarantor’s liability is reinstated as if the beneficiary neve discharged the guarantee in the first place.

Guarantor’s rights versus counterparty

Frequently guarantors only agree to issue a guarantee on payment of a fee, and on condition of reimbursement by the obligor should the guarantee be called. The beneficiary should require that until it has been fully paid:

  • Guarantor can only proceed against the obligor with the beneficiary’s consent (this incentivises the guarantor to pay out on the guarantee of course)
  • The guarantor holds any sums it receives from the obligor to the beneficiary’s order to be applied at the beneficiary’s direction.


  • Tax gross-up: If the guarantor is subject to some withholding that the obligor wouldn’t have been the guarantor has to gross up to put the beneficiary in the same place it would have been in against the obligor.
  • Successors and assigns: the guarantee inures for the benefit of the beneficiary’s successors. Especially for long-term guarantees this can be important, given the propensity of those in the international capital markets to merge, expire or shape-shift.

See also


  1. The ISDA Master Agreement itself is never actually terminated, but carries impotently on in undead twilight, roaming the badlands like Nosferatu or the Flying Dutchman, unloved, unredeemed, until the end of days.