Practitioner Series: Demand Guarantee Rules for Project Finance — ICC URDG 758

This article is for any stakeholder seeking In3’s project funding using a financial guarantee as completion surety.  It defines the underlying legal venue, a set of well-proven rules for international “standby” or “demand guarantees” practices, with independent legal analysis.

What is a financial or “demand” guarantee and why might you need one?  More

URDG-based financial guarantees stand as an excellent mechanism to obtain advantageous terms and access to funding that might otherwise be out of reach to developers seeking project finance, the main area of focus for In3’s capital partners.  Such guarantees streamline due diligence, ensures continuity and certainty of project acceptance (once pre-approved using our 3-stage process), improve investment terms and expedite closings, simply by acting as a source of assurance or “surety” that the project will be successfully completed and commissioned to begin commercial operations. 

Synopsis available at

Detailed Analysis and Significant Findings 

Well proven since 2010, per independent legal review (more), URDG has gained popularity as the best method for bringing in project capital (among other uses), protecting both the guarantor and lender/investor.  Developers/owners enjoy better terms than would be otherwise available, which leaves room for others (EPC / construction firms, or “at large” guarantors) to also get paid well.

Developers can achieve quite affordable, flexible and advantageous project financing through In3 CAP using a variety of instruments to qualify, but what is actually required happens to be less stringent than most realize. A financial guarantee (bank-related or sovereign) used for project finance through our capital partners relies on established international rules for such “demand guarantees,” in sharp contrast to either (a) Traditional loan guarantees (left in force during the life of the loan) or (b) For import/export trade finance transactions, the so-called Documentary Letters of Credit, most often underpinned by the Uniform Customs & Practice for Documentary Credits (UCP 600)*.  Neither of these are what we are doing in the case of In3’s Completion Assurance Program™. 

Instead, we use instruments that conform with the Uniform Rules for Demand Guarantees ICC Publication No. 758 (short name URDG 758), as a type of bank-issued “performance” Standby Letter of Credit (SbLC), or alternatively, or as an Avalized Promissory Note (AvPN or PN with Aval introduction), which in either case, are well tested to actually protect the issuer/guarantor more than other types of guarantees or other models.  

Why don’t we accept non-financial guarantees, such as performance or completion bonds?  See FAQ 5.2.

For “standby” letters of credit (a type of demand guarantee, typically issued by a bank or credit union), we also prefer to combine URDG’s efficacy with the customary Brussels SWIFT system for bank-to-bank correspondence, which controls the legitimacy of the documents.  More on how SWIFT is used for these transactions, and a definition of “financial guarantee” used for project finance here. 

How this “Standby” or “Demand Guarantee” differs from a Documentary Credit

There is a sharp contrast between what we use for financing projects and the practices used by commodity traders to buy and sell goods.  We are not using a “documentary” type of letter of credit (sometimes just called a “documentary credit), which sharply differs in terms of verbiage and practice.  For reference, such a documentary credit can be defined as a written undertaking given by a bank to a seller on the instruction of the buyer to pay a stated amount of money. Such Documentary Credit instruments are conditioned upon the seller’s compliance and a ‘complying presentation’ of documents. There are no commodity buyers or sellers involved in project financing.  Further, money moves (gets “cashed in” and transferred to the seller) upon completion.  Not so with project finance.  Project capital moves from the investor/lender’s bank to the project’s Special Purpose Vehicle bank account per a pre-approved draw schedule, while the SbLC or AvPN must not be touched except in extreme cases of fraudulent use of the funds or similar malfeasance.

Summarizing and expanding on these key points: 

• At the end of a transaction, a “Documentary” Letter of Credit, under ISP98 (ICC pub 590), UCP (ICC600), or even URDG 758, the instrument is cashed to complete the transaction. (See course description that compares these three common types.) By contrast, only if the developer is in breach of contract can there be a demand made on the SbLC or AvPN under URDG 758 that results in the guarantor paying, which in the case of our project finance, would be as a result of our funding being delivered but then fraudulently used. URDG ensures that the guarantor (the party issuing the guarantee) is protected from arbitrary or frivolous claims — only under extreme cases of fraud, gross negligence, or uncured/incurable breach of contract can there be a claim, if properly written, thus used as a last resort. Aside from this “default” on the governing contract (which with CAP funding is a Loan Agreement) the instrument cannot be called. The purpose of most Guarantees is to serve as security or surety, and this one is no different. It is actually quite difficult to make a claim with URDG — the beneficiary (our capital partners) would have to prove their case.
  Note that in our entire history, no BG/SbLC or AvPN has ever been called by us, that doing so would be a strong negative reflection on all parties involved (indicating that somehow we misjudged the client’s legitimacy), and thus it really must not happen. If you are non-fraudulent, then there’s nothing to worry about.
• This “Documentary” LC is in sharp contrast to what we are asking – a BG/SbLC or AvPN used to backstop the project’s funding, as a way of ensuring the project assets get completed. Developers and their sponsor may not care which LC – Standby versus Documentary – is used, but bankers typically won’t issue the more-familiar Documentary LC without cash on deposit because the LC itself is destined to get cashed in to complete the underlying trade transaction. Project finance, however, is entirely different. We use the BG/SbLC or AvPN to offset the risk of project non-completion. Once the project reaches Commercial Operation Date (COD), the guarantee is allowed to expire, and the underlying asset (if any) is released, not taken.
• URDG 758 sets a balance in the legitimate and competing interests of the applicant, the guarantor and the beneficiary; it limits the risk of unfair calls and demands on guarantors and counter-guarantors. In particular, it protects the issuer (the project developer, not the funder or “beneficiary”) by making a BG/SbLC or AvPN more difficult to draw upon in the event of default or breach of contract. URDG requires that the beneficiary prove (provide evidentiary documentation) that the issuer/applicant has indeed breached the contract and that there is thus a legitimate reason that the instrument can be called/drawn. It is otherwise not callable.
• Moreover, URDG 758-based guarantees give a 30 day ‘extend or pay’ window for negotiation before payout due to such failure would be required. Note that events like “breach” and “default” are worst case scenarios, and must be avoided, as such outcomes would be a strong, negative reflection on all parties involved. We raise this topic here in hopes of clearing up a common misunderstanding and expressed concern by some issuers (especially those more familiar with Documentary LCs under ICC 600, or other rules that are simply not applicable here), so this is really quite good news that URDG 758 actually helps protect the issuer more than most people even realize.
• Generally, the URDG 758-based BG/SbLC or AvPN combined with the referenced Loan Agreement (per binding contractual terms established as a result of our due diligence, before the BG/SbLC would be issued) cannot be called arbitrarily, where cash-backed funds provided by the guarantee cannot be drawn at the issuing bank’s counter.  More at our FAQ on this topic, “What reassurance is there that the BG/SbLC, once sent, will not be misused, called or cashed in?”
• Lastly, URDG itself brings much needed consistency and uniformity to construction projects, among others, harmonizing how such guarantees are interpreted within the various legal venues (a given country’s national rules or laws), now that internationally-respected courts have tested and endorsed the clarity and simplicity it offers. More (principles of two cases decided in 2020)

Our partners only require the guarantee to be in force up to the completion of the project assets … until reaching Commercial Operation Date (COD). Then, as mentioned above, the BG/SbLC or AvPN goes away; technically, it is allowed to expire. Again, the collateral used to issue the BG/SbLC is released, not “cashed in”, as it often would be with trade finance guarantees (commodity/commercial or Documentary LCs or Standbys). Trade-related payment guarantees can use similar ICC rulebooks — URDG ICC 758, or the more generic Uniform Customs & Practices (UCP) for Documentary Credits (ICC Pub 600) or International Standby Practices, (ISP98, ICC Pub 590).

Conclusion:  The above URDG 758 points work in the project developer/sponsor’s favor, as the type of guarantee most widely used, such that most bankers would initially assume was being requested, is either
A) Traditional “documentary” LCs that can be drawn upon at the counter of the issuing bank at the completion of the transaction (so the seller of goods can be paid), as described above, or

B) A loan guarantee used to protect the lender after COD, during project operations, as additional credit enhancement, assuring that the lender does not go away empty handed in the event the borrower defaults on the loan. 

Such guarantees are not needed or usable here for project finance. What we require is far less stringent, and in practice does not involve moving the guarantee’s underlying collateral, if any, at all. This is an important facet of CAP funding’s “faster, easier, better” advantages, which is much more than just a slogan, about which we encourage careful scrutiny, clarifying questions, and respectful challenges to our claims.

References:

• See whitepaper by top global law firm Reed Smith that outlines how the URDG 758 verbiage is advantageous to the issuer relative to other types of verbiage.
• Two case studies (published 18 June 2020):  URDG 758: finally tested and it does what it says showing the supremacy of these rules via legal decisions in the courts.
• Comparing UCP600, ISP98 and URDG758:  ICC Article 
• Investopedia Definition of
  • URDG ICC 758
  • A commercial Bank Aval used with our Promissory Note template (only works when PN issuer is creditworthy)
• How is a financial guarantee different from an insurance product?  2019 ICC Course Description

Contact us for further information on how to take advantage of Financial “completion assurance” Guarantees to accelerate project finance closings and obtain the best terms.

More at options & resources for new In3 Clients

* The International Chamber of Commerce (ICC) is an official body that provides such banking rules, endorsed by the United Nations.  

Still hungry for more?

1. Decision-making Support for developers on this pathway.
2. See our 4-page whitepaper, Introduction to Financial Guarantees for Project Funding through In3. 
3. Download this comprehensive ICC Academy guide to UCP, ISP and (honorable mention) URDG Standby Letters of Credit.  URDG discussion starts on page 11.