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This guide explains the different parts that make up a performance guarantee
A performance guarantee (sometimes referred to as a parent company guarantee) is an undertaking by a parent company in which it provides assurance that it will fulfill the obligations of a subsidiary company if the subsidiary is unable to do so.
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This guarantee often forms part of a contract between the subsidiary and a third party, and it provides additional security for the third party, ensuring that the contractual obligations will be fulfilled even if the subsidiary fails to perform.
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Let’s look at an example. Suppose you are a business (let’s call it Business A) and entered into a Software Development Agreement with a smaller software development company (Company B). Company B is a subsidiary of a larger, more established tech company (Company C). As part of this agreement, Company B is to develop a custom software solution for your business over a period of 18 months.
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You have a significant level of risk in this scenario because a lot depends on the successful completion of this project:
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To mitigate this risk, you could request a performance guarantee from Company C (the parent company of Company B). In the guarantee, Company C generally agrees that in the event Company B cannot fulfil its obligations under the Software Development Agreement, Company C will step in to ensure the completion of the project or compensate you for any losses incurred due to non-performance or inadequate performance.
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This performance guarantee provides you with an added layer of protection. You have the reassurance that even if Company B fails to deliver on the agreement, the more financially robust Company C will ensure that your interests are protected and your project can still be completed.
This part identifies the party or parties who are providing the guarantee. Typically, this is the parent company of the party that is obligated to perform under the primary agreement. This section might include details like the legal name of the parent company, its place of incorporation, and its principal place of business. It’s important to correctly identify the guarantor to ensure the enforceability of the guarantee.
This is the core of the guarantee. It’s where the guarantor promises to fulfill the obligations of the subsidiary in case the subsidiary fails to do so. The scope of the guarantee can vary, and it may cover all obligations under the primary agreement or only specific obligations. Generally the terms unconditional and irrevocable are included as part of the wording which means thatthe guarantor is making an absolute commitment, which cannot be cancelled or altered unless certain specific conditions, as outlined in the guarantee, are met.
Limitations in a guarantee could include a cap on the maximum amount payable by the guarantor. This limit could be expressed as a specific dollar amount or as a percentage of the contract value. The guarantee could also limit the guarantor’s obligations to certain types of obligation (e.g., payment obligations, performance obligations, etc.). These limitations serve to manage the risk exposure of the guarantor.
This typically refers to the process that must be followed to call on the guarantee. This might involve providing written notice to the guarantor, providing evidence of the subsidiary’s failure to fulfill its obligations, or following other procedures. These procedures should be followed carefully to ensure the enforceability of the guarantee.
This part of the guarantee outlines the period during which the guarantee is effective and the conditions under which the guarantor’s obligations under the guarantee are considered fulfilled. For example, the guarantee might last until the subsidiary has fully performed its obligations under the primary agreement or until a specific date. It also includes the conditions under which the guarantee could be terminated or discharged. For example, the guarantor might be released from its obligations once the subsidiary has fulfilled its obligations, once a replacement guarantee is issued, or in other circumstances specified in the guarantee.
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