Bank guarantees on first demand: Pay now, sue later




Bank guarantees on first demand: Pay now, sue later

Bank guarantees on first demand have become common practice in foreign trade issues. The parties of a contract usually have opposing interests. While one party wants to reserve its right of retention if the other party’s performance is defective, the other party needs to make sure that wrongly brought claims of defective performance will not cause financial harm. In this scenario, a bank guarantee can help to protect the interests of both parties.

A bank guarantee is an irrevocable payment obligation of a bank securing the contractual performances of one party (called applicant) to the other party (called beneficiary). The appeal of bank guarantee is not only due to their securing function, but originates also from a liquidity perspective.

Formalisation of a bank guarantee or “Pay now, sue later!”

Characteristically a bank guarantee on first demand is strictly formalized. The beneficiary will in many cases merely have to claim that an event causing a guarantee claim has occurred. Sometimes the parties have agreed that certain additional requirements must be met, e.g. the submission of an additional declaration or the presentation of certain documents. It is (at this point) not significant whether the principal claim has any merit. The bank has in general and with only a few exceptions no right to check whether the claim is justified. Therefore, in order to protect a party’s interest, legal actions have to be taken cautiously but at the same time expeditiously. Otherwise, the bank will have to pay the guaranteed amount to the beneficiary and is limited to the opportunity to take subsequent legal actions. Therefore, the basic principle is: “Pay now, sue later!”

Direct vs. indirect bank guarantees

A distinction can be made between direct guarantees and indirect guarantees. With direct guarantees, there are three parties involved:(1) the applicant, who needs a bank guarantee on first demand to cover a particular performance by him in an underlying transaction, e.g. in a sales or service contract; (2) the beneficiary, who can make use of the guarantee on first demand if the applicant breaches his contractual duties; and (3) the bank, which issues the guarantee and which is usually situated in the same country as the applicant.

Indirect bank guarantees on first demand involve more than three parties. Compared to direct guarantees, in indirect guarantees another bank, which is usually situated in the same country as the beneficiary, is added. Therefore, indirect bank guarantees are typically to be found in cross-border trading.

Direct bank guarantees on first demand

The beneficiary’s request for payment must only fit the formal requirements of the guarantee event so that the applicant’s bank renders a payment. It has to be remembered that generally it is not necessary that the requirements for the principal claim actually exist. To prevent the payment, the applicant must take legal actions cautiously, but quickly. The applicant can either challenge his bank or the beneficiary in order to protect his interests. Either way, it is advisable to proceed by way of interim measures.

The prospects of being successful in challenging the bank depend on the one hand on the arrangements the applicant negotiated with his bank. On the other hand, the applicant can invoke an exemption of the bank’s duty to pay the beneficiary: In cases of an abuse of law, the bank must not pay the beneficiary.

The German Federal Court of Justice found that an abuse of law occurs when “it is apparent or liquidly provable that the creditor’s substantive entitlement is not given” (Federal Court of Justice, judgment of 20 September 2011, docket number XI ZR 17/11). There is comparable jurisprudence by the High Court of England and Wales. If these requirements are met, the applicant has a good chance to receive an interim injunction against the bank prohibiting the bank to pay the beneficiary. Yet, the applicant bears the burden of proof for the facts corroborating an abuse of law. Another advantage of an interim injunction against the bank is that the beneficiary will only subsequently learn about the applicant’s approach and will, therefore, not be able to bypass it by making an early payment request to the bank.

Depending on the case at hand, challenging the beneficiary may also be advisable. This action is especially useful when prohibitory interim injunctions against the beneficiary can be based on specific contractual provisions of the underlying transaction or the security purpose agreement. As soon as the applicant has obtained an interim injunction against the beneficiary, he can instruct his bank not to pay.

The beneficiary’s prime interest is to ensure his claims and, thus, to achieve a quick payment by the bank. Therefore, it is often in the beneficiary’s best interest not to inform the applicant if he is planning to invoke a guarantee claim. To ensure his interests when the applicant has initiated interim measures, the beneficiary can deposit a writ of protection with the court. If the bank still refuses to pay, the beneficiary can bring an action for payment against the bank or the applicant.

The bank’s first interest is to either not pay at all or get a refund from the applicant. The bank can only refuse to pay the beneficiary if formal requirements are not met or in case of an abuse of law. Therefore, the bank has to precisely evaluate whether the circumstances indicate an abuse of law by the beneficiary. If so, the bank can refuse to pay the beneficiary. But if the bank pays the beneficiary even though an abuse of law was noticeable, it might not get a refund from the applicant.

Indirect bank guarantees on first demand

An indirect bank guarantee on first demand differs from the situations described above as there is more than one bank involved. This additional bank is often situated in the beneficiary’s country and, therefore, more likely have its trust. This bank is the first one to make a payment if the beneficiary claims a guarantee event. To ensure a refund for payments by this bank, the applicant’s bank gives the beneficiary’s bank a counter-guarantee. The core of this counter-guarantee is that the applicant’s bank will reimburse the beneficiary’s bank for all justified payments to the beneficiary.

There are more difficulties when the applicant is confronted with the case of an unwarranted guarantee claim by the beneficiary. Since the beneficiary’s bank is situated abroad and does not have contractual relations with the applicant, it is even harder to influence the bank actions. Also, objecting to a reimbursement by the applicant’s bank to the beneficiary’s bank is difficult as it requires not only an abuse of law by the beneficiary but also an abuse of law by the beneficiary’s bank. This requirement is called a “doubled abuse of law” by the jurisprudence (Federal Court of Justice, judgment of 10 October 2010, docket number XI ZR 344/99). The applicant will therefore have to consider precisely if actions against his bank are promising and effective. Often, it might be preferable to proceed against the beneficiary to obtain a fast court decision. This decision can subsequently be presented to the beneficiary’s bank to prevent any payments in good faith to the beneficiary.


We have advised banks and companies (as applicants or beneficiaries) from Germany and abroad in different scenarios of dealing with interim measures in connection with bank guarantees on first demand. For further information and advice contact:


Dr. Stephan Bausch, D.U.
Telefon +49 221 9937 25782



Simon Heetkamp
Telefon +49 221 9937 25050