Research & Analysis

Provisions of Standard Commercial Guarantee Agreements

Loan guarantees can help borrowing microfinance institutions (MFIs) obtain loans that otherwise are unavailable to them. An MFI typically seeks to facilitate a (third-party) loan guarantee to obtain a bank loan that would not be possible without the guarantee. Thus, the guarantee can help an MFI gain access to commercial funding markets and provide support for the MFI’s creditworthiness in the eyes of potential lenders. The expectation is that a guarantee will also ease future borrowing for the MFI by increasing the bank’s willingness to lend to the MFI again, perhaps without requiring another guarantee so long as the MFI complies with the terms of the loan agreement. In addition, MFIs that already have access to commercial funding markets may still benefit from loan guarantees because they can use the guarantee as a structuring tool, enabling the MFI to obtain a loan under conditions more favorable than those applicable to a typical unguaranteed loan (for example, by obtaining a lower interest rate).

With these benefits of a guarantee in mind, this Technical Guide introduces MFIs to the principal provisions of a standard commercial guarantee agreement, while offering general guidance and tips for drafting and negotiating standard clauses. It is not intended to be, nor does it provide, an exhaustive description of the contents of a guarantee agreement. MFIs should use this Guide to help them understand the risks associated with some of the important provisions of a guarantee agreement. This Guide can also help MFIs identify departures from generally accepted provisions that may negatively affect their interests.

It is also important to note that this Guide addresses only standard commercial guarantee agreements governed by common law legal systems, with specific emphasis on New York law, the U.S. Bankruptcy Code, and the Restatement (Third) of Suretyship and Guaranty, unless otherwise noted. The type of legal system that applies to the loan guarantee is critical, because common law and civil law legal systems involve different approaches to the respective rights of creditors and debtors, may use different legal terms, may offer different types of self-help remedies to creditors, and may apply, through local courts, different interpretations to terms and conditions. MFIs should consult with local legal counsel to determine whether the law governing the loan agreement follows common law or civil law principles and what the implications of this may mean for them. Indeed, MFIs should consult with local counsel to understand the local laws related to guarantees, as well as how the local legal system addresses other issues highlighted throughout this guide.

Topic: Policy