Strategies in Risk Management of On‐Demand Guarantees

Abstract

When international construction expanded in the 1960s and 1970s, owners in countries in the Middle East demanded guarantees that they could draw on like cash. Contractors often had no choice but to comply. While this compliance is often a requirement and is sometimes an aid in obtaining contracts, it also exposes contractors to several types of dangers and risks, such as unfair calling of guarantees, the extend‐or‐call threat, and drain on their financial resources. These risks can be reduced if contractors would negotiate with the owners on the terms and conditions of the guarantees without touching the on‐demand principle. For example, the guarantee should be drafted so that it cannot become effective until the construction contract is in full force and effect and the owner has carried out his obligations. A clause to reduce the guarantee amount in relation to the progress of the work will limit the contractor's liability. If a contractor must face an unfair call, the contractor can attempt legal action to prevent the issuing bank in its country from honoring an unfair call on the guarantee.