Have you ever heard of a contract where someone else than the parties bound in the contract guarantees on a party to it? This is possible through a Corporate guarantee. This is a powerful tool that strengthens the agreements and protects a party involved in the contract. In case you are overwhelmed with legal jargons like “corporate guarantee meaning” and “parent company guarantee”, this blog post will guide you to understand the meaning of corporate guarantees in the world of construction contracts.
What is a Corporate Guarantee?
Let us consider a scenario in which a construction company (Say, Company A) bids on a construction project. The client, say, Company B, wants to be absolutely certain ‘A’ will perform as per the contract requirement. This is where a corporate guarantee comes in. Company A might convince a financially stable company, say Company C, to act as a guarantor. This guarantee may be for the performance, or for any unsecured advance payment to be paid to Company A by Company B. Here, Company C will provide a ‘Corporate Guarantee’ to Company B in the name of Company A.
Understand the Key Players in the above contract:
- The Creditor is the Company B: The party who is awarding the contract
- The Debtor is the Company A: The party responsible for completion of the construction project.
- The Guarantor is the Company C: The financial guarantor stepping in the contract to cover Company A’s obligations in case of any default.
Difference between Corporate Guarantee and Parent Company Guarantee
Understand, there is a difference of corporate guarantee with parent company guarantee. If the company C is the parent company of company A then it will be a parent company guarantee. But company C can also provide a corporate guarantee even if they are not the parent company or holding company of company A, and still be able to provide a corporate guarantee for Company A, in case they have a vested interest in the project or the company itself.
Difference of Corporate Guarantee and Bank Guarantee
There is a difference between a corporate guarantee and a bank guarantee. Bank guarantees involve financial institutions as a guarantor. Banks issues a guarantee for a percentage fee. Below are some common types of bank guarantees in construction:
- Advance Payment Guarantee: This is the advance payment guarantee for paying any unsecured advance to the contractor.
- Performance Guarantee: This is the guarantee to be submitted by contractor to protect the client about the contractor’s performance and quality of the work.
- Bid Bond: This protects the client if a contractor doesn’t accept the contract after being the lowest bidder.
The Contract Performance Guarantee Template
A parent company guarantee is a formal agreement where the parent company acts as the guarantor for the subsidiary’s contract. This can be a resort for the subsidiaries with limited financial resources by boosting their credibility and helping to secure contracts.
You can view a sample format for contract performance guarantee here
Remember, every contract is unique. We advise to consult a legal professional for the right format of a contract performance guarantee to your specific needs.
The Pros and Cons of Parent Company Guarantees
Pros:
- Enhanced Credibility
- Risk Mitigation: additional security and reduces the financial risk associated with the contract.
- Improved Cash Flow For subsidiaries without any additional cost for bank guarantee
Cons:
- Financial Strain on the parent company in case of default of the subsidiaries.
- Tax Implications: There might be tax implications associated with issuing or receiving a corporate guarantee. Thereby, we recommend consultation with a tax advisor.
- Over-reliance: Subsidies relying highly on parent company guarantees may not develop strong financials on its own.
Read More: What is Force Majeure Clause in a Construction Contract?
Is GST Applicable on a Corporate Guarantee?
Yes, Corporate guarantees are taxable under Goods and Services Tax, or GST. The rate of GST is 18%, calculated on either 1% of the guaranteed amount or the actual consideration.
Parent Company Guarantee vs. Bank Guarantee: Making the Right Choice
Both parent company guarantees and bank guarantees offer security in construction contracts. Here’s a quick comparison for you:
- Cost: Parent company guarantees are cheaper than bank guarantees.
- Control: With a parent company guarantee, there’s more control over the terms and conditions. Bank guarantees might have more strict requirements.
- Creditworthiness: A strong parent company’s financial guarantee for its subsidiaries can be more reassuring than a bank guarantee, especially for large projects.