If you’re supplying high-value goods, leasing out a commercial space, or awarding a significant contract, you might ask the other party to provide a bank guarantee. In that arrangement, you are the “favouree” - the beneficiary who can claim under the guarantee if something goes wrong.
Bank guarantees can be incredibly useful risk tools for small businesses. They can also be confusing, especially when the form of guarantee is buried in the back of a contract or varies from bank to bank.
In this guide, we’ll explain what a favouree bank guarantee is, when you might use one, the terms you should insist on, and how to call on a guarantee if needed - all in plain English and with an Australian lens.
What Is A Favouree Bank Guarantee?
A bank guarantee is a promise from a bank to pay you (the favouree) a stated amount on demand, if the other party (your customer, tenant or contractor) breaches their obligations. It’s a common form of performance security in Australia.
Think of it as the bank “standing behind” the other party. Rather than you holding that party’s cash, the bank issues a written guarantee for a fixed amount. If a claim arises, you present a compliant demand to the bank, and the bank pays up to the guaranteed amount.
Importantly, a bank guarantee operates independently from the underlying contract. In most cases, the bank must pay if the demand meets the guarantee’s formal requirements, even if the other party disputes your claim. That independence is why the wording and structure of the guarantee matter so much for a favouree.
For a broader overview of how these instruments work in Australia, it’s worth understanding Bank Guarantees in general.
When Would Your Business Ask For A Bank Guarantee?
Small businesses act as the favouree in many everyday scenarios. You might require a bank guarantee where:
- You’re a landlord granting a commercial or retail lease and want security for rent and make-good obligations (often 3-6 months’ rent).
- You’re a supplier offering large credit limits or upfront investment (e.g. bespoke manufacturing) and want protection against non-payment or order cancellation.
- You’re a principal on a construction or services contract and want performance security to cover delays, defects, or failure to complete.
- You’re providing a franchise or distribution arrangement and want security for fees, inventory, or fit-out costs.
If your arrangement is a retail shop lease, state-based Retail Leases laws may set rules about how much security you can require, how it’s held, and when it must be returned. For example, NSW has specific rules under the Retail Leases Act (NSW). Similar rules apply in other states and territories, so consider local requirements when you’re the landlord favouree.
In all cases, the bank guarantee should complement the risk allocation already in your main contract. It’s not a substitute for clear contractual terms.
How Do You Set Up A Favouree Bank Guarantee Correctly?
Whether you’re finalising a lease, a supply contract or a services agreement, build the bank guarantee into your contracting and onboarding process.
1) Require It In Your Contract
Include a clear clause requiring the other party to provide an unconditional, irrevocable bank guarantee from an Australian bank for a specified amount. State when it must be provided (e.g. before access or supply), any top-up requirements, and when it will be returned or reduced.
If you’re negotiating a lease or major contract, a short-form commercial deal summary or Heads of Agreement can lock in the security requirement before detailed documents are drafted.
Attach your preferred form of guarantee as a schedule to the contract, or require a form acceptable to you acting reasonably. Different banks use different templates. As the favouree, you want a straightforward, “pay on demand” form with minimal conditions.
3) Check The Details Before You Accept
When the other party delivers the guarantee, check:
- Your correct legal name as favouree, including ACN/ABN if relevant.
- The bank’s details and branch (a major Australian bank is standard).
- The amount, currency (AUD), and expiry/claim period.
- That it’s unconditional, irrevocable, and payable on written demand without set-off or counter-claim.
- That the demand mechanism is simple (e.g. a signed written demand stating the amount claimed).
File the original securely. Many banks require the original instrument to process payment.
4) Timing, Reductions And Return
Set out when the guarantee can be reduced (for example, after practical completion or after 12 months of on-time payments) and when it must be returned. For retail leases, check state timelines (some laws require return within a set period after the lease ends and obligations are met).
Hold firm on receiving the guarantee before you deliver keys, ship goods, or start works. If performance has already started, your leverage to obtain proper security is reduced.
What Should A Favouree Look For In The Wording?
The protections you get as a favouree depend on the words on the page. Here are key items to insist on.
- Unconditional and irrevocable: The bank’s obligation to pay shouldn’t hinge on any external facts or disputes. “Unconditional and irrevocable” language is standard.
- Payable on demand: The guarantee should state the bank will pay on your written demand (often in a prescribed form) up to the stated amount.
- No set-off or counter-claim: The bank should not be able to refuse payment because of disputes under the underlying contract. This preserves the independence principle.
- Clear demand mechanics: Specify how to make a claim (address, contact, any required attachments, who may sign). Avoid requiring certificates that are difficult to produce quickly.
- Expiry and claim periods: Choose an expiry that covers the risk period. If the risk end date is uncertain (like a construction defects period), consider an open-ended guarantee with a return trigger tied to milestones or a reasonable long-stop date.
- Top-up provisions: In the main contract, require the counterparty to replenish if part of the guarantee is drawn.
- Governing law and jurisdiction: Prefer an Australian jurisdiction relevant to your business or the contract.
Your main contract should work in tandem with the guarantee. For example, ensure your contract doesn’t accidentally undermine your right to draw by allowing “set-off” against amounts owed to you. It’s common to tighten risk allocation with a well-drafted Limitation of Liability clause and a clear position on Set-Off Clauses.
How Do You Call On A Bank Guarantee As Favouree?
Calling on a bank guarantee should be procedural, not dramatic. Plan ahead so you can act quickly if needed.
1) Identify The Trigger
Confirm internally that a claim event has occurred (e.g. unpaid rent, non-performance, defects not remedied). Align with the contract’s default provisions and any required notices or cure periods.
2) Prepare Your Demand
Follow the guarantee’s demand instructions exactly. If a prescribed form is attached, use it. Ensure the demand:
- States the guarantee number and the amount you’re demanding.
- Is on your letterhead and signed by an authorised signatory (as required).
- Is delivered to the correct bank branch or address by the permitted method (hand, courier, email if allowed).
3) Deliver The Original (If Required)
Some banks require the original instrument to be presented when you make a demand. If so, make arrangements to courier the original with your demand letter.
4) Timing And Expiry
Don’t leave it to the last day. If the guarantee is expiring soon and the dispute is ongoing, consider drawing down before expiry according to your contractual rights, to preserve funds while the dispute is resolved.
5) Handle Disputes Strategically
Occasionally, the other party may seek an urgent court injunction to restrain a call. Australian courts generally uphold the independence of bank guarantees; injunctions are exceptional (usually limited to clear fraud or egregious unconscionable conduct). Acting consistently with the contract and the guarantee terms reduces that risk.
Legal Risks, Compliance And Practical Alternatives
As the favouree, you have strong leverage - but use it fairly and within the law. Here are key risk and compliance issues to keep in mind, plus alternatives when a bank guarantee isn’t available.
Retail And Commercial Leasing Rules
Retail leases are regulated and may limit the amount or type of security you can require and set rules for return. Build your processes to meet those timelines. If you’re negotiating terms or a dispute has arisen, a focused Commercial Lease Review can help you protect your position.
Good Faith And Unconscionability
Calling on a guarantee in a way that is misleading, punitive or clearly outside the contemplated risks may expose you to allegations of unconscionable conduct. Maintain a paper trail showing the breach, your contractual rights, and your good-faith rationale for the call.
Don’t Rely Only On The Security
A bank guarantee is a backstop. Your primary protection is still a well-structured contract. Ensure your underlying agreement clearly addresses milestones, payment, defects liability, make-good, termination rights and dispute resolution.
PPSR Security Interests
If you supply goods on credit or retain title, consider registering a security interest on the Personal Property Securities Register (PPSR) alongside, or instead of, a bank guarantee. A PPSR registration can give you priority if your customer becomes insolvent. It’s useful to understand what the PPSR is and why it matters when structuring your overall security package.
Personal Guarantees And Deeds Of Indemnity
Where a bank guarantee isn’t practical (or you want layered protection), you might ask for a director’s personal guarantee or a deed of guarantee and indemnity. These operate differently to a bank guarantee - they allow you to pursue the guarantor directly if the company defaults. Review the risks and suitability of Personal Guarantees, and when appropriate, have a tailored Deed of Guarantee and Indemnity prepared.
Practical Alternatives
- Cash security/security deposit: You hold cash in trust and return it at the end of the term. Simple, but ties up the other party’s funds and carries trust accounting considerations.
- Insurance bonds/surety bonds: Issued by an insurer rather than a bank. Check wording and provider strength.
- Progress payments/retentions: Hold a percentage of each invoice or the final payment until completion or defects periods end.
- Title retention and PPSR: Retain ownership of goods until paid and register that interest.
Often, a layered approach works best. For example, a landlord may require a bank guarantee plus clear make-good provisions, while a supplier might use modest retentions plus PPSR.
Key Documents Your Business May Need
If you’re the favouree, your documents should work together to manage risk from day one. Depending on your situation, consider:
- Customer Contract or Services Agreement: Clear scope, milestones, payment terms, default and termination rights, and a security clause requiring the bank guarantee.
- Commercial Lease: A well-drafted lease with a security clause, top-up obligations, and make-good provisions; consider a Commercial Lease Review before signing.
- Heads of Agreement: Short-form document to confirm key terms (including security) before detailed drafting, using a Heads of Agreement template tailored to your deal.
- Guarantee/Indemnity: Where relevant, a director or parent entity guarantee via a bespoke Deed of Guarantee and Indemnity.
- Risk Clauses: Ensure your contracts include appropriate Limitation of Liability and Set-Off Clauses aligned with your bank guarantee strategy.
- PPSR Support: If using title retention or other security, align your terms with your PPSR registration process after you decide how to use the PPSR.
Not every business needs all of these, but most favourees will need a strong main contract and a clean, enforceable security arrangement. Getting these documents right upfront reduces disputes and gives you confidence if you ever need to call on the guarantee.
Key Takeaways
- A “favouree bank guarantee” makes you the beneficiary of a bank’s promise to pay if the other party defaults - it’s a powerful risk management tool for small businesses in Australia.
- Use guarantees for higher-risk arrangements like leases, major supply credit and services contracts, and make sure your contract requires an unconditional, irrevocable, pay-on-demand form.
- Control the wording and check the details: correct favouree name, clear demand mechanics, no set-off, appropriate amount, and a claim period that truly covers your risk.
- Plan your call process in advance and act before expiry; banks usually pay if your demand complies, given the independence principle for guarantees.
- Watch compliance issues such as retail leasing rules and act in good faith; combine your guarantee with strong contracts, and consider alternatives like PPSR and personal guarantees.
- Tailored documents - including your main contract, lease, and any guarantee or indemnity deed - work together to minimise disputes and protect cash flow.
If you’d like a consultation on setting up or reviewing a favouree bank guarantee strategy for your business, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.
