Payment guarantee

Payment guarantee
See also
Revolving letter of credit Conditional sale agreement Confirmed letter of credit Payment against documents Collecting bank Counter guarantee Transferable letter of credit Lombard loan Ijarah

Payment guarantee is a form of protection connected with the guarantee for payment of goods issued by the buyer or proprietor to the seller or contractor. The guarantee ensures that the purchaser shall fulfill its contractual obligation of payment. There are payment guarantees often in construction contracts. We can classify them into those by the contractor and by the subcontractor. Those, by the contractor, ensures the subcontractors (and suppliers, and workers) that the contractor shall pay for all costs and wages under the terms of the contract. The second ones ensure the contractor that the subcontractor shall pay workers and suppliers for all costs and wages arising from the contract (for example construction contract). In the contract the contractor should provide the period of validity of the payment guarantee (J. C. M. Kao i in. 2015, in. s. 191).

From the end of 2010, The Canada Mortgage and Housing Corporation (CMHC) had two programs connected with mortgages. The first, National Housing Act Mortgage- Backed Securities (NHA MBS) program provides a timely payment guarantee on privately issued securities combined of pools of amortizing, residential mortgages insured against borrower default by the Corporation or private mortgage insurers. The second program, the Canada Mortgage Bond (CMB) Program, facilitates the housing funding. In CMB the Canada Housing Trust (CHT) issue the securities. CHT was established especially for funding insured residential mortgages, where the proceeds are used to purchase the National Housing Act Mortgage- Backed Securities. The Canada Mortgage and Housing Corporation provide a timely payment guarantee of Canada Mortgage Bond's principal and interest. The Government of Canada back ultimately the guarantee provided by CMHC under both programs (E. Tsounta 2011, s.27).

Forms of guarantee

Payment guarantee is one of the forms of guarantee issued by all types of entities like corporations, banks, sovereigns and also individuals. The seller is assured by the payment guarantee that the purchase price will be paid on the agreed date if the contractual obligations are met. The other forms of guarantee are (M. Choudhry 2018):

• An advanced payment guarantee, which assures that if the seller does not meet contractual delivery obligations in full, the advanced payment will be reimbursed to the buyer
• A bid bond which is called tender bond also; it is a security to the organiser's expenses in tenders which requires from participants to pay if their bid is accepted but withdrawn
• A performance bond, which provide goods and services promptly and as contractually agreed when the seller failed; it is a collateral for cost incurred by the buyer
• A warranty obligations guarantee, which is a security in case of defects appearing after delivery
• A credit security bond, which is collateral for loan repayment

Examples of Payment guarantee

• Bank Guarantee: A Bank Guarantee is a payment guarantee issued by a bank on behalf of a customer. The bank guarantees to the seller of goods or services that if the customer fails to pay for the goods or services, the bank will cover the cost of the goods or services.
• Performance Bond: A Performance Bond is a payment guarantee issued by an insurance company on behalf of a contractor. The bond guarantees to the customer that the contractor will fulfill the terms of the contract and if the contractor fails to fulfill the terms of the contract, the insurance company will cover the cost of the breach.
• Surety Bond: A Surety Bond is a payment guarantee issued by a surety company on behalf of a contractor. The surety guarantees to the customer that the contractor will fulfill the terms of the contract and if the contractor fails to fulfill the terms of the contract, the surety company will cover the cost of the breach.
• Letter of Credit: A Letter of Credit is a payment guarantee issued by a bank on behalf of a customer. The letter of credit guarantees to the seller of goods or services that if the customer fails to pay for the goods or services, the bank will cover the cost of the goods or services.

Advantages of Payment guarantee

Payment guarantees provide a range of advantages for both parties in a contract:

• They provide a level of security and reassurance to the seller or contractor that the buyer or proprietor will fulfill their obligation of payment.
• They serve to protect the contractor or subcontractor in the event of a dispute over payment, as the guarantee is legally binding.
• Payment guarantees can help to ensure that a project is completed on budget and on time, as the risk of non-payment is greatly reduced.
• Payment guarantees can also serve to improve the creditworthiness of the contractor or subcontractor, as the guarantee serves as a demonstration of their financial strength.
• They also provide the buyer or proprietor with the assurance that the seller or contractor will complete the project and provide the agreed upon services or products.

Limitations of Payment guarantee

Payment guarantee is a form of protection that ensures that the purchaser shall fulfill its contractual obligation of payment, however, it is not without limitations. These include:

• Payment guarantees may not be able to cover all costs and wages arising from the contract, as in some cases the contractor may not have sufficient funds to cover the entire amount.
• Payment guarantees may not be valid if the contractor fails to meet the conditions of the contract in any way.
• Payment guarantees can often be difficult to enforce as there may be legal complications in some cases.
• Payment guarantees may not be applicable in certain countries, as some countries may not recognize them as a form of legal protection.
• Payment guarantees may not be applicable if the party issuing the guarantee is not financially sound.
• Payment guarantees may not be applicable if there is an issue with the title of the property or the ownership of the property in question.

Other approaches related to Payment guarantee

The other approaches related to Payment guarantee are:

• Letters of Credit – it is a document issued by a bank guaranteeing payment to the beneficiary of a loan in the event that the borrower defaults.
• Bank Guarantee – it is a type of guarantee provided by a bank to a buyer or seller of goods or services in the event of non-payment by the other party.
• Performance Bonds – it is a type of surety bond issued by an insurance company or a bank to guarantee satisfactory completion of a project by a contractor.
• Retention Bonds – it is a type of surety bond, which is held by the employer on behalf of a contractor, and is released when the contractor fulfills their obligations as defined in the contract.

In summary, Payment guarantee is a form of protection connected with the guarantee for payment of goods issued by the buyer or proprietor to the seller or contractor. There are other approaches related to Payment guarantee, such as Letters of Credit, Bank Guarantee, Performance Bonds, and Retention Bonds, which are used to ensure the payment of goods or services in the event of non-payment by the other party.

References

• Choudhry M. (2018), An Introduction to Banking: Principles, Strategy and Risk Management, John Wiley & Sons, Sussex
• Istrate L. G. (2019), The Role of Credits and Bank Guarantee Letters in Financing Trading Companies, "Ovidius", volume 19
• Kao J. C. M. (red.) (2015), Green Building, Materials and Civil Engineering, CRC Press, London
• Luoa P., Wang H., Yang Z. (2015), Investment and financing for SMEs with a partial guarantee and jump risk, "European Journal of Operational Research", no.249
• Tsounta E. (2011), Home Sweet Home: Government's Role in Reaching the American Dream, International Monetary Fund, Western Hemisphere
• Vliet K., Reindorp M. J, Fransoo J. C. (2013), The price of reverse factoring: Financing rates vs. payment delay, "European Journal of Operational Research", no. 242

Author: Joanna Milowska