Difference between a guaranty and a surety?

As an entrepreneur, you are constantly entering into obligations with your customers. Your customer wants to be sure that you keep to your agreements. And you want to be sure that you see your money. Guarantees and sureties are instruments with which you can offer each other more security in a business deal.

You want certainty, but so does your customer

Suppose you produce machines or ships or you have a construction company and you take on large construction projects. These are usually expensive projects, so you ask your customers if they will pay a part in advance. Your customer also wants to be sure that you keep to the agreements. Paying in advance is all very well, but work has to be done in return. A surety or a guarantee can then be used as security for the execution of the work.

Example

There are all kinds of guarantees and sureties: for (advance) payment, implementation, maintenance and transfer (customs guarantee). Take the example of a construction company. A performance surety or guarantee protects the client against damage (losses) if the contractor fails to fulfil its contractual obligations, for example because the company goes bankrupt. The client will receive the amount covered by a surety or guarantee and can use this money to have the work completed by another contractor. Has the work been completed and are defects identified? A surety or guarantee can also be entered into for this.

Differences between guarantee and surety

The terms guarantee and surety are used interchangeably. However, from a legal point of view, the obligations are clearly different.

Surety

With a surety, the entrepreneur (or a third person) acts as guarantor. This means that if the entrepreneur is unable to fulfil the obligation, the creditor can claim payment from the guarantor. The guarantor does not always have to be the entrepreneur. Parents, relatives or friends may want to act as guarantors for the entrepreneur.

A surety alone offers little security in itself. If the surety cannot offer concrete securities, creditors will have to wait and see whether they can reclaim the money. That is why a surety is preferably linked to a security. If parents want to act as guarantors for the entrepreneur and they have excess value in their homes, this underlying security can be used to draw value from the surety.

Guarantee

A guarantee is an independent, private commitment that is separate from the deal you have entered into. This is very different from a surety.

The guarantor must fulfil their obligation irrespective of complications that may arise around a deal (the contract). They can only get out of doing so when there is clear evidence of abuse.

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Guarantee means extra risk

A guarantee is more risky for the provider. So be cautious and try to avoid offering an effective guarantee during contract negotiations. You can also try to include a number of conditions of the underlying contract in the guarantee text that must be met before the guarantee provider has to pay out.

If there is trust between the two contracting parties, a surety offers sound additional protection to the contractual agreement for the beneficiary.

The similarity between guarantees and sureties not only means that business partners offer each other security, but also that both the guarantee provider and the surety provider are exposed to a credit risk in relation to the client. As mentioned, that risk is greater with a guarantee than with a surety.

Get good advice

Sureties and guarantees are often used interchangeably. However, they are two different instruments with different legal and economic implications. You should therefore be well advised before providing a guarantee or surety.

Both banks and insurers offer sureties and guarantees. dummy Discover five good reasons why a specialized insurer is the best option. At Allianz Trade, we are specialized in sureties and guarantees for real estate projects, international trade, capital goods producers and construction and installation.