Corporate guarantee

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Corporate guarantee is a type of financial mechanism used to demonstrate company's financial responsibility for closure and liability obligations [1]. It is a contract between the guarantor and the debtor, in which the former agrees to take the responsibility of the latter's obligations. The corporate guarantee can be used in two forms [2]:

  1. Corporate guarantee of the full debt - a standard guarantee that is designed to include the full faith and credit of the guarantor. There is also a possibility of the guarantee containing a limitation on recourse itself.
  2. Corporate guarantee of a portion of the debt - this partial guarantee creates a risk of a project non-completion for the lender on the unguaranteed portion of the loan, but the minimum amount of post-completion non-recourse debt is determined not after the completion, but at the outset. This form of guarantee also helps with reducing the pressure on banks to fund cost overruns.

Usage of the corporate guarantee

It is a soft type of guarantee which is typically used when[3]:

  • the risk of default is low,
  • the closure plan and estimation of cost is independently confirmed (which indicates that the technical risk is low),
  • the closure has a short-term nature,
  • the company has relevant financial strength to support the guarantee (for example an investment grade rating).

The corporate guarantee policy

An owner or operator can receive the corporate guarantee from[4]:

  • a direct or higher-tier parent corporation,
  • a company that shares the same parent corporation as the owner or operator,
  • a company that has a "substantial business relationship" with the owner or operator.

This substantial business relationship is an extension of a business relationship that is necessary under applicable state law in order to make a guarantee contract issued to that relationship as valid and enforceable. This relationship "must arise from a pattern of recent or ongoing business transactions in addition to the guarantee itself, such that a currently existing business relationship between the guarantor and the owner or operator is demonstrated to the satisfaction of the applicable EPA Regional Administrator" [5].

Examples of Corporate guarantee

  • Asset-backed guarantee: A guarantee that uses an underlying asset as collateral for the guarantee. This could be a tangible asset such as a building or piece of equipment or an intangible asset such as a patent or copyright.
  • Performance guarantee: A guarantee that is provided to demonstrate that a company will meet its obligations under a contract. This could be a guarantee related to the completion of a project, the delivery of goods or services in a timely manner, or the quality of the goods or services provided.
  • Credit guarantee: A guarantee that is provided to a lender as a form of security in case of a borrower's default on a loan. The guarantee can be provided by another company, an individual, or a government entity.
  • Surety bond: A financial instrument that is used to guarantee the performance of an individual or organization. The bond is provided by an insurance company and is typically used to guarantee the completion of a construction project or the fulfillment of a contract.
  • Parent company guarantee: A guarantee that is provided by the parent company of a subsidiary in order to guarantee the obligations of the subsidiary. This type of guarantee is commonly used to help secure financing for the subsidiary.

Advantages of Corporate guarantee

A corporate guarantee is a financial mechanism used to demonstrate a company's financial responsibility for closure and liability obligations. It provides assurance to the lender that any obligations will be fulfilled even if the borrower is unable to do so. The main advantages of a corporate guarantee include:

  • Reduced Risk: A corporate guarantee reduces the risk of non-payment for the lender by offering assurance of the company's ability to pay in the event of the borrower's default.
  • Improved Creditworthiness: For the borrower, a corporate guarantee can help improve their creditworthiness and make it easier to secure financing.
  • Increased Leverage: A corporate guarantee gives companies more leverage when negotiating credit terms with lenders.
  • Increased Profits: Companies can use a corporate guarantee to increase profits by taking on more business that they may not have been able to pursue without the assurance of the guarantee.
  • Improved Cash Flow: A corporate guarantee can help improve cash flow by providing access to additional sources of funding.

Limitations of Corporate guarantee

A corporate guarantee is a financial mechanism used to demonstrate a company's financial responsibility for closure and liability obligations. However, it is important to be aware of the potential limitations of a corporate guarantee. The following are some of the limitations associated with corporate guarantees:

  • Creditworthiness: The guarantee will be only as good as the creditworthiness of the guarantor. If the guarantor has poor credit, the guarantee may not be worth much.
  • Financial burden: Providing a guarantee puts an additional financial burden on the guarantor, which could affect the guarantor's financial health.
  • Limitation of Liability: The guarantor may be limited in the amount of liability they can assume, depending on the terms of the guarantee.
  • Scope of Guarantee: The guarantee may be limited to certain obligations or liabilities and may not extend to all of the obligations or liabilities of the principal.
  • Time Limits: The guarantee may be subject to time limits, meaning that it may only be valid for a certain period of time.
  • Termination: The guarantee may be terminated by either the guarantor or the principal, depending on the terms of the guarantee.

Other approaches related to Corporate guarantee

A corporate guarantee is a financial mechanism used to demonstrate a company’s financial responsibility for closure and liability obligations. Other approaches that can be used to provide similar assurances of financial security include:

  • Establishing a trust fund: A trust fund is a type of legal entity that can be used to protect a company’s assets and liabilities from creditors. The trust fund is often used to provide assurance to creditors that the company will be able to meet its financial obligations.
  • Securing a line of credit: Establishing a line of credit is another approach to demonstrate financial responsibility. A financial institution will provide a line of credit to a company, which can be used to cover expenses that arise as a result of closure or liability obligations.
  • Obtaining a surety bond: A surety bond is a type of insurance policy that provides assurance to creditors that a company is able to meet its financial obligations. The surety company can provide financial assistance to the company in the event of a default.

In conclusion, a corporate guarantee is one approach that companies can use to provide assurance to creditors that they can meet their financial obligations. Other approaches, such as establishing a trust fund, securing a line of credit, or obtaining a surety bond, can also be used to demonstrate financial responsibility and provide assurance to creditors.

Footnotes

  1. ↑ Garret T.L., 2004, p. 204
  2. ↑ Terry B.J., 1997, p. 340
  3. ↑ Lima H.M., Costa F.L., Peixoto R., Caldiera V., 2003, p. 183
  4. ↑ Garret T.L., 2004, p. 207
  5. ↑ Ibidem


Corporate guarantee — recommended articles
Advance payment bond — Back-To-Back Letters Of Credit — Contract guarantee — Bonding company — Cash Collateral — Payment guarantee — Credit Facility — Non current liability — Counter guarantee

References

Author: Monika Ptasińska

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